Spending cuts today only store up problems for tomorrow
4 min read
Rachel Reeves was right to say that the world is changing before our eyes. The government should respond by changing its economic policy.
No one would envy the position the Chancellor found herself in this week. Lower than expected growth forecasts and higher borrowing costs have squeezed the economic position that the government set out last October. Both these factors are largely linked to international shifts, having more to do with decisions taken in DC or in Berlin than in London. But even if this isn’t the government’s fault, it is their problem to fix.
Faced with vanishing fiscal headroom and global instability, Rachel Reeves opted for a short-term fix: trimming budgets, tinkering with efficiency savings and deferring harder choices. Despite her recognition that the world had changed, there were no dramatic shifts in economic or political strategy.
The risk though is clear. In an insecure world, there is no guarantee that further bumps in the road might mean the Chancellor is back where she started sooner, rather than later.
It’s well-worn territory by now but it is still true that the new Labour government inherited a poisoned chalice: stagnant growth, crumbling services and tax cuts that blew a hole in the budget. Her October fiscal rules rewrite and tax revenue raisers — freeing capital for green investment and infrastructure and spending on public services — was a necessary departure from the economic status quo. But this week’s measures reveal the limits of not leaning even further into that approach.
By raiding the aid budget to fund defence and squeezing welfare to “rebuild headroom", the Chancellor has prioritised fiscal optics over transformative reform. The gamble is that efficiency drives (from Whitehall productivity to benefits conditionality) will generate painless savings. But it’s hard to reform a system whilst pre-emptively cutting its budgets. History shows that upfront cuts to “unprotected” departments — whether justice, transport or local government — end up costing more downstream. Just look around at our prison overcrowding, court backlogs, or potholes.
Reeves rightly argues that stability is the precondition for growth, but in December last year, the Prime Minister pivoted away from Labour's “fastest GDP in the G7” mission and towards targeting rising living standards. This creates a paradox. To maintain fiscal stability, the Chancellor opted for cuts, but £5bn of welfare cuts is £5bn directly taken out of the living standards of some of the worst-off households. The OBR itself recognises this, saying : “[the government’s] policy measures lower real household disposable income per person slightly…. The main driver is lower benefit income due to the Government’s welfare reforms”.
To govern is to choose, and the choice that faced the Chancellor was “who should pay for the higher costs of debt interest in an economy that’s growing less quickly”. The government’s choice was that a large chunk of this cost should fall upon households in receipt of welfare. But there are alternatives – notably raising tax revenues.
There are obvious risks in raising taxes, including for growth, business sentiment and living standards. But these risks can be mitigated by focusing on targeted measures which put tax burdens on those who can best afford them – and by seeking to reform taxation to help rather than hinder economic growth.
Closing loopholes in inheritance tax that benefit the well-advised and the wealthy (AIM shares exemption) could raise up to half a billion pounds. Closing another loophole in capital gains tax that allows millionaires to flee the UK tax rates everyone else has to pay (deemed disposal upon departure in CGT) would raise up to another billion. Going even further and fully reforming the CGT system to introduce an inflation allowance and raising the rate would take thousands of people out of paying the tax and raise up to the tens of billions of pounds. Increasing levies on the profits of online gambling companies could raise up to £2n.
These are fair, not radical, measures. Nor do they break the promises Labour made in their election manifesto.
Labour won power by promising to turn the page on austerity. Whilst this week’s announced cuts are nowhere near the scale of the cuts of the last decade (in fact public spending is still rising) they still harm people's sense that the economy is working better for them.
Stepping back from this week’s announcements and looking at the bigger picture, it's hard not to conclude that we are in for more of these shocks, not less. The global picture is less stable and less certain than it has ever been. The government is doing the right thing in raising investment and repairing public services. But the world has changed, and the government must change plans in response. Making further cuts to stick to commitments and plans made in a different world is a high-risk choice.
There are other options available.
Dr George Dibb is associate director for economic policy and head of the Centre for Economic Justice at The Institute For Public Policy Research.
