Don’t expect rabbits, it will be a boffins’ Budget

Rachel Reeves became the first woman to wave a red box outside No 11 on Wednesday morning, but there was no special budget red box made just for her.

There will be no such frills, few jokes, and don’t expect a giant rabbit to pop out of a hat.

The number crunchers, actuaries and abacus economists that Liz Truss derided have taken back control. Inside that reused red box will be a researcher’s budget.

In fact, it could be defined as the polar opposite of everything Truss and her Prime Minister Kwasi Quarten had in their infamous mini-budget two years ago.

They famously rejected forecasts provided by the Office for Budget Responsibility, which Truss later determined were part of a “deep state” conspiracy against her premiership.

Reeves is planning a comprehensive 10-week audit of public finances and all tax and spending policy measures by the OBR, adding to what appears to be a lengthy pre-audit timetable. -Budget preparation.

The three-month wait after the election has cast a pall over consumer and business confidence and the economy. Business leaders tell me they can handle tax increases, but long-term uncertainty is an economic sentiment killer. Some believe they missed the opportunity to seize the summer’s big turning point, when a new government stabilizes and interest rates finally fall, after three years of crisis.

But the turning point may be coming now. The budget is part of an important global economic pivot. Years of increased government spending and borrowing, as well as higher interest rates to curb rampant inflation, have now given way to the opposite. Loose monetary policy (i.e. falling interest rates) and tight fiscal policy (or higher taxes and borrowing restrictions) are the new normal.

The budget box contains a wide range of tax increases. It might be easier to list the ones that aren’t going up. As I have reported, the most prominent is the increase in employer National Insurance Contributions (NICs). I understand that Reeves received internal advice in July simply to withdraw the Conservative Party’s “unfunded” policy of cutting workers’ national insurance by 2%. But she insisted she could not break her election promise not to propose this form of NIC.

Of course, there will be lively debate over whether raising employer NICs equates to the same thing. Labor insiders pointed to a footnote in their election materials clarifying that the manifesto pledge only applied to employee NICs, and said they had been attacked by this in Conservative advertising and speeches. This means that the wording of the Labor manifesto has been carefully crafted to allow for an increase in employer NICs.

Last week, at the International Monetary Fund meeting in Washington, I challenged the chancellor directly on why she had not provided clearer information to voters about possible widespread increases in taxes, including on national insurance.

She told me there were three factors behind this tough budget. She repeated her calculations of the “£22bn black hole” of inheritance – which she said she inherited from her predecessor but did not foresee. She now says the deficit will continue “for years to come.” She said the UK Budget Office would publish a review alongside the budget into how overspending was “allowed to occur”. The Treasury sees this as an important subplot in Wednesday’s main budget narrative.

Reeves also pointed to compensation for the tainted blood and Horizon Post Office scandals, which she said “the previous administration did not fund”.

Thirdly, she told me, given the state of public services such as prisons and the health service, and the new government’s promise that “there will be no return to austerity”.

What we’ve heard about the budget so far sounds pretty austere, but the Chancellor has defined austerity as real cuts to government departments. Departments appear set to receive top-ups to cope with rising service costs.

The trade-offs in her budget are driven by her new fiscal rules. New rules governing borrowing and investing, “Investment Rules” It will replace previous debt rules, allowing the reversal of planned cuts of £20bn in spending on major capital projects. A new, broader measure of debt will fall over five years. But new “stability rules” will be a binding constraint on Wednesday. All day-to-day spending by departments, including benefits and interest on debt, must be funded by tax revenue within a certain, as-yet-unspecified time frame. This could be a very tough rule, much tougher than the Conservative rule. Borrowing is for investment only.

These two rules will form not only this budget but the framework for the next five years, affecting every penny of government spending. Labor calculated that its overwhelming majority was rooted in the public’s desire to tackle underperforming public services such as the NHS and the declining quality of the public realm, from transport to town centers to housing. The real “black hole” in this view lies in public services. The “fiscal fiction” of unrealistic spending plans will become fiscal fact.

By forcing large tax increases to fill the spending gap, the strategy here is to convey an overwhelming tolerance for political pain to the markets that borrow money from the Treasury. Essentially, the vast majority will be used to reliably guarantee a surplus for “current” spending. Some taxes will rise, but the payoff is that it should help lower interest rates for households, businesses and the government itself.

As one prominent central banker said on the sidelines of an International Monetary Fund meeting, when it comes to market credibility, it’s not just the amount of borrowing that matters, but the coherence of the story and strategy around it.

The new prime minister needs to establish his financial credibility, which is notoriously hard to gain and even easier to lose. That’s the purpose of these self-imposed rules. But in recent years, German chancellors have also faced political credibility problems. More than one person has been in office for too short a time to even have a formal budget. This is not an absolute given that virtually all budget measures will be enacted by the rebellious and unruly ruling party. Across the English Channel, this is where France’s problem lies, and Reeves’s opponent Antoine Armand must be convinced that he can actually pass draconian measures as a minority government. Rachel Reeves has no such problem.

Indeed, at an event at the British ambassador’s residence in Washington, where he addressed bankers, MPs and senators, the chancellor had a moment of reflection. Just two years ago, amid widespread mini-budget turmoil, Quarten made the same speech, which included jokes about his co-starring role as Isaac Newton, who solved the historic pound crisis. Board members of UK Bank Clearing Bank have been forced to reassure counterparties that the UK is “okay” due to the fallout from Cowarteng’s “fiscal affair”. Finance ministers from developing countries are making the same tongue-in-cheek remarks about Britain, their erstwhile master, now mired in an economy in crisis.

For the chancellor, who was seconded to the British Embassy as an economist two decades ago during Argentina’s debt crisis, this is anathema.

That’s why Thursday morning, she and her team expected outrage from wealthy taxpayers and bad headlines in some newspapers. But on the other hand, there will be relief for many struggling users of public services, not least the Treasury’s hope that financial markets will remain calm as she embarks on a long-delayed plan to invest in the future of the UK economy.

This is a Budget that will take months, if not years, to unpack and sort through.