Labour’s black holes and revelations

Is Rachel Reeves dishonest? That’s the question, with a valuation perhaps between £9.4bn and £18bn.

For anyone who has been focused on bigger things, the economic supremos of Britain’s two biggest political parties are scrapping over whether or not the Conservatives left Labour with a nearly-£22bn overspend (aka a “black hole”, despite it not resembling gravitationally collapsed space-time deformations in any way) for the current financial year.

Here’s the Table of Doom, from HM Treasury’s ominously-titled “Fixing the foundations” document:

Or, in colourful shapes:

It’s been heavily noted that the biggest single component of this is the £9.4bn of above-plan pay awards Reeves announced on Monday, although that leaves £12.5bn of other costs that are not the pay awards.

Reeves said she has already taken “immediate action” to reduce this overshoot, with £5.5bn of cuts, mainly to capital investment and departmental-level spending, to begin addressing this borderline-imaginary issue. We‘re sure there is no way that can backfire.

So, immediately the supermassive black hole is a little smaller, already down to £16.4bn in current fiscal year.

What’s happened since? Well, the Office for Budget Responsibility is gently whining, in a way that is pro-Reevesian by supporting the ‘Tories wot done it’ narrative she is peddling:

If a significant fraction of these pressures is ultimately accommodated through higher DEL spending in 2024-25, this would constitute one of the largest year-ahead overspends against DEL forecasts outside of the pandemic years.

And the Institute for Fiscal Studies, after initially saying the Chancellor is “right to be cross” has now started gently whining in an undetermined-consequences-for-Reeves kind of way:

What did happen to the with that £8.6bn of Normal Reserve overspend (something which, at the risk of getting deservedly bollocked, we’d compare to a planned overdraft)? Well, the footnote directly under the table offers a hefty clue, albeit a cryptic one:

1. It was agreed that some of the 2024-25 pressures would be funded by switching Capital DEL to Resource DEL.

But, like, how much? With no added specificity, the second-biggest part of the black hole might as well be a load of question marks and a sadface.

Wags, naturally, have conjured all kind of funny answers, but FT Alphaville is a deeply serious place, so we just asked the Treasury instead. As of pixel time, they had not responded — we’ll update if they do.

Royal Bank of Canada’s Cathal Kennedy reckon there was “some degree of double counting” in the figures, and concludes:

£16.4bn is likely, therefore an upper estimate, an opening gambit if you will, for how much the eventual ‘fiscal hole’ the Chancellor will have to cover at the Autumn Statement will come to.

Which is all a bit weird, or perhaps we’re just not cynical enough. Clearly, a decision was taken in the production of this political document for a meaningful chunk of £8.6bn to be added to the black hole.

Presumably, this is because Reeves wants the black hole to look as bad as possible, while also being as easy as possible to fix (how hard could it be to re-shift some of these costs back from day-to-day budgets to capital budgets in the future?). Politically, it’s a self-inflicted corked ’gator.

All of this is to miss the wood for the trees, of course. Let’s flash back to — why not, May 27? — and quote from the Guardian:

Rachel Reeves will pledge on Tuesday to lead the most “pro-growth” Treasury in UK history if Labour wins the general election.

Addressing business leaders, the shadow chancellor is poised to claim her party would “return to the centre ground of politics” by striking a balance between workers’ needs and business interests.

If this is what pro-growth looks like, we’d hate to see the alternative. How soon things get forgotten when the fiscal fear takes hold. Goldman Sachs’s James Moberly neatly summarises how trivial this all is:

To the extent that the overspend is not fully offset by spending efficiencies or by tax increases, higher spending would further reduce the drag on growth from fiscal policy. A £16.4bn (0.6% of GDP) increase in spending from FY2024 would boost our fiscal impulse by around 0.25pp in calendar year 2024 and 0.1pp in 2025. That said, we would expect further offsetting measures to be taken at the Autumn Budget that would reduce the impact on demand growth.

But the island must have its little fiscal rules — so how does one find £17bn? One option is to lean upon the Bank of England for a little help, the practicalities of which really drive home just how silly all this framework stuff is. Goldman’s Moberly again:

We continue to expect that the government will fund some of the additional spending through reduced accounting losses on the Asset Purchase Facility. The headwind from APF losses would reduce by around £10bn a year if the BoE slows the pace of active gilt sales (and the OBR extrapolates that lower pace of active sales forward). Alternatively, the government could choose to target headline rather than underlying public sector net debt, as the former is less heavily affected by losses on gilt sales.

[Alphavilles passim . . .]

The other obvious way — the likely way — is, of course, tax. Barclays’ Jack Meaning:

With the focus on fiscal rectitude and a narrative that these hard choices are the fault of the previous government, we think this raises the likelihood that Chancellor Reeves has to find revenue savings from taxes, with capital gains and inheritance tax judged to be among the leading candidates for changes.

Capital Economics’s Ruth Gregory sees £10bn of tax hikes, and £7bn of extra borrowing:

Our best judgement is that in order to fund the increase in spending of £22bn outlined by the Chancellor [on Monday], Reeves will raise an additional £10bn a year (0.3% of GDP) via higher taxes and increase borrowing by about £7bn a year (0.3% of GDP). The remaining £5bn will be met by cuts in spending in other areas.

Is this good politics? We would guess yes, probably. As Michael Saunders, formerly of the Bank of England’s Monetary Policy Committee and now at Oxford Economics, put it in a note ahead of Reeves’s black hole revelation:

Any political costs from higher taxes could be outweighed by the scale of Labour’s majority and, using the cover of the review, putting the blame on the weak fiscal position left by the previous Conservative government. This strategy of early tax hikes was adopted by the first Blair government (1997—2001) and was followed by two further election victories.]…

Such a windfall might provide a platform later on from which — if needed for political purposes — fiscal policy could be loosened closer to the next election.

Is it good economics? No, of course not, we’re British.