101. How Rachel Reeves Will Re-Write Fiscal Rules

0:10Hello and welcome to The Rest is Money with me Steph McGovern and with me Robert Perston. So I've seen you going all around the country on your social media feed. I was poking the show. You don't keep secrets from your devoted followers. Are you calling me an oversharer? I mean, listen, those are your words. But I was particularly struck as somebody who's developing a business to franchise that you've been mixing with other franchise, I don't know, what do you call franchisees? Franchisees, franchisors. so yeah I was at the National Franchise Exhibition which is basically it's you know all the different companies connected to franchising who are showing their wares and you know it's a chance to kind of network and things and for me it's that slime retail business I have we were there because we've now launched the franchise part of our business so we've talking to people interested in setting up their own Gootopia shops wherever they are in the world I think what's really interesting about it is I don't think people realise unless you're connected to franchising how many different types of businesses there are out there.

1:11So there are over 50 ,000 of these, what we call units now. And if you look at their profitability, it's something like 89 % of them are profitable, which is pretty good numbers, I think, in the business world at the minute. Just the variety of them that always interests me. So you've obviously got your McDonald's, your Domino's, people know about those types of ones, your Anytime Fitness. But you might not know the kind of accountancy firms doing it, the dog walking businesses, even in the Irish dancing world now you can get a franchise of one of the classes so I was at this event meeting all the different types of people who were doing them including for example a dentist who's given up his dentistry practice and is now running a McDonald's franchise sorry you met a dentist who's now running a McDonald's okay that sort of goes to the heart of everything that's wrong in the UK in my view we haven't got enough dentists and some people would say there are too many McDonald's but it's stressful what's gone wrong yeah so so I know so this is the thing so it's people who think they're going to have a better way of life by doing a franchise and being their own boss but in an area where they're facing more stresses I guess so it's really fascinating for me is the types of people doing this because you might think all of that is the big and obviously McDonald's is a big corporate but on that lower level that accounting firm so it might be someone who's trained to be an accountant and they want the backing of having that credibility of a particularly big name accountancy firm and so they run a franchise of it just looking at some research the association that's done that represents them they're saying 89 percent of franchise businesses are profitable and they're optimistic about the economy and often we talk about how pessimistic everyone's feeling about the economy should we talk about the budget because that's coming up it is the big economic and political event certainly of this year that we're in it could be of this entire parliament and one of the things i constantly talk about is how unprepared this new government appeared to be for this budget before and indeed in the early weeks of the election.

3:06So the Office of Budget Responsibility has just submitted to the Treasury its last set of forecasts for, for example, the outlook for growth in the economy, inflation, and all those other parameters. Not including budget stuff. but absent what Rachel Reeves may do. So she's now been told what the OBR thinks is both happening now and will happen to the economy over the last five years on the assumption that she doesn't do anything at all. And that is the set of conditions that she now has to work with to decide how much to borrow, how much to tax and all the rest. And I think the most important thing that I want to say about that is quite a lot of people have been pointing to published data, which showed that there's perhaps a bit of a recovery in the economy.

3:57Other people have been looking at what you might call real-time information and noticed that actually maybe that recovery has run out of steam and we're going through another period of stagnation. Some people blame Keir Starmer and Rachel Reeves for being too gloomy and therefore deterring people from, consumers from spending and businesses from investing. So it's a bit murky, frankly, about where we are at the moment in terms of the economy. But the fundamental question is, will the OBR be more or less pessimistic than it was in March about the five-year outlook for the economy? And my own view is that it is very unlikely to change its position.

4:38And the reason I say that is I think people have slightly forgotten that back in March, the Office of Budget Responsibility was about the most optimistic of all the forecasters about what would be happening to the UK economy over the next five years. It then forecast that potential growth in the UK economy would be about one and two thirds percent per annum, which was way higher than the Bank of England. It was way higher than many other forecasters. I cannot think of anything that has happened since that budget which would persuade the OBR to be more optimistic than it was then, which means that growth cannot bail out the Chancellor in terms of the problems that she faces.

5:25If the OBR, for example, had decided in the last few weeks that actually our prospects were better than it thought in March, that would mean that tax revenues would be higher and there would be more so-called headroom in five years' time under the so-called fiscal rules. And she'd be able to, for example, spend now without raising taxes or borrowing more. And the answer is, I don't think that they have increased their projections for the growth rate. So whatever mess she thought she was in, she's still in. Right, so it's not any better, but it's not any worse either. I think it's unlikely to be worse.

