(Bloomberg) — Chancellor of the Exchequer Rachel Reeves embraced a fiscal overhaul that could allow the UK to borrow as much as £70 billion ($91 billion) more over the next five years, as the government defended a budget that looks increasingly likely to tax investors.
At next week’s budget, the government “will be changing the way that we measure debt” to a new arrangement that will “free up money to deliver a long-term return to our country and taxpayers,” Reeves told reporters on Thursday in Washington, where she was attending the International Monetary Fund’s annual meetings.
Meanwhile in Samoa, at an annual meeting of Commonwealth heads, Prime Minister Keir Starmer was challenged over the definition of working people — who his government has vowed will avoid tax rises in Wednesday’s economic plan.
People who own assets are not “working people”, he said, adding that the type of person he intended to protect was someone who “goes out and earns their living, usually paid in a sort of monthly check” but who does not have the ability to “write a check to get out of difficulties.”
One measure being weighed by Reeves is increasing the capital gains tax levied on entrepreneurs when they sell their businesses, according to people familiar with the matter.
The shift in the fiscal rules and hints of a forthcoming tax hike on investors come as the Treasury tries to scrape together enough cash to reverse a decline in spending on infrastructure, and keep its manifesto pledge of boosting growth in the UK economy.
Yet Starmer’s comments will add to fears that Labour will prompt a flight of the wealthy out of the UK. Reeves has pledged that those with the “broadest shoulders” will have to bear the burden of greater taxes, but many have already made plans to leave. One investor who moved last month to Lugano from London to avoid increased levies on his wealth, Christian Angermayer, told Bloomberg at the time that “every non-dom I know has left or is about to leave,” referring to non-domiciled residents who are currently given some tax breaks on assets held overseas.
Speculation on what the budget might hold has also been weighing on households more broadly. Consumer confidence edged lower this month, according to a closely watched survey, as Britons became more downbeat about the economy.
By targeting the fiscal rules, the chancellor is trying to free up as much capital to invest as possible to eliminate the need for further painful tax hikes. Reeves said she didn’t want to see public investment fall, as currently projected, to 1.7% of gross domestic product by 2029 from 2.5% now. “We would be embracing the path of decline,” she said.
The chancellor is trying to strike a balance between fiscal prudence to keep financial markets on side while increasing investment in roads, schools and other public infrastructure, to drive up economic growth and tax revenues while also ending austerity in public services.
Reeves’ remarks on Thursday confirmed speculation that had mounted ahead of the Oct. 30 budget that she would alter her fiscal rules, and in particular the measure of debt that guides them, in order to allow Britain’s new Labour government to make those investments.
“The reason we’re doing that is because there are massive opportunities to invest in Britain,” Reeves said in a Sky News interview. “To get the growth and jobs for the future here for the UK, it’s not possible under the current rules.”
Maintaining investment spending at 2.5% of GDP across the parliament would cost a cumulative £70 billion, according to Ben Zaranko, a senior research economist at the Institute for Fiscal Studies. Reeves said she would set out the path for public sector net investment in next Wednesday’s budget.
At the IMF, the chancellor told fellow finance ministers that everything Labour plans will be “built on the rock of economic stability.”
However, markets have wobbled this week at news of the scale of the potential borrowing, with the spread between gilt yields and German bunds widening since a report in the Guardian newspaper late Wednesday. The yield on 10-year gilts rose on Thursday, widening the spread over equivalent German notes to 199 basis points, the highest in a year. They recovered some of their losses on Friday.
Before Reeves announced her plan to borrow more, the International Monetary Fund this week supported the prospect of Britain moving to a debt rule allowing more investment but also warned that UK debt is already on an unsustainable upward trajectory.
At the budget, she’s planning to set out two fiscal rules to set the tone for Labour’s first term in office since 2010. The first requires her to pay for day-to-day spending out of taxes. To meet that rule with sufficient headroom to give her flexibility in a crisis, Reeves needs about £40 billion from tax rises and welfare cuts.
She refused to be drawn on which taxes will rise but there is widespread expectation that employers will pay more national insurance and that capital gains and inheritance taxes will rise. Income tax thresholds may also be frozen for two more years. That could raise about £20 billion, according to analysis by think tanks such as the IFS, Resolution Foundation and the Institute for Public Policy Research.
Reeves’ second rule is that debt must be falling in the fifth year of the official forecast. The measure of debt has yet to be defined but is widely expected to be “public sector net financial liabilities,” which captures the value of assets created alongside the cost of any investment, effectively removing the debt from the books. As a result, the National Wealth Fund and GB Energy would have more scope to invest.
Compared with the existing measure of “public sector net debt excluding the Bank of England,” PSNFL will give Reeves £53 billion of additional annual borrowing headroom. Under PSNFL, she would meet her rule with three years to spare.
Speaking to reporters, the chancellor hinted she may make the debt rule tougher by moving from a rolling five-year target to a fixed date of 2029-30. She said: “It is important to do that in the course of the parliament because otherwise it’s always in the future and it never actually gets met.”
To give markets confidence that Labour will not use all the available borrowing headroom, she said “guardrails” will ensure that “any taxpayer money invested will get a return for taxpayers.” The government will also “work with the National Audit Office and the Office for Budget Responsibility to make sure that all those investments are properly validated,” she said. “In terms of markets, that’s why I think these guardrails are important.”
Zaranko said that “the key constraint” on the government’s borrowing for investment will now be its “ability to find good projects and the construction sector’s ability to deliver them,” rather than its fiscal rules.
–With assistance from Greg Ritchie and Lucy White.
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