Amid turbulent speculations – and barely concealed lobbying – about Britain’s next Chancellor of the Exchequer, the general consensus is that, whoever it is, he or she won’t have much room to manoeuvre. With Prime Minister Andy Burnham already committed to preserving Rachel Reeves’ fiscal rules and troubled bond markets, the new occupant of No 11 Downing St appears to have little room to spend or borrow more than Rachel Reeves has.
However, this general consensus says more about the limited imagination of the economic commentator than about the reality of politics. In practice, there are plenty of things the next chancellor could do, within Labour’s fiscal rules and tax promises, that would deliver the “change” that Burnham has promised.
The main constraints on the government’s ability to spend or borrow at the moment are less fiscal rules than high inflation and the Bank of England’s base rate. As long as the latter – because of the former – is higher than the Eurozone’s, UK bonds will command a premium over European bonds. The Bank of England’s base rate is currently 3.75 percent, and British 10-year yields are around 4.7 percent. These compare with the ECB’s base rate of 2.4 percent and 2.9-3.6 percent for major European bonds.
But surely the government can’t do anything about inflation? Most economic commentators insist that this is the job of the Bank of England, and the last thing Burnham would want is for the Bank to seek to reduce inflation by raising interest rates further. This is long-standing economic orthodoxy, but it is wrong. governments can lower prices. This is because some of the main prices that go into making up the consumer price index are in regulated sectors which can be influenced by government policy.
We have direct experience of this. During the last energy crisis, in 2022, when oil and gas prices rose and everyone asked the government to do something to protect consumers, the Conservative government introduced an Energy Price Guarantee (EPG), regulating energy retail companies to lower their prices and compensating them through subsidy. As this reduced the prices consumers paid, the Office for National Statistics (ONS) adjusted the UK headline inflation rate in response. It has been evaluated that the EPG, which cost around £23 billion, reduced the overall rate of inflation by around 2.7 per cent in the months following its introduction. The effect was dramatic. Inflation peaked at 9.5 percent in October 2022 instead of 11.8 percent that was would have done without EPG.
In last November’s Budget, Rachel Reeves did something similar, shifting some green taxes from energy bills to general taxation, thus lowering the CPI by 0.4 percent. Energy bills are the largest item in the consumer price index subject to government intervention. But there are others, including bus and rail fares, water bills and even private sector housing rents, which are also now regulated. The VAT rate – which can be changed for major products – also affects prices. And although it was widely criticized for investigating this a few weeks ago, if the government can persuade some supermarkets looking for a customer incentive to cut some basic food prices, that too would help reduce the rate of inflation.
Of course, the government will have to pay for any such measures (except for private rents and food). But Burnham has tax options that would not break his commitment to Labour’s manifesto pledge, which was not to increase income tax rates, National Insurance contributions or VAT. Most economists think that reforming the structure of capital gains tax and bringing its rates into line with those of income – first done by Margaret Thatcher’s chancellor, Nigel Lawson – would be fiscally sensible. This would bring around £14 billion a year. Further equalization of tax rates on investment income (such as rents) would bring Another £4 billion. Since both of these would mainly affect the wealthiest households (who spend less and save more than the poorest), they would take less from overall consumption than measures to reduce inflation would stimulate it. So they would provide a welcome “balanced budget stimulus” to the economy.
If the government were to implement a price-focused “cost of living package” financed by these tax increases, there would be a chain of positive effects. It would lower the cost of living in a direct way that the public would notice, and lower the measured rate of inflation, potentially by at least 1 percent. Doing so would take pressure off the Bank of England to raise interest rates; thus the lowest gilt yields; on the other hand, they reduce the cost of total government borrowing; therefore free up fiscal space for other spending to improve public services. A win-win-win-win-win-win.
There are other measures a new chancellor could take that orthodox economic opinion has missed. Fiscal rules limit the deficit and total debt. But not all borrowing is created equal. After World War II, the government created public development corporations to buy land to build new cities. it could be done again. Indeed, an act passed by conservatives, the Leveling and Regeneration Act of 2023, specifically enables it. The law allows public authorities to buy land close to its “use value”, ignoring the increase in value provided by potential planning permission in calculating the compensation owed to the existing landowner.
This power has not yet been used, but it is transformative for public finance. Once transport and other infrastructure is built on the land and planning permission is granted for housing and other developments, plots can be sold to housebuilders and others at significantly higher values. This is a much cheaper way to develop land for housing and infrastructure than the private financing method currently favored by the government. If the government created new public development corporations that could issue their own bonds, off the government’s balance sheet, with their own guaranteed future revenue stream that way, they would attract a different set of buyers. This would create a source of public borrowing for public investment – in the very areas of infrastructure and housing that everyone is clamoring for – in ways that the current arrangements preclude.
Allowing the National Wealth Fund to borrow to finance infrastructureas other national investment banks do, would have a similar effect. The government can attract new sources of investment funds for its growth plans without requiring an increase in overall government borrowing; indeed, allowing it to fall.
The overall lesson here is an important one. Over the past 40 years, economic analysts and commentators have been so accustomed to believing that governments are essentially powerless in the face of market forces—their only role is to “get out of the way”—that they have failed to notice that the relationship between the state and the private sector is actually much more complex and open to innovation. It is to be hoped that the Burnham government will not make the same mistake.
Michael Jacobs is Emeritus Professor of Political Economy at the University of Sheffield and former member of the Council of Economic Advisers to the Treasury