6:03The one potential negative is around the amount that the government has to pay to borrow because the guilt rate, the amount that it pays in interest on newly issued government bonds has gone up a bit in the last few weeks. that would imply that it would have to essentially pay out more in interest over the coming years. Not sure the extent to which the OBR will have factored that in. And it's also not clear whether that's a temporary factor that will at some point be rectified. So on that side, I haven't really got a very clear view, but I have got a view that says I'd be staggered if simply as a result of momentum in the economy.

6:44She suddenly found she had more money than she thought. But that said, when I talk to senior people in this government, they are desperately trying to be more optimistic than they were. You cannot have a conversation at the moment with any member of the government in which they don't talk about the imperative to invest. Invest, invest, invest. You saw that Rachel Reeves used that phrase, I think, in an interview with the FT. And they've all been given the script that the budget is all about encouraging investment. And what that says to me is that she has now massively shifted her position on the fiscal rules.

7:27Yes. And on that point about the fiscal rules, we've actually had a question on that from James T. I know you're obsessed with this, Robert, but James is asking, which I know you'll know the answer to, what are Rachel Reeves' options in terms of tweaking the fiscal rules? You know, can you walk me through the different amounts of headroom between changing the different measurements? I'll let you explain what they are and which ones of these are kind of viable without scaring the market. How much headroom might they open up and how much of that headroom will actually be money available to spend on public services rather than just kind of offsetting this£22 billion black hole we keep talking about.

8:02During the general election campaign and in the weeks after the general election campaign, She constantly said, and her officials doubled down on this, that she was not going to increase more flexibility into those fiscal rules that would allow her to borrow to invest more. It's quite clear to me that her position has changed radically on that. Interesting. And that she will rework those rules. I talked about this a little bit in the last edition, and that borrowing to invest will be taken off balance sheet to a significant extent. It will not be that constraint in terms of the debt target. There are two ways of doing this.

8:44The radical way of doing it is to make the target net worth rather than just gross debt. The current target is to reduce the value of the national debt as a share of GDP after five years. There are many economists who say, actually, the problem with that is that it massively constrains your ability to borrow to invest, which means that the growth rate of the economy is way less because you're investing much less than you could be. And as a result of that, tax revenues are lower and you never have the money to invest in public services. So you're in this sort of doom loop. So there are some economists who say the target you should be aiming for is debt minus the value of the investments you're making because that gives you the flexibility to borrow, to invest, to grow, to increase productivity, to increase living standards, to increase tax revenues.

9:37There is a sort of halfway house before doing something as bold as that, which is to simply take some of the investment, say the investment that goes through the National Wealth Fund, and say that is not included in the calculation of debt in five years' time. Either way, and she's going to do one of those two things. I'm absolutely certain she's doing one of those two things. Either way, it does create the capacity to borrow to invest, you know, 20, 30 billion more. I mean, you could create a scenario in which per annum, you could be investing, let's say, 20 or 30 billion pounds more by changing the fiscal rules, which is a lot of investment.

10:16And many people, including I think both of us would regard that as a good thing. Oh yeah, definitely. And I mean, in short, it's basically fudging the numbers so you've got more money. I don't think it's fudging the numbers because if you talk to investors, so there's a very interesting contribution to all of this from a bunch of pension funds reported in the Financial Times who are actually almost begging the Chancellor to make this change because they want to invest their money alongside the public sector. But it's an accounting thing though, that's the point. But it's not money that suddenly appeared.

10:52It is just changing the accounting rules. Can I make just one other point, though? Because although this sounds great, if you, like me, believe that after decades of the UK investing way less than our competitor economies, and if you regard that relatively low level of investment as one reason why our living standards are so much lower than in other comparably big economies, I would regard as being a very sensible approach to take. But unfortunately, there is still a problem that she's got from her second fiscal rule in terms of how much you can borrow to invest. It's sort of amazing to me she hasn't told us what the target date is for this other fiscal rule.

11:33But the other fiscal rule is for day-to-day spending, and day-to-day spending is things like paying the wages of teachers and nurses and civil servants, paying benefits, paying pensions, those payments should be matched by tax revenues. You don't borrow for day-to-day spending. We had a very interesting conversation in the last episode, I thought, about the negative impacts of some of the taxes that she could put up. I said that I didn't think she was going to reduce the tax allowance for pension investment because that would, in effect, reduce the living standards, particularly of public sector workers, because they are most exposed via their pension contributions to effectively what would be an increase in their tax rate as a result of changing the tax allowance on pension contributions.

