How Labour can balance the books without doing more damage

Welcome back. This week, as promised, I return to Britain and its mounting fiscal problems.

Capital Economics estimates that UK chancellor Rachel Reeves may need to raise up to £24bn in the forthcoming autumn Budget to restore the buffer against her main fiscal rule to balance current spending by 2029/30.

That figure includes around £6bn in shelved savings, following recent U-turns on plans to reduce welfare payments, and potential downgrades to productivity growth and immigration forecasts.

In the June 29 edition of this newsletter, I outlined five low-cost policy levers Labour could pull to deliver a jolt to near-term economic activity, which in turn would boost tax revenues.

However, the size of the government’s fiscal hole — and elevated borrowing costs — means the chancellor will also need to cut spending and, most likely, raise taxes.

In Labour’s first Budget last autumn, employers, investors and the wealthy were targeted with higher taxes. Since then, employment has fallen, investment has crawled, and the uber-rich have been actively looking to move abroad.

Burdening this cohort saps a significant source of revenue and growth. Labour’s failure to quash recent speculation around wealth taxes doesn’t help. The spectre of higher taxes is enough to damp business activity and investor confidence.

So I asked UK policy experts how the government might raise funds while minimising further damage to growth and its political support.

Here’s how, beginning with some suggestions that could expediently plug the near-term fiscal hole:

Extend the freeze to personal tax thresholds

“Extending the fiscal drag, by freezing all tax thresholds to 2029/30, could add nearly £7bn in tax revenues per annum,” estimates Sanjay Raja, chief UK economist at Deutsche Bank.

Raise levies on gambling

Harry Quilter-Pinner, executive director at the Institute for Public Policy Research, recommends simplifying and raising taxes on betting.

“Britain’s Remote Gaming Duty — which is essentially a tax on online casino profits — stands at just 21 per cent. This is far lower than many other countries,” he says. “Applying the same levy rates across online betting, slots and casinos and “Machine Game Duty”, which is payable on the profits from in-person slot machines, makes sense too.”

He estimates that raising these tax rates to 41 per cent could raise up to £2.4bn a year in revenue.

Reduce VAT exemptions

Jon Moynihan, Conservative life peer, says tax rises have proved ineffectual at substantively raising revenue in recent years and also risk undermining growth. That said, he notes that if the government were to simplify and broaden Britain’s complicated VAT system — with its numerous distortionary exemptions — then it could boost revenue quickly.

“We collect VAT on less than half of products. If we raised that closer to the OECD average, we could lower the actual VAT rate to 18 per cent from the current 20 per cent, and raise around £17.5bn per year more,” he says, citing analysis conducted by his team of researchers.

Moynihan’s suggestion to broaden the VAT tax base by easing reliefs, while cutting the headline rate, could allow Reeves to claim she hasn’t broken her promise not to raise VAT.

The government could also consider lowering the small business VAT turnover threshold of £90,000. This is higher than in most advanced economies, and there is evidence that some businesses restrict their size to avoid passing the threshold. A reduction could raise revenue and support growth.

These measures alone would cover most of the chancellor’s maximum expected shortfall on her main fiscal rule.

Next are some slightly more involved suggestions (both politically and practically) which could deliver significant revenues and savings above and beyond near-term needs. After all, sizeable public finance improvements are essential as demands on the state are rising, and they can also help lower the premium investors demand to lend to Britain.

Retire the ‘triple lock’ on pensions

Britain’s “triple lock” guarantees state pensions are uprated annually by the highest of earnings growth, CPI inflation or 2.5 per cent. It was implemented in April 2012. Labour has promised to retain it.

A system that tracks earnings growth over the long term would be more fiscally sustainable. It would also be fairer for workers, who ultimately fund state pensions.

The Institute for Fiscal Studies estimates the additional spend in 2050 due to the triple lock could be up to £40bn a year in today’s terms, relative to earnings indexation only.

In the near term, using OBR data, the IFS estimates that replacing the triple lock with an earnings uprating could save up to £1.4bn by 2029/30 in today’s terms.

Long-term welfare reform

“There remains a strong case for reforming personal independence payments (Pip),” says Mike Brewer, deputy chief executive at the Resolution Foundation think-tank. “The system isn’t working for either claimants or the public finances.”

Pip is paid to those with health conditions or disabilities, regardless of their working status. The government rushed recent efforts to cut Pip support, which contributed to its U-turn.

Analysts reckon billions of pounds could be saved in the long run by updating payments according to the additional costs individuals actually face due to their disability; raising the frequency of in-person reassessments; and creating more viable routes off benefits (particularly for mental health-related claims, which have underpinned the post-pandemic surge).

Improve tax collection

Short of a wholesale simplification of the tax system, analysts recommend bolstering HMRC’s resources to ensure it collects more of the tax it is owed.

For measure, of the £36.7bn estimated to be owed to HMRC by small businesses during 2023-24, only £22bn was collected — leaving 40.1 per cent missing.

Introduce road pricing

Fuel duty brings the Treasury about £25bn annually. The switch to electric vehicles — which are exempt from the tax — means revenue has been falling, and will continue to do so.

A flat, per mile road-use charge for EVs — with non-EVs continuing to face the duty — is a sensible starting point. For measure, a 6p-per-mile charge, plus VAT, would offset the fall in fuel duty revenues, according to the Resolution Foundation.

John Springford, associate fellow at the Centre for European Reform, notes the added benefits from targeted pricing. “Dynamic road pricing, with higher prices at rush hours on congested major roads, policed via automatic number plate recognition, would cut the cost of delays in transporting goods around the country, reduce commuter times by encouraging people to travel off-peak and promote healthier ways to get to work.”  

New Yorkers resisted congestion pricing for years. After its implementation in January, they appear to have warmed to it.

These are just a sample of measures Labour could introduce relatively quickly. Send your policy recommendations to freelunch@ft.com or on X @tejparikh90.

Rethinking promises not to raise income tax, employees’ national insurance and VAT would give the government more options.

But ultimately Labour’s cabinet must articulate the trade-offs it now faces, to its own MPs and the broader electorate.

Blighting the business and investment environment doesn’t help the “working people” the party claims to support. After all, there are fewer payrolled employees today than when Labour started its term.

The recommendations outlined here — including broad-based tax rises and cuts to pension payments — will need to carry more of the burden. They are not perfect, nor are they painless. Few options are.

But if Labour continues to shun these types of options, it will push Britain deeper into a spiral of lower growth and higher taxes.

Food for thought

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Free Lunch on Sunday is edited by Harvey Nriapia