Moving towards a smarter state

By Charlotte Alldritt | 08 November 2023

Charlotte Alldritt feels Westminster needs a serious reality check on the state of public finances

Voters want honesty ahead of elections, and economic credibility is seen as crucial to win their trust. This puts both Labour and the Conservatives in difficult binds. Trapped by their own fiscal baggage, Labour’s caution on economic policy might suggest they don’t grasp the scale of the challenge. Much as Keir Starmer’s frontbench likes to tell us reform is the answer, there’s no such thing as free reform. At the same time, the Tories are trapped in a lose-lose situation, in which increasingly divided backbenchers call for tax cuts while the grim reality of the public finances means Rishi Sunak and Jeremy Hunt are running out of room for manoeuvre.

But both parties have a small amount of wiggle room. Rumours are circulating the chancellor will scrap inheritance tax in the Autumn Statement if independent forecasts identify enough headroom. This is a neat political play, as the Tory leadership can signal intent and fiscal responsibility, even if the numbers don’t add up. But I’ll be looking out for compensating stealth tax rises elsewhere and don’t expect Tory MPs – nor prospective Tory voters – to be fooled for long.

In opposition, Labour have slightly more space. Fiscal prudence is seen as the number one priority to nullify fears of unrestrained tax and spend, and Rachel Reeves has rightly ruled out borrowing to fund day-to-day spending. Yet by giving Gordon Brown’s ‘golden rule’ a subtle makeover, the shadow chancellor has created room for spending on projects with long-term returns. In other words, not just borrowing to invest, but borrowing to grow.

This chimes with the Centre for Progressive Policy’s (CPP) pro-growth agenda. We know that to increase productivity over the medium term, we will need to shore up our public services and invest in an ambitious industrial strategy.

But we do not shy away from the increase in the tax burden that will be required. In CPP’s new report we estimate that, given demographic pressures as our population ages and prices rise, maintaining existing public services (including health, welfare and pensions) over the next Parliament will cost an additional £142bn per year.

In lieu of spending cuts, CPP estimates taxes will need to increase from 36.5% to 38.8% of GDP to halve the projected deficit in this context. CPP recommends equalising the rate of capital gains tax with income tax and abolishing ineffective tax reliefs as a first step.

But this must be paired with targeting additional spending on areas proven to have an impact on productivity growth. We identify a £19bn package of extra public spending concentrated in public health, early years, childcare and adult skills, with the latter focused particularly on equipping the workforce to benefit from net zero. We will not get our economy onto a more productive, sustainable or equitable footing without investments in these areas.

Labour has been light tipped on tax rises, all but ruling any out. This will put pressure on Rachel Reeves’ revamped golden rule, but a fiscal framework based on borrowing to grow presents a credible route forward, especially when accompanied by increased independent scrutiny by, and of, the OBR. We recommend making fiscal rules more flexible to accommodate investment in projects that help narrow inequalities between people and places and therefore generate a platform for faster, fairer growth over the long run.

In addition, in what would be a step change for local government finance, CPP’s new report recommends 2% of income tax receipts be devolved to local or combined authorities where applicable. Places would be able to retain 50% of tax receipts allocated through this route locally, providing a significant boost to their ability to plan and spend according to the needs of their residents.

An expanding state – and debates about how to fund it – will be an unavoidable feature of the next Parliament. While Labour and the Conservatives may have boxed themselves in pre-election, they have more room for manoeuvre than they think. The changes set out in CPP’s latest report would move the UK towards a smarter state and a more productive economy. Whoever wins the election will need to do both.

Charlotte Alldritt is chief executive of the Centre for Progressive Policy

X – @CentreProPolicy

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