12:17And I thought she's not going to want to take on the public sector unions again over this. So I didn't think she was going to raise money in that way. And we also talked about when you put up capital gains tax significantly, you end up with potentially less money because, you know, people find ways not to pay it. Yeah. And there was some really interesting research from the IFS, wasn't there, this week on capital gains tax. It raises£15 billion a year and it's paid by 350 ,000 people a year. But two thirds of the revenue comes from just 12 ,000 people. That's amazing, isn't it? Yeah. And I think they had a statistic about how much on average...

12:534 million, the gains on average. So 12 ,000 people, this is a pretty amazing statistic, right? 12 ,000 people have profits, capital gains of 4 million quid each. On average, yeah. On average, and they are paying two thirds of CGT. Yeah. And so one of the things that is sort of obvious from that is when you are as wealthy as that, you are capable of moving to Switzerland or moving to a place like Milan, where there are amazing tax breaks. Italy is offering amazing tax breaks for wealthy individuals to go and live there. That explains why one of my friends has just moved there, actually. Did your friend not explain why?

13:34Quite a lot of people are going to Milan for that reason. And although, obviously, most people would say it's really important for everybody to pay their fair share of tax, and it does seem unfair to many people that capital gains are taxed at a lower rate than income is taxed. And we know that some people actually convert what would traditionally be income into capital for the express purpose of paying lower tax. And that doesn't seem fair. On the other hand, no chancellor wants to shoot themselves in the foot. There's this word performative, which means you're doing something for show rather than substance, as it were.

14:16And all chancellors have a performative element in what they do. So if you're on the right, you cut taxes because it appeals to a base of supporters who think taxes are just in general bad. And if you're on the left, you quite often put taxes up on the rich because you think it's part of social justice to make sure the rich are paying more. But if you're working in the treasury and what you really care about is funding public services, you want to part the performative bit to one side and you want to change taxes to maximise revenues to fund public services. And so even if you think there's a good case for putting up capital gains tax, it's really important you don't raise it so much that you end up with less tax.

14:57But calibrating that is incredibly difficult. Yeah, of course it is because you're just trying to work out how people's behaviour is going to change, aren't you? The IFS have also talked about the fact that if you just put up capital gains tax without reforming it, that's going to discourage investment and reduce economic growth because they're saying the system is unfair in the fact that you pay different tax rates depending on what the asset is. So it feels like they can't just put it up either because that's going to be a huge problem for the economy. It's got to be reformed. It is fascinating.

15:30And behavioural science has massively improved over recent years. And it sort of keeps us in work because there's always something to talk about. Now, let's look at some of the questions that have been sent into us. Yes, I mean, we did just answer one. David Harlett says, my question is, how do service industries become more productive? I'm reading Torsten Bell's book. Of course, we had him on the show before he became an MP. His book, Great Britain, he accepts the fact we're now a mainly service-based economy, which again, we've talked about, we're kind of 80, 90 % service-based now, but says productivity is not growing.

16:01Every example of the service industries becoming more productive that I can think of seems ludicrous. and he gives some quite comedy examples here. So he mentions musicians. He says, you know, is it a case of productivity going up if they have fewer members in the band and produce the same amount of music or play the songs twice as fast so they get through their setting half the time and rush to another gig, which is, you know, obviously that's a funny way of looking at it. The way I look at it, it's about value added. If it's a retail business, it's about the value added in every transaction.

16:31So for example, if it's the slime business, I'll give you that 20 quid later, Gootopia it's called, We do add-ons where as well as selling like the kids workshop they're doing, we'll also try and add on as other little bits and bobs for them. They might buy a little accessory, a little toy, or we'll tell them about other things. Because if you're measuring productivity on the basis of how much money you make divided by the number of employees, then that value added is where you increase your productivity. So the reason that I think David's question is also just incredibly important right now is because of the artificial intelligence industrial revolution that we're living in.

17:10One of the examples that I've talked about on this program of how AI improves productivity is, and this is a very basic example, if you just look at a call center, you've got somebody who's got to give information to a customer about it might be some insurance they want to buy or about a product they want to buy. And the advantage of AI is it can massively speed up that conversation because it allows the human to answer the particular query way faster. And this is a very simple example of how artificial intelligence massively increases the productivity of that individual. And it has a second impact, which is it also empowers somebody who might be 18 or 19 to have exactly the same information as somebody who might have been doing this job for a couple of decades because it is all provided by the AI rather than residing in the individual's memory.

