Amid the agitated speculation – and barely concealed lobbying – around Britain’s next chancellor of the exchequer, the general consensus is that, whoever it is, he or she won’t have much room to manoeuvre. With prime minister-in-all-but-name Andy Burnham having already committed to maintaining Rachel Reeves’ fiscal rules, and bond markets jittery, the new occupant of No 11 Downing St would seem to have few options to spend or borrow any more than Rachel Reeves has done.
Yet this general consensus says more about the limited imagination of the economic commentariat than it does about the reality of policy. In practice, there are quite a few things which the next chancellor could do, within the fiscal rules and Labour’s tax pledges, which would manifest the “change” that Burnham has promised.
The primary constraints on the government’s ability to spend or borrow at the moment are less the fiscal rules than high inflation and the Bank of England’s base rate. So long as the latter – because of the former – is higher than the Eurozone’s, UK gilts will carry a premium over European bonds. The Bank of England’s base rate is currently 3.75 per cent, and British 10-year gilts stand at around 4.7 per cent. These compare with the ECB’s base rate of 2.4 per cent, and 2.9-3.6 per cent for major European country bonds.
But surely the government cannot do anything about inflation? Most economic commentators insist that that is the Bank of England’s job, and the last thing Burnham would want is for the Bank to seek to reduce inflation by raising interest rates further. This is the longstanding economic orthodoxy, but it is wrong. Governments can reduce prices. This is because some of the key prices which go to make up the consumer price index are in regulated sectors which government policy can affect.
We have direct experience of this. During the last energy crisis, in 2022, when oil and gas prices skyrocketed and everyone demanded the government do something to protect consumers, the Conservative government instituted an Energy Price Guarantee (EPG), regulating the energy retail companies to reduce their prices, and compensating them through subsidy. Since this lowered the prices consumers paid, the Office for National Statistics (ONS) adjusted the UK’s headline inflation rate in response. It estimated that the EPG, which cost around £23bn, reduced the overall inflation rate by approximately 2.7 per cent in the months following its introduction. The effect was dramatic. Inflation peaked at 9.5 per cent in October 2022 rather than the 11.8 per cent it would have done without the EPG.
In last November’s Budget Rachel Reeves did something similar, shifting some green levies off energy bills onto general taxation, thereby reducing the CPI by 0.4 per cent. Energy bills are the largest item in the consumer price index amenable to government intervention. But there are others, including bus and rail fares, water bills, and even private sector housing rents, which are also now regulated. The rate of VAT – which could be changed for key products – also affects prices. And although it was widely excoriated for investigating this a few weeks ago, if the government could persuade some supermarkets looking for a customer boost to reduce some basic food prices, that too would help pull the inflation rate down.
Of course, the government would have to pay for any such measures (except on private rents and food). But Burnham has taxation options which would not break his commitment to Labour’s manifesto pledge, which was not to raise income tax rates, National Insurance contributions or VAT. Most economists think that reforming the structure of capital gains tax and equalising its rates with those on income – first done by Margaret Thatcher’s Chancellor Nigel Lawson – would be fiscally sensible. That would bring in around £14bn a year. Further equalising the tax rates on investment income (such as rents) would bring in another £4bn. Since both of these would mainly affect wealthier households (who spend less and save more than poorer ones), they would take less out of overall consumption than measures to cut inflation would boost it. So they would provide a welcome “balanced budget stimulus” to the economy.
If the government implemented a “cost of living package” focused on prices, funded by such tax rises, it would have a chain of positive effects. It would reduce the cost of living in a direct way the public would notice, and reduce the measured inflation rate, potentially by at least 1 per cent. In so doing it would take the pressure off the Bank of England to raise interest rates; thereby lower gilt yields; in turn lower the cost of total government borrowing; therefore free up fiscal space for other spending to improve public services. A win-win-win-win-win-win.
There are other measures a new chancellor could take which orthodox economic opinion has missed. The fiscal rules limit the deficit and total debt. But not all borrowing is made equal. After the Second World War the government created public development corporations to buy land to build new towns. This could be done again. Indeed, an act passed by the Tories, the 2023 Levelling Up and Regeneration Act, specifically enables it. The Act permits public authorities to acquire land at close to its “use value”, ignoring the value uplift given by prospective planning permission in calculating the compensation owed to the existing landowner.
This power has not yet been used, but it is transformative for public financing. Once the transport and other infrastructure is built on the land, and planning permission is granted for housing and other development, plots can be sold to housebuilders and others at significantly higher values. This is a much cheaper way of developing land for housing and infrastructure than the private finance method the government currently favours. If the government established new public development corporations which could issue their own bonds, off the government’s balance sheet, with their own guaranteed future income stream in this way, they would attract a different set of buyers from gilts. This would create a source of public borrowing for public investment – in the very fields of infrastructure and housing which everyone is clamouring for – in ways that current arrangements preclude.
Allowing the National Wealth Fund to borrow to finance infrastructure, as other national investment banks do, would have a similar effect. The government could attract new sources of investment funds for its growth plans without requiring an increase in general government borrowing; indeed, allowing it to decline.
The general lesson here is an important one. Over the past 40 years or so economic analysts and commentators have become so used to believing that governments are essentially powerless in the face of market forces – their only role to “get out of the way” of them – that they have failed to notice that the relationship between the state and the private sector is actually much more complex and open to innovation. It is to be hoped that the Burnham government does not make the same mistake.
Michael Jacobs is Emeritus Professor of Political Economy at the University of Sheffield and a former member of the Council of Economic Advisers at the Treasury
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