How dogmatically ideological will Labour’s UK Budget delivered by Rachel Reeves be?

The first Labour Government budget since March 2010 will not only provide the funding lines for how it plans to “change” the UK according to its own vision, it will also reveal if it can be trusted to honour pledges it gave in the general election and in the future.

Usefully, a couple of reports were published last week that raised questions about Labour’s economic policy and the answers the Budget provides will say much about what we can expect over the next five years.

The first report came from the independent Growth Commission that provided an alternative budget. It was an attractive effort, full of evidence-based ideas worthy of consideration, but ironically gave focus to the desperate need for the future Conservative leader to break away from the centrist tax and spend orthodoxy gripping both parties.

A particularly useful insight was its examination of Rachel Reeves’s claim of a £22 billion ‘black hole’ in the previous government’s fiscal plan that she used to justify removing the Winter Heating Allowance from some ten million pensioners – a policy previous Labour estimates argued could cause nearly 5,000 deaths.

Using the latest Office for Budget Responsibility (OBR) figures and other estimates now available the Growth Commission found that extrapolating the overspend for the first five months of the current fiscal year for the full 12 months would see spending of £20.4bn above the past Conservative Government target.

A black hole? Only if you ignore the other half of the equation. With the economy growing better than the Conservatives expected, the extrapolated income would deliver an additional £21.9bn in revenues for the year.

To sum up: “In other words there should not be a fiscal black hole. If anything, borrowing without a change in government might have ended up £1.5bn below the OBR’s target.”

So Labour’s premise that spending restraint is urgently required thanks to Conservative economic laxity does not stand scrutiny. Rather, Reeves’s sudden acceptance of increased public sector pay without any productivity gains, and other commitments made since she became Chancellor, means actual public spending will likely be substantially higher than the extrapolation suggests, while tax receipts might not be as good. The Growth Commission suggested if there is a black hole, it will have been created on Labour’s watch and not that of the Conservatives.

The second paper was a consideration of the impact on the British economy of Capital Gains Tax (CGT) written by Peter Young, published by the Adam Smith Institute. Sir Keir Starmer and Reeves have consistently refused to rule out an increase in CGT on the grounds that it is not a tax on “working people” – but Young argues it does have a negative impact on all workers even though they do not pay it.

Young’s reasoning is that much of the benefit of encouraging capital to go to where it can best achieve a return accrues not to investors, but to the workers whose new machines and equipment increases productivity and leads to higher wages.

Increasing CGT, Young laments, will only maintain Britain’s poor record on low productivity growth and unenviable reputation as a low-wage economy. Annual average growth in UK GDP per hour worked has been just 0.5 per cent per year since 2008, but three times higher in the US, where salaries are typically between 30 per cent to 50 per cent higher like-for like. In fact, allowing for inflation, UK real wages today are around the level achieved in 2005.

Young estimates cutting CGT to phase it out altogether would improve national income by £25bn a year within a year, with the foregone tax revenue eventually being replaced by the increased economic activity, higher productivity and improved wages.

Helpfully, historical and international evidence suggests reductions in CGT lead to an increased tax take, such as the revenues from the tax doubling within two years when Ireland halved its rate in 1997. In fact, when then-chancellor Gordon Brown acted similarly, bringing rates down to as low as 10 per cent, much more revenue flowed into the Treasury. Countries such as Belgium, the Netherlands, New Zealand and Singapore choose to have no Capital Gains Tax and even communist run Hong Kong has no CGT.

As if to support Young’s thesis, the threat of Reeves raising CGT has been driving many people to dispose of assets so they do not get caught with a higher tax bill. Worse, if CGT rates do rise, those with assets often choose to sit on them and not dispose of them unless they really have to. An HMRC study for the government estimated a higher CGT rate of 10 percentage points would actually lead to a £2.025bn decrease in revenue by 2027/28.

What then is Reeves to do – accept the damage raising so-called “wealth taxes” that the left of her party is committed to, or seek to create a more dynamic economy that provides higher revenues to fill any black hole, real or imaginary, and leading to higher wages for “the workers”?

The decisions Reeves now takes on taxes and spending will define Labour for the next four years and could decide if Labour is a one or two-term government.

It’s not just about whether or not Labour breaks its promises to the British people – on many issues it has done that already. She will define why it is breaking its promises. Is it because Labour will be dogmatically ideological no matter the cost to the country or the people – or because Starmer and his ministers have a propensity to poor judgment and incompetence?

After only four months in office, neither reason provides an attractive foundation for building a second term.

- Brian Monteith is a former member of the Scottish and European parliaments and a senior advisor to the Tax Reform Council