18:18So this is a very clear example of a massive boost in productivity. The big challenge from all of this is how do you make sure that that improvement in productivity flows to the worker in terms of increased wages rather than being stripped out by the business owner, either the combination of the executives at the top of the business and the owners of the business. The reason I regard this as almost the big question of our age is the big scandal of this economy is too many people work too hard for too little money. And they depend on food banks and universal credit. And we do not have a fair economy.

19:02As I say, we just have too many people struggling to make ends meet despite the fact that they have jobs. Artificial intelligence has the potential to solve a lot of that because it will increase the productivity of people across all sorts of different kinds of industries. Pretty much every industry you can think of is going to have a beneficial effect in that sense. But how do we make sure that that improved productivity flows through to living standards? And it does depress me. I think we should come back to this again at some point, but it does depress me that there is no debate going on among our political leaders about any of this.

19:40And my worry is that this ship will have sailed and that basically we will have replicated what happened in the last digital revolution, that all the profits essentially flow to the billionaires. It will simply increase inequality rather than benefiting millions of people. So I do want to come back to this. Yeah, and we definitely will. But thank you very much for that question, David. I think this is a good point to break. We'll be back in a few minutes.

20:30Welcome back to The Rest is Money with me, Robert Peston. And me, Steph McGovern. This section is brought to you by BT, a leading managed security services provider who's got your back when it comes to cyber security. You and I have talked loads about, you know, the impact that cyber attacks can have on businesses. So they've got a specific question that they wanted to ask us our thoughts on. We've seen a number of businesses hit the headlines recently for being the target of some pretty major cyber attacks. What risks should businesses be guarding against and how have these changed as connected tech?

21:02and we're talking about things like it might be a smart coffee machine you have in the office, it might be the software you're using for HR. They've become the norm. So how is that changing the risks for businesses? And this is of particular interest this month because it's Cybersecurity Awareness Month. And they've got data showing that cyber criminals scanning devices connected to the internet happens every 90 seconds. I can do everything from my phone. Now, my partner's sat in the office at home. I could literally turn the lights off and the heating off from me. So other people can do that in your office and things too.

21:37We've talked on a serious note about the big cyber attacks that have happened to businesses and organisations and that really scary what can happen as a result of them. Look, there have been many examples of big institutions, NHS, British Library, being hacked. I'm a member of the British Library. The service that it was able to provide was massively impaired for months as a result of the cyber attack that it faced. Actually, I think they did it ultimately a pretty good job. Remind us what happened to that one. This happened in October 2023. A group called, I don't know how you pronounce this, it's Rizida, attacked the online information systems of the British Library and they demanded, this is actually quite classic actually, these hackers, in order to get restoration, they often demand cryptocurrency, in this case 20 Bitcoin, it was worth over half a million.

22:32The reason they obviously demand Bitcoin and crypto is because it's untraceable and something like 600 gigabytes of leaked information was published online. The British Library had to dig into its reserves. They used something like 40 % of their financial reserves to restore the systems, get the service back up and running. But it meant that, for example, you couldn't order stuff online. Pretty much all its online service was down. They also run something called the public lending, right, which is, if you're an author, it's a bit of money you receive when people borrow your books from public libraries.

23:13That PLR service was wiped out for a period. And, you know, that's a concern to lots of authors who depend on a bit of money from this PLR service. So, you know, this was quite a significant and damaging attack on a public service. of course if you're a smaller business quite often you're so struggling to just keep afloat quite often smaller businesses are less protected yeah funny i was doing some work in the insurance industry recently and and that's the big thing for them is now how do you insure for cyber attacks in companies too because it's mad to think about all the different now i guess they're called surfaces aren't they the way hackers can get into the different systems to get this information a lot of it's about data which is then sold on the dark web as well do you remember when i think we might have mentioned this on the podcast last year when we got letters from the bbc about the cyber attack that had happened there so this was not just the bbc it was british airways it was boots and it was hackers had managed to get into the payroll software of these different companies and then your and my data was stolen so then in the end the bbc did you take up their offer then of having like a credit check thing.

24:22So I've now got a kind of Experian thing happening because of all that. Yeah, no, I also took it up. Often cyber attacks, they sound kind of like something that only happens to big firms, that only happens to big institutions. But the reality is this can happen on any level now. But the thing that's sort of depressing, and one finds this in life so often, is one simply can't, it seems, afford to relax and trust ever in almost any part of our life. The extreme case, we talked in the past about the National Risk Register, which is this government register that assesses really huge, potentially damaging threats to the UK.

