The Labour government is realising that the economic structural constraints on British economic policy making are real. Deteriorating global economic circumstances have forced the Treasury to enforce spending cuts to departments in order to remain within the fiscal rules.
Bond market shifts, the backlash to taxation plans and the importance of perceived economic competence demonstrate the power of these constraints. This underlines the limited policy space available to increase borrowing, introduce a wealth tax or raise general taxation.
Starmer’s government has reasonably concluded that it must remain within its fiscal limits by reducing state spending. Tim Bale sets out how previous Labour governments faced similar economic and electoral constraints – this is the cost of governing a capitalist democratic state from the left.
Charles Lindblom (1982) outlines why the government should be attentive to avoiding a market backlash against its economic strategy. If business actors lose confidence in the government’s economic strategy then firms delay or review investment decisions, which can impact economic growth. The resulting downturn negatively impacts voters who start to question the economic competence of the government. These doubts can result in the government losing support at the next election.
This effect can also be observed in the gilt markets. Layna Mosley argues that a failure to convince bond traders that Britain’s inflation and debt levels are stable results in international market actors demanding higher interest rates in return for buying government debt. Higher interest rates can increase the cost of lending for banks and consumers whilst also forcing governments to spend less on public services and more on servicing debt.
This was validated by the fallout from Liz Truss’ ‘Mini-Budget’: international financial actors panicked; UK bond yields surged; the Bank of England intervened to save pension funds from collapse; most of the measures were abandoned and Truss resigned.
A loss of market confidence caused mortgage rates to rise, the pound fell sharply and international financial actors began to doubt Britain’s ability to repay its debts. Consequently, the British electorate lost confidence in the party’s ability to competently manage the economy and the Conservative Party suffered in the opinion polls.
Some Labour MPs believe the fiscal rules should be changed or abandoned. However, even the small changes to Reeves’ rules in Autumn 2024 led to a jump in government borrowing costs. Consistent fiscal rules are key to maintaining the confidence of international financial actors.
A cross-party group of MPs advocates for a wealth tax, which Labour ruled out in the election. However, there are doubts about how much revenue a wealth tax would raise. Changes to Britain’s non-dom tax regime incentivised millionaires to leave the UK for other countries, such as Italy, which have introduced tax equivalents to attract high-net-worth individuals leaving the UK.
If the government wanted to generate substantive tax revenues it would need to increase national insurance, VAT or income tax rates. However, Labour also promised not to raise any of these taxes on ‘working people’ to match the Conservatives’ promises on tax in the 2024 General Election.
Changes to the national insurance levy paid by employers announced in the Autumn 2024 Budget slowed labour market growth. Business leaders criticised the decision and provided the Conservative opposition with a key line of attack. This highlights the point that any tax increases have political and economic costs.
Labour’s fiscal rules are labelled as ‘self-imposed’. But if politics is a racetrack and parties are the cars, then fiscal rules are as self-imposed as the car brakes. Parties must use the policy space available, but without slowing for the corners, they risk crashing. The challenge is knowing where maximum acceleration ends and danger begins – something critics often judge only in hindsight, arguing the government could have been bolder.
