This week’s Briefing examines Labour’s macroeconomic policies in the wake of the release of the party’s manifesto.

The manifesto states that “Labour's first mission in government will be to grow our economy” and sets an ambitious goal, of securing the highest sustained growth in the G7 group of major western economies. This would involve raising the UK growth rate from an average of 1.3%, which was seen between 2010 and 2019, to above the US trend rate of around 2.0%. The last time the UK posted sustained growth in excess of 2.0% was before the financial crisis, in the period 2003–07. The lag between successful economic reforms and faster growth is long. While every government aspires to faster growth, few achieve it.

Whichever party forms the next government faces a difficult fiscal position. Countering the effects of the pandemic and the energy crisis has forced the current government to spend, borrow and tax on a vast scale. Public debt stands at the highest level in 60 years and taxes at the highest level in over 70 years.

You get a sense of the mismatch between public spending and the country’s ability to pay for it from the fact that the UK will need to borrow to fund spending in each of the next five years – despite historically high levels of taxation and the Office for Budget Responsibility’s forecast of growth returning to normal levels. The pandemic and the energy crisis have left the UK and the next government with a fiscal hangover.

Labour fiscal rules are similar to the current government’s, with a target of reducing the ratio of public debt to GDP in the final year of a five-year forecast. This, coupled with a commitment not to “increase taxes on working people”, suggests a Labour government would have very limited scope to increase public expenditure. That view is consistent with the costings in Labour’s manifesto which proposes only modest increases in spending funded through selective tax rises and a slight increase in public borrowing.

The manifesto shows the largest tax yield, of £5.2bn, coming from reduced tax avoidance and changes to the taxation of UK non-domiciled residents. Together with the imposition of VAT on independent school fees, a windfall tax on oil and gas companies, and a higher tax rate for private equity carried interest, Labour plans to raise a total of £8.6bn extra in taxes.

by £12bn a year for a ‘Green Prosperity Fund’ including the creation of a publicly-owned company, Great British Energy, and a National Wealth Fund tasked with investing in green energy, infrastructure and industry.

£12bn of extra public expenditure is small beer relative to total public expenditure this year of £1,226bn. Paul Johnson, Director of the Institute for Fiscal Studies (IFS) describes it as “tiny, going on trivial”.

Labour’s planned tax rises of £8.6bn would come on top of £23.5bn of future tax rises already announced by the current chancellor, Jeremy Hunt. According to the Resolution Foundation, the freeze on personal allowances proposed by Mr Hunt will raise taxes for the average UK household by £800 a year (in 2028–29 prices) while Labour’s planned increases would add an extra £310.

Taxes currently account for 36.5% of GDP, the highest level since 1949. The Resolution Foundation estimates that, taken together, Mr Hunt’s and Labour’s planned tax increases would raise the ratio to 37.4% by 2028–29, the highest on record.

The central challenge for an incoming government is that despite high levels of taxation, debt and public spending, public services are under significant pressure. A recent Institute for Government (IFG) report summarised the problem: “This parliament has seen some of the worst hospital performance in NHS history….Prisons are at crisis point….The Crown Court backlog is now the worst on record… rising demand and budget cuts have forced local authorities to cut prevention and universal services”.

Those pressures will not go away whichever party wins the election. As well as tax rises, Mr Hunt’s March budget involved plans for significant real-term cuts to expenditure in departments accounting for about one-third of all public spending.

A Labour government would inherit those plans. As the Resolution Foundation observes, “… an incoming Labour government would still need to deliver around £18bn of cuts to… departments such as Transport, Justice and the Home Office. Neither party has said anything on how they intend to deliver these extremely challenging cuts”. In a similar vein the IFS notes, “it is hard to see how these real-term cuts can be made each year without a significant worsening in performance or a scaling back of what the state currently provides”.

Faster economic growth could help a Labour government cope with such pressures. The OBR’s forecasts already assume a return to the sort of trend rates of growth that have not been seen since the pandemic. Even with faster growth the OBR’s forecast for the next five years leaves little room for increases in public spending without breaching the debt reduction rule or raising taxes.

While Labour is committed to its fiscal rule, describing it as “non-negotiable”, the UK does have a history of moving the fiscal goalposts. Since 2010, under the coalition and then the Conservatives, the fiscal rules have been eased on no less than eight occasions. The tendency, when faced with bad news on growth, has been to change the rules and borrow more, rather than to double down on tax rises or spending cuts. According to the IFG, no developed world economy has changed its fiscal rules as frequently as the UK.

This is not to say that Labour would do so. Credibility in fiscal policy is, as Liz Truss’s October 2022 budget demonstrated, easily damaged and hard to repair. Sticking to fiscal rules helps build credibility.

What about tax rises? Labour is committed not to increase rates of income tax, national insurance, VAT or corporation tax. That has led to speculation about what scope that might create for a Labour government to raise revenues through changes to allowances or by extending the scope of VAT or by raising capital gains tax, inheritance tax or council tax. It would also be possible to impose windfall taxes on banks or other companies or increase tax on pensions.

The situation today is far removed from what Tony Blair encountered when he entered Downing Street in 1997. Public debt and taxes were at low levels by post-war standards and it was a period of rapid growth. The incoming Labour government was able to raise public spending significantly, from 35.6% of GDP in 1996–97 to over 40% in 2007–08. 

Today public spending accounts for almost 45% of GDP, but dissatisfaction with public services is rife and, on current plans, some services face further cuts. Faster growth, if Labour were able to achieve it, would make a difference. Improving public services, containing debt levels, avoiding big tax rises and rebooting growth – a Labour government would face big challenges.