Rachel Reeves’ tinkering won’t rescue Britain’s economy

The news just seems to get worse for Rachel Reeves. After the slight relief of last week’s inflation and GDP figures, this morning brings headlines that are even grimmer than economists expected. The government was forced to borrow £17.8 billion in December, more than twice the £6.7 billion which Rishi Sunak’s government borrowed in December 2023. In just one month, taxpayers had to spend £8.3 billion to service the government’s debt. Interest payments are now consuming over 8 per cent of government expenditure – more than is spent on education or defence – and very nearly as much as the welfare bill, which is itself ballooning.

The Chancellor's immediate problem is that most of her tax rises – in particular the rise in employers’ National Insurance Contributions (NICs) – don’t take effect until April. Spending increases on public sector wages, however, have very much taken effect, especially as some deals involved backpay. How much extra revenue she will receive once NICs are raised is far from certain, however. Yesterday’s slight rise in unemployment suggests that employers may already be restricting hiring in preparation for higher tax bills. If businesses continue to shed staff it will hit the public finances with a triple whammy: not only could revenue from NICs fall, but tax revenues from employees will drop and the benefits bill will rise. Reeves is pushing against an invisible barrier: there is, inevitably, as per the Laffer curve, a point beyond which a government will struggle to raise extra revenue, even if it jacks up tax rates because those tax rises will disincentivise economic activity. It is hard not to wonder whether Britain has reached that point.

Tempting though it might be to lay the blame for December’s appalling public borrowing figures at Labour's door, the problem goes back far further. No government of any colour has succeeded in balancing the books in 22 years. Instead, each carried on piling up debt during good times and bad – in spite of charges of ‘austerity’. They convinced themselves, as per Modern Monetary Theory, that spending more money would generate extra economic growth which would, in turn, help boost revenues. It didn’t. All it has achieved is to switch spending from the more productive private sector to the less productive public sector. Not only is debt sky-high, but productivity growth is on the floor, trapping the public finances into an increasingly unsustainable position.

Reeves has reportedly asked departments for five per cent spending cuts. She will do well to achieve that, given Labour’s tax and spend culture – does she really think that ministers will be onside for that project? Moreover, last year’s pay awards for the public sector have whetted the unions’ appetite for more. Not only that, the Prime Minister seems determined to spend money where he doesn’t even need to: such as on rent to Mauritius for the privilege of continuing to use an air force base in a British overseas territory. 

Tinkering around with spending is not going to be enough. Sooner or later, Britain is going to need a Prime Minister in the mould of Argentine president Javier Milei, who is prepared to take a metaphorical chainsaw to public spending. Bond markets have already sounded a warning. Their cries are only going to get louder.