25:02One of the most serious threats identified there is a cyber attack that, for example, wiped out the whole national grid, which could lead to deaths if hospitals don't have power and could, in theory, take weeks and weeks and weeks to restore. So I think the bottom line of all of this is whether you run a huge institution or whether you're just running your own life, you just have to be on your guard about this stuff and protect yourself where you can. Yeah, definitely. And obviously, that's the type of protection that BT Cybersecurity provide with all of this. So you just need to search BT's Got Your Back or visit business.bt.com to learn more about it.

25:40Right, should we have another question? Let's do that. So this is a question from Andrea Whitehead, who's talking about, I guess, the mess the NHS is in. So she's someone who says she's been close to the NHS and she's saying, I'm not sure giving a lot more money is the answer to sorting it out. Every person I've spoken to has since said the NHS is broken. So what do you honestly think is the way forward? And she also makes the point, the staff were brilliant, by the way, which is, you know, we're never slagging off the staff when we're talking about the NHS being in a mess. We're talking about it's not functioning properly, is it, in the way it should?

26:13Look, I think Andrea has hit the nail on the head here. Plainly, money helps all public services. But when it comes to the NHS, it frankly can't just be all about money, and I'll explain why. For most of my adult life, even if you could see that outcomes in the NHS in some areas, like cancer care and treatment, were worse than in many other countries, but what you could always say about the NHS is it looked like value for money. We were a very rare example of a country that simply provided a publicly owned, free at the point of view, health service. And what that cost as a share of national income was less than even the more insurance-based systems that we saw, for example, in other rich countries within Europe.

27:08What is genuinely shocking and depressing about the NHS at the moment is that what we spend on the NHS as a share of national income is now higher than in most other comparable countries, for worse outcomes. And when you see that, you know that money can't just be the answer. There must be something really depressingly structural going on. Just to be clear, these are not numbers I plucked from thin air. The Office of Budget Responsibility has made that calculation. Lord Darcy, who was appointed by the government, has made that observation about how relatively expensive now the NHS is compared to other health systems for two reasons.

27:53One is because the health of British people is deteriorating. So we need to spend more money earlier. There's a comparable thing to that discussion we had about child services, how when you put a kid into a care home, it's way more expensive than helping to keep the family together if you spend money at early years in helping families to survive and stay together and produce a caring childhood experience within the home. Comparably, if we spend money on helping people have better diets, they will be healthier and they'll make less demand on the health service. So that's one element of what you could do.

28:34To get back to the cancer outcomes, if you tilted spending from crisis intervention, when somebody is acutely ill, it costs a fortune to treat them and keep them alive. So anybody who has a late stage cancer, obviously the NHS is desperate to help them, but it's unbelievably expensive at that point to do so. If we, for example, bought a thousand additional scanners and you had a national screening program for people at certain ages, you would pick up cancers at a much earlier age where the chances of actually basically curing them become a much greater and it's much cheaper. And so what we ought to be doing is reallocating money from treating acute people to identifying illness before it becomes acute.

29:28And that means we've talked already in this program about the imperative of this government investing much more. A huge amount of that investment needs to go into the NHS to detect illness before it ruins people's lives and becomes incredibly expensive for the NHS to treat. That's a kind of longer term solution as well, isn't it? But my mum worked in the NHS for 40 years and she was a radiographer, so in the unit where they're using all these expensive bits of kits for various different things and i remember when she used to tell me about days where like one machine would break but it'd be three days before they could get an engineer so that's three days of like people's appointments being cancelled and then reallocated and you know that's a grotesque management issue yeah so there's like there is on that level on that kind of you know things around maintenance around how they cope with when things go wrong that type of thing which are all as you say badly managed so there's probably management things that need to change as well as investing in the early intervention it's about how do you make sure that they are efficient coming back to that original question about productivity and services how do you increase the productivity so as many people can be seen and scanned and everything else because that's the other thing people are waiting a long time I've you know got a family member who's got cancer and the appointment system is shocking it's constantly being cancelled and then we're waiting several months again before you get the next bit of information about it so there's so much that can be done you could have way more data on the nhs app about previous treatments and health needs which again would increase the efficiency of treatment but then there are so many other opportunities out there but it's not just throwing money back to angie's original point if it's not you know when we're talking about investment it's got to be investment that's targeted to improving productivity it's not just we need to give them more money so they can reduce the weight in list and employ more people it's about making things more efficient it's investing in both kit yeah and indeed in much better management and the final piece of all of this that is worth pointing out is that managers around the uk in the nhs manage budgets that are broadly the same size as really quite substantial multinational companies.