Reeves Lifts UK Taxes, Borrows to Invest in Debut Budget

(Bloomberg) -- Chancellor of the Exchequer Rachel Reeves unveiled £40 billion ($51.9 billion) of tax rises and ramped up borrowing, a dramatic move to meet Labour’s pledge to “rebuild” the UK that still risks disappointing voters.

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Reeves put the tax burden on course for a postwar high with hikes impacting businesses and the wealthy in particular, pointing the finger at her Conservative predecessor for leaving a fiscal black hole she said had undermined Labour’s plans. UK gilt prices fell as traders digested the long-term ramifications of taking on so much debt with a smaller than expected fiscal cushion.

The budget was a make-or-break moment for both Reeves and Prime Minister Keir Starmer that will define their government. The scale was eye-watering, from the extra £142 billion of borrowing over the Parliament to tax rises that were the most in at least 30 years, when former Tory Chancellor Norman Lamont was also trying to restore economic stability. Labour’s inheritance from the Conservatives dominated Reeves’ narrative that offered a glimpse of the likely battle lines ahead of the next election still five years away.

“The scale and seriousness of the situation that we have inherited cannot be underestimated,” said Reeves, the first female chancellor to deliver a budget in the 800-year history of the role. “Any chancellor standing here today would face this reality, and any responsible chancellor would take action.”

Yet Reeves’ intervention still carried risk of a letdown. Estimates by the Office for Budget Responsibility appeared to fall short of Labour’s manifesto pledge to have the highest growth in the Group of Seven developed nations, and day-to-day public spending will rise just 1.5% per year — with several government departments facing real-terms cuts.

“There’s going to be an ongoing debate about whether this is really the end of austerity as felt by the delivery of public services,” former Labour shadow chancellor Ed Balls said on his Political Currency podcast.

The risk for Reeves and the government is whether those numbers justify the pain of any backlash in the coming days and weeks. Businesses were already raising the alarm about the added tax burden, but UK budgets have a history of measures that unravel under the spotlight.

On Wednesday, Reeves faced early pressure over the decision to apply inheritance tax on farm assets over £1 million, which critics warned would force farmers to sell land or even their farms to foot the bill.

Financial markets were relatively muted while Reeves was speaking, though UK bond prices fell later as investors balked at the prospect of historically high debt issuance and fiscal stimulus that could mean interest rates stay higher for longer. The Debt Management Office said it will issue £297 billion of government bonds in the fiscal year 2024 to 2025, broadly matching the £293 billion estimated by 16 bond dealers in a Bloomberg survey.

What Bloomberg Economics Says...

“The budget will provide a near-term cyclical boost to the economy, which will catch the eye of the Bank of England. It will also provide a modest lift to the economy’s supply capacity in the long-term.”

—UK economist Dan Hanson. Read the full UK REACT on the Terminal.

In her statement, Reeves took aim at the Conservatives and especially former Chancellor of the Exchequer Jeremy Hunt sitting across the chamber.

“Let me make this promise to the British people: never again will we allow a government to play fast and loose with the public finances and never again will we allow a government to hide the true state of our public finances from our independent forecaster,” Reeves said.

But former Conservative Prime Minister Rishi Sunak, who led his party to a historic defeat in July, hit back, accusing Reeves of having “fiddled the figures” to justify raising taxes and borrowing. “The chancellor has launched an enormous borrowing spree, saddling our children and grandchildren with billions upon billions of pounds more debt,” he said.

It was a reprise of the election campaign spat that looks set to run through the next Parliament. How that plays out will depend in on Reeves’ ability to convince voters her hands were tied by the Tories’ legacy in government.

It “wasn’t the budget that I was expecting to deliver,” Reeves said in a Sky News interview, referring to commitments made by the previous government — including compensation for victims of the infected blood and Post Office scandals — she said weren’t budgeted for.

Major moves included increasing the national insurance payroll tax for businesses by 1.2 percentage points to 15% from April 2025, and reducing the threshold at which companies start paying the tax. She also raised capital gains tax and scrapped the VAT exemption on public school fees.

To bolster the impression that wealthy people would bear the brunt, Reeves also decided to freeze fuel duty, increased the minimum wage and didn’t extend a freeze on income tax thresholds introduced by the Conservatives.

But she opened herself up to criticism with the national insurance hike, with the OBR pointing out that the brunt of the additional cost for businesses would be passed on to workers in the form of lower real wages.

Reeves also changed the debt measure targeted by the government for its other fiscal rule — which requires debt to be falling as a share of the economy — to give herself space to borrow for investment. The government will now target public sector net financial liabilities instead of public sector net debt excluding the Bank of England, she announced.

“This means we count the benefits of investment, not just the costs,” she said. Reeves also said the debt rule would be met on a three-year rolling basis, rather than the previous five-year rolling horizon.

The first budget by a Labour government since 2010 was always going to draw scrutiny. With the Tories overseeing Brexit, the pandemic and the economic fallout from Russia’s war in Ukraine, Reeves was determined to present Labour as having been tasked by voters with a “rebuild” job.

But Labour’s election promise of “change” has been undermined by a difficult start in power, including drops in business and consumer sentiment as well as Labour’s popularity. The budget presented the seemingly contradictory tasks of ending austerity in public services, boosting growth and delivering fiscal stability to reassure markets Labour can be trusted with the UK’s finances.

It is likely to be judged first on the market reaction, as Reeves’ tries to convince investors that Britain is a safe destination for their money and to avoid a meltdown comparable to the infamous Liz Truss mini-budget of 2022.

UK government borrowing costs increased in the build-up to the budget and rose further after Reeves spoke, but the market reaction is a long way from the selloff experienced by Truss.

Still, interpreting how the budget has landed typically takes time as economists and businesses assess the impact. Even Truss’s budget took days to unravel — and arguably it was then Chancellor Kwasi Kwarteng’s promise that there was far more to come that helped tip financial markets into turmoil.

“This government was given a mandate to restore stability to our country and to begin a decade of national renewal,” Reeves told Parliament. “That is our task, and I know we can achieve it.”

--With assistance from Philip Aldrick, Anchalee Worrachate and James Hirai.

(Updates with reaction, further details from sixth paragraph.)

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