Rachel Reeves Dumps Bad News Early to Clear Labour a Path to Next UK Election

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(Bloomberg) — Chancellor of the Exchequer Rachel Reeves made one thing clear in her audit of UK public spending on Monday. The new Labour government plans to front-load the bad news, leaving as much time as possible to repair and rebuild the economy before the next election in five years’ time.

During the election campaign, Reeves promised the British public she would always level with them and now in office, has wasted little time. Just over three weeks into the job, she said the outgoing Tory administration had bequeathed her £21.9 billion ($28.2 billion) of “unfunded and undisclosed” spending commitment, before outlining a series of measures to address the budgetary pressures. 

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Some 10 million pensioners will lose their winter fuel payments from this Christmas as a result of measures announced by Reeves in the House of Commons on Monday. She also scrapped rail and road projects and placed under review a hospital-building program championed by former Prime Minister Boris Johnson, as part of a package designed to shore up the public finances and help fund above-inflation pay rises for over 5 million public sector workers.

In all, the chancellor drew up £5.5 billion of savings, leaving a budget shortfall of £16.4 billion that laid the groundwork for a painful, potentially tax rising budget, which will be held on October 30.

“There will be more difficult decisions around spending, around welfare, and around tax” later in the year, Reeves said in a press conference after her Commons statement.

During the election, Labour promised to find the money to fix Britain’s dilapidated public services by delivering faster growth. As a result, many economists expected a one-year spending review to give the economy time to pick up and limit the tax rises needed to repair public services at a multiyear spending review in late 2025.

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The party now appears to have jettisoned growth as a solution. Reeves will set out overall departmental spending limits for at least three years at the budget, with detailed plans published in the spring. First year spending totals will be brought forward to October to provide departments time to plan for 2025-26. But that schedule leaves no time for Labour’s planning and investment reforms to have any effect. Reeves will also stick to the fiscal framework in the manifesto that gives her very little headroom for borrowing, the Treasury said.

Ruth Gregory, deputy chief UK economist at Capital Economics, said she expects the £16.4 billion shortfall to be filled by £10 billion of tax rises and £7 billion of extra borrowing. 

Reeves has ruled out raising the headline rates of VAT, national insurance, income and corporation tax but an increase in capital gains tax or inheritance tax is widely believed to be on the cards.

For now, it’s pensioners who will lose out. The traditionally Conservative-voting demographic has been shielded since 2010 by a so-called “triple lock” on their pensions — meaning they rise every year by the greater of inflation, wage growth or 2.5%. Reeves said she would keep that protection in place, but announced changes to winter fuel payments — a policy launched by former Labour Chancellor Gordon Brown in 1997 — that means  mean only pensioners in receipt of benefits will qualify, saving £1.4 billion a year. Past Treasury officials, including the department’s former head Nick Macpherson, welcomed the decision, which was one of a slew of measures unveiled to shore up the UK’s public finances.

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Reeves set up the Conservatives to carry the blame, accusing them of leaving Labour a financial mess and covering it up until after the election. Richard Hughes, chair of the Office for Budget Responsibility, reinforced the claim in a letter to the Treasury select committee. He said the OBR was only “made aware of the extent of these pressures last week” and that they “would constitute one of the largest year ahead overspends outside of the pandemic.”

Jeremy Hunt, the former Tory chancellor, hit back at Reeves’ claim, saying it was “shameless” that none of the measures were in Labour’s manifesto.

The war of words established a new, more abrasive tone since the July 4 election that is likely to shape the next five years. In a straight role reversal, Reeves is adopting the Conservative tactics of 2010 when the new Tory premier, David Cameron, blamed Labour for the financial crisis and collapse in the public finances. Reeves and other cabinet ministers now claim their inheritance is the worst since World War II, leaving them only unpalatable options. 

Yet the biggest “unfunded” cost Reeves unveiled Monday was arguably Labour policy, rather than a prior commitment. She approved public sector pay rises of between 5% and 6%. While that’s in line with the recommendations of independent pay review bodies, only 2% had been budgeted for, in line with inflation, taking the additional cost to £9.4 billion. From that, departments have been told to find savings of £3.2 billion.

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“Half of spending ‘hole’ is public pay over which the government made a choice and where pressures were known,” Paul Johnson, director of the Institute for Fiscal Studies, said on X. He added that the “overall challenge for spending was known and remains.”  A separate pay deal worth as much as 24.6% for junior doctors struck on Monday to end rolling strikes will be on top of that.

Other spending pressures in the current year outlined by the Treasury included:

• A £6.4 billion projected overspend this year on the asylum system
• £2.2 billion of past public sector pay rises that were not properly accounted for
• £2.9 billion in unfunded rail costs
• £8.6 billion in emergency “reserve” claims to meet unauthorized spending
• £1.7 billion of support for Ukraine

To help cover the costs, Labour scrapped plans to lift the savings threshold above which the elderly pay for their own care to £100,000 from £23,000 starting next year, saving £1 billion next year and £4 billion by the end of the parliament. Transport programs including a planned road tunnel near Stonehenge were dropped and savings were also identified in the government’s earlier decision to scrap the Tory plan to deport asylum seekers to Rwanda.

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The government also pressed ahead with tax proposals set out in its election manifesto. It will implement its policy to add 20% value-added tax to private school fees from January 1. Tax breaks for people with non-domiciled status would be removed for income arising after April 6 next year, and Britain’s energy profits levy would increase to 38% from November 1, the documents said. But Reeves made it clear that more pain will have to follow.

“My main takeaway from Reeves statement is how much more there’s left to do,” said Nick Davies, program director at the Institute for Government. “The savings announced only cover a quarter of the pressures this year. A lot of unpalatable decisions are coming on October 30.”

—With assistance from Andrew Atkinson.

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