225. How Damaged Is Reeves By Budget Chaos?

0:11Hello and welcome to The Rest is Money with me, Steph McGovern. And with me, Robert Peston. And we're recording on Sunday night ahead. I think of most sort of traders will regard as a sort of anxious wait to see if UK government bond prices have stabilised. Because we did see, it wasn't devastating, but we saw quite a big fall in the price of UK government debt on Friday after, I mean, just actually chaos ahead of a budget like I've never experienced. I've been around this territory for decades. I mean, I've lost count of how many budgets I've covered and I've never known chaos. It is really remarkable.

0:56Yeah, because we are used to, from doing the budgets every year, having leaks and, you know, things being put out there to kind of test the water on what people might think of these potential decisions that they're then going to announce on the budget. that's quite common but not to you all to be brought into you know into a meeting a briefing one morning to be told about this big change that's potentially going to happen and then a few days later it to be said is not going to be happening like why why didn't I don't understand why we're not just waiting until the day but anyway we can talk more about that do you want to just explain a bit about why we had this kind of u-turn then on friday because you you know you've got some interesting stuff on the numbers behind this and the black hole and that's part of the the change is to do with this that we has not been having a bigger black hole as we thought but explain what you know robert uh it was weeks and weeks and weeks ago and the abr had concluded having done what's called a supply side review of the economy it concluded it would be growing slower than it had been expecting in recent years.

2:06They then downgrade their expectations of tax revenues. And that caused a 20 billion hole. It meant that the Chancellor would be missing her fiscal targets by just over 20 billion. But then on top of that, you had another, I don't know, six, seven billion from the fact that she'd failed to deliver the welfare savings she wanted because of the revolt of Labour MPs earlier this year. You had interest rates a bit higher than the OBL thought they would be, adding another few billion. And when you added all that together, you know, you were looking at this very big hole. And then overnight on Thursday, there is a very good scoop in the Financial Times.

2:49And I sort of wake up Friday morning to see this scoop in the FT, which says that after all, the basic rate of income tax is not going up because the other thing that the Treasury had been briefing was not just this very, very big fiscal hole that she had to fill with tax rises, but a painful decision that the Chancellor had taken. But most economists said was the correct decision, which was to fill the hole by putting up the basic rate of income tax by two pence in the pound, which on its own raises about 16 billion if you do 2p. And if you do all the other rates as well, it takes you to about 20 billion.

3:36And the advantage of putting up the basic rate of income tax is, although it causes pain across the board for anybody who's got an income above the bare minimum. It is a simple tax rise for everybody to understand. The burden is shared across pretty much the entire population or certainly across the entire working. And you can sort of forecast its consequences with a degree of predictability. If you're of the view that, you know, tax rises, and this is a perfectly reasonable view, you'd rather avoid if you possibly can avoid them. The advantage of putting up the basic rate of income tax is that it's simple to model, you know, the economic effects, the burden is shared.

4:30And it's why, for example, on this podcast, while you were away, somebody like Jim O 'Neill, a very well-respected economist, you know, I was chatting to him on the podcast and he said that he'd been arguing for months that that was what should happen. It would, of course, have breached their manifesto because their manifesto said no rises in the rates of income tax, VAT, national insurance and corporation tax. But there was a sort of sense of needs must in government. They knew it was going to be politically controversial. They knew that they They would get, you know, the opponents, the Tories and reform in particular would have a go at them.

5:11But they broadly took the view, given to an extent the hole in the public finances, they could sell as not their fault because that slowdown in productivity is really the legacy of the previous 15 years of low growth. And if you were going to blame any government, you would probably blame the previous Tory governments for not doing enough to get the growth rate up. So I think they, well, they did think, I don't think, they absolutely thought, yes, we're going to be widely criticised. But if we can put together a compelling story about how, aside from that tax rise, we're going to get the growth rate up, then maybe by the time of the next election, people will have forgiven us for breaking the manifesto promise.

5:57All of that changes overnight on Friday. And, you know, it was quite a moment when I'm talking to members of the government and they are confirming that they are no longer going to put up the basic rate of income tax. Really quite a moment. The one thing I was going to say is, and we've said this on the podcast before about this manifesto, how many people, normal people, can ever remember what someone's manifesto is when they've come into power? There's been such obsession with a manifesto of breaking it that it feels absolutely redundant. and it's such a kind of niche political thing to care about and not really what people are talking about day to day.

6:46What people are talking about day to day is the chaos, is the not really knowing what's going to happen. And I think, you know, even though in the last episode I was kind of, you know, arguing a bit against the income tax rise on the basis of, you know, that feels like we're doing everything just to fill a hole rather than to grow the economy and that's my big beef. Something like that, as you've just explained, is really simple though and it feels fair in the sense of, right, we're all getting hit with this, but hopefully this will then improve things for us. But now we're going to go back to, and I know you're about to explain why this, the U-turn, but just from my perspective, what I'm now worried about as, you know, as a homeowner, as a business owner, as a parent and all these other different things, is this smorgasbord we're going to get and how complicated that's going to be and where it's going to hit.

7:37I'm already, you know already talking to my business partners about what it might mean or what might they do and it's that uncertainty we always talk about and we're back there and it just feels so chaotic but take us back to this story then like what happened overnight on thursday and why on friday did they then start saying hang on a minute we know we brought you in for this big briefing but that's not going to happen anymore i mean you made the intelligent point that that you know the practice of budgets has changed a lot over the last few years, 20 years, I would say. I mean, I just want to remind people that in Clement Attlee's post-war government, a chancellor of the Exchequer was forced to resign over what now would look like a fairly innocent, inadvertent leak.

8:27Because back in those days, you know, the idea that you would reveal anything about a budget was, you know, It was tantamount to, you know, breaking, you know, for a religious person, breaking one of the Ten Commandments. I mean, it was literally the worst possible crime, whereas now there is a sort of convention that more or less everything is briefed out. I hate this expression of more and more pitch rolling. The pitch has been rolled, you know, weeks ago. I think it's actually now months ago I'm originally told about this big hole due to the productivity downgrade. I'm also told they're right, you know, they're going to put up income tax.

9:03Big, big, big and controversial. Then overnight on Friday, the FT says, no, as you were, they're not putting up income tax. And the FT actually doesn't really explain it. There's something in there about, you know, economic conditions being a bit better. But I then get a very, very detailed briefing on Friday morning. A poor individual who said he's been up since four in the morning trying to deal with this stuff. Anyway, they're delivering a message that there's been some good news. Hooray, good news! Which is that wages have been rising faster than the Office for Budget Responsibility had been expecting.

9:49The OBR expected those wages to continue to rise faster