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Louise Thomas
Editor
Rachel Reeves is thought to be considering making a major change to Labour’s fiscal rules at the budget on 30 October by borrowing billions for infrastructure investment.
The move has sparked fears of the potential of rising debt, but the chancellor is reported to have told the cabinet she wants the Treasury to change how it accounts for capital spending to also reflect the benefits of investment.
The change to Labour’s fiscal rule – laid out in the party’s manifesto – could unlock up to £57 billion for infrastructure spending, some experts predict.
Ahead of the general election, Labour pledged to follow two rules. The first was that in the current budget, costs are met by revenues such as tax. This has proven much more of a challenge for Ms Reeves than she anticipated after she unveiled Treasury analysis in late July which showed a £22 billion shortfall in public spending.
The chancellor has acknowledged this herself, saying at a Labour Party Conference fringe event that the measure would be “incredibly hard” to meet and require “tough decisions” to be made.
The second rule is that debt must be falling as a share of the economy by the fifth year of the economic forecast. This measure rules out excessive borrowing to fill Labour’s black hole, as debt would be driven up as a result.
However, during her speech at the conference, Ms Reeves said: “It is time that the Treasury moved on from just counting the costs of investments to recognising the benefits too.” The comment caused experts to speculate that she may be looking to alter Labour’s fiscal rules at the budget to deal with what Labour calls its unexpected “inheritance”.
How could Reeves change Labour’s fiscal rules at the budget?
There are two main options on the table. Firstly, the Institute for Public Policy Research (IPPR) has urged the chancellor to adopt a ‘public sector net worth’ target at the budget instead of her second fiscal rule. In simple terms, this is a measure of the total value of what the government owns, minus what it owes.
The proposed change would mean that Labour aims to increase public sector net worth in year five, rather than reduce debt. This seemingly simple change would enable to government to invest more in infrastructure by looking at the growth potential, rather than just debt.
The IPPR, understood to be influential amongst Treasury officials, compares the change to a company “looking not merely at a company’s indebtedness, but also at its assets and growth strategy.”
Commenting on the findings, former Treasury minister and Goldman Sachs executive Lord Jim O’Neill said: “This report highlights how Labour can implement its fiscal rules in a way that embeds a more long-termist approach.
“Focusing on a more comprehensive debt metric – such as public sector net worth – would provide greater room for borrowing to invest in line with more credible transparent rules on deficits and debt.”
However, the chancellor could also opt for moderate changes. She has privately considered excluding losses from the Bank of England from the debt calculation, reports The Guardian, as well as the borrowing required to set up public institutions like the national wealth fund. Such a move could raise up to £20bn and would provoke less reaction in the markets.
It remains unclear what the chancellor’s final decision will be, as public messaging and her words in private meetings have given different clues.
Why might she hold off on making any changes?
Director of the Institute for Fiscal Studies, Paul Johnson, warned either option could risk “spooking the markets,” with borrowing costs and interest rates spiking in response.
Speaking to BBC Radio 4’s Today programme, the think tank director said: “At the moment we have to pay an enormous amount of interest on our debt. You might be able to reassure the markets by redefining our debt.”
“But I don’t think you are going to pull the wool over anybody’s eyes by redefining debt.”
At worst, some experts suggested a major change in Labour’s fiscal rules could provoke a response similar to the economic fallout which followed Liz Truss’ ‘mini-budget’ during her brief tenure as prime minister in late 2022. This was when the pound hit an all-time low against the value of the dollar in response to a series of unfunded personal tax cuts.
The prime minister’s official spokesperson has rejected this assessment, saying: “Obviously, I wouldn’t accept that characterisation.”
Responding to questions about changing its fiscal rule pledges, they added: “The government has made clear that one of the first steps of this government is to restore economic stability in the budget. It will absolutely deliver on that, delivering on the robust fiscal rules that were set out in the manifesto.”
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