Historically, Labour’s answer to making the sums add up when it comes to tax and spending has always been to borrow more.

However, Rachel Reeves wants to move the party away from its profligate reputation, pledging “iron-clad” discipline to balance the books.

So far, the Chancellor has said she will only borrow to invest as part of new rules that she has vowed to live by.

But some of Labour’s biggest backers want her to do more, while others say she can still stick to the letter of her rules while turning on the fiscal taps.

Sharon Graham, the boss of Unite, which represents more than a million British workers, compared the UK’s borrowing constraints to a “straitjacket”.

Britain should be more like America, she believes, suggesting that our debt pile of 100pc of GDP was nothing compared with the US, at 130pc of its economy.

She’s not alone. Paul Nowak at the Trades Union Congress believes Reeves must “think as flexibly as possible on fiscal rules” in her first Budget.

Andy Haldane, the former chief economist at the Bank of England, has also urged Reeves to “tweak” the rules so investment choices are seen through the lens of how valuable they are, not just by how much debt is racked up.

“This is not recklessness fiscally, this is doing a sensible thing,” Haldane said this week.

‘Crying out for investment’

But as unions and economists continue to pile pressure on Reeves to spend more, will the Chancellor succumb to that pressure and, with debt already high, will financial markets let her?

Lord O’Neill, a crossbench peer who has served both as a minister in the Tory government and advised Labour as part of a review on scaling up British businesses, says the UK is crying out for more public investment.

“There needs to be a more ambitious position that I’ve not seen from any political party yet,” he says. “The Labour Party is closer to finding a credible way of actually having greater investment spending themselves.”

Reeves has two borrowing rules. The first allows her to borrow for investment as long as she brings day-to-day spending back into balance within five years.

This is different to her predecessor Jeremy Hunt, who ruled that total borrowing – including investment – had to be less than 3pc of GDP at the end of the Government’s five-year forecast.

The second rule essentially imitates Hunt’s goal of getting debt falling in five years.

Lord O’Neill wants Reeves to be more ambitious. He says: “I’ve talked to senior Labour figures a few times on replacing the current fiscal rule with a more sophisticated version of the so-called golden rule.”

This was former Labour leader Gordon Brown’s old rule of borrowing only for investment, one that he introduced in 1997 and kept until the financial crisis.

Fickle fiscal rules

The Institute for Government (IfG) says Britain changes its rules governing tax and spending on average once every four years, more than any other country in the world. By contrast, New Zealand’s fiscal rules have been the same for almost 15 years.

Lord O’Neill says Labour should hand Britain’s tax and spending watchdog responsibility of auditing big infrastructure projects like HS2, aiming to ensure they are value for money. 

“In order to make it credible, you would only do the ones that the OBR independently verified as having a significant positive multiplier effect” or in other words, enough bang for your buck.

He warns the current tax and spending rules are not conducive to growth.

“Infrastructure spending truly has the potential to boost the economy in the long term,” he says. “But judging their benefits through an arbitrary five-year debt reduction target is just insanity.”

Lord O’Neill is not alone. The influential Tony Blair Institute (TBI) think tank has called for Reeves to completely overhaul the rules to make them fit for the future.

The Chancellor is resisting calls for a major overhaul. But James Browne, a senior policy adviser at the TBI, says there are two ways Reeves could give herself more space while sticking to the letter of her debt rule.

The first involves including the Bank of England in its debt measure. The reason it is excluded at the moment is because of the term funding scheme (TFS), which offered cheap loans following the Brexit vote and Covid. 

This added significantly to debt while the loans were being dealt out, then reduced as the loans were paid back. The TFS will have wound up completely by the end of the decade. By including the Bank’s debt, Reeves’ headroom could increase to £25bn compared to £8.9bn in the last Budget.

The TBI says going a step further and excluding student loans from the debt measure could hand Reeves £52bn to play with in the Autumn, in a move that would align more closely with her mantra of taking into account investment.

The TBI’s Browne says: “The current debt rule is very constraining. A big reason why you’re not getting a big fall in the official measure by the end of the decade – despite actual borrowing being forecast to be pretty small by then – is because of the student loans that will be issued, adding to the debt. 

“So it seems slightly odd to be arguing we should be investing less in hospitals and schools just because we’re issuing lots of student loans.”

While Reeves has said she doesn’t want to tinker with Hunt’s definition of debt, Browne adds that this definition would allow her to borrow £7.3bn for her National Wealth Fund without being constrained by her rules.

‘A simple problem Reeves cannot ignore’

Reeves said in her Mais lecture this year that she would ask the OBR to “report on the long-term impact of capital spending decisions”, adding that she would publish “wider measures of public sector assets and liabilities at fiscal events, showing how the health of the public balance sheet is bolstered by good investment decisions”.

Our headline measure of public investment also includes the student loans that the Government assumes won’t be paid back, according to the Institute for Fiscal Studies. Stripping this out could enable more money to be spent on big-ticket projects.

Accounting tricks aside, there is a simple problem Reeves cannot afford to ignore. Outside the pandemic, the UK is already issuing the most debt in its history.

Fears are also rising ahead of the public sector pay deals that will be made by Reeves instead this summer.

The Chancellor already recognises the challenges ahead, while Prime Minister Sir Keir Starmer has insisted the Government will not “return to austerity”. 

The International Monetary Fund has warned that £30bn of tax rises or spending cuts will be needed by the end of the decade to top up departmental budgets.

Imogen Bachra, a bond strategist at NatWest Markets, says traders recognise the difference between investment and profligacy. “I think markets in general will tend to forgive borrowing for investment that could drive economic growth more than borrowing for other things that might not improve the productive capacity of the economy,” she says.

But Bachra adds that markets will be wary of handing Reeves a blank cheque for investment spending.

“Whilst borrowing for investment may bring growth over the medium to longer term, markets tend to be more short-sighted and the near-term concern of higher borrowing may outweigh any long-term positives,” she adds.

Thomas Pope, an economist at IfG, agrees: “There are certainly good arguments in favour of higher public investment.

“What I would say is that there shouldn’t just be a free pass on extra investment. The Government needs to make sure that the money is spent well.”

Pope highlights that while Boris Johnson’s pledge to build 40 new hospitals was an eye-catching announcement, it is smaller investments that provide the most value for money.

“Too often in the UK, we’ve invested not as well as we could have,” he says. “So it’s really important that if the Chancellor wants to increase investment, she ensures there are really robust processes within the Treasury to ensure that what we’re investing in is genuinely good value for money and therefore justifies borrowing for it.

“The risk is that we end up with debt higher than we intended, and that’s a burden on future generations.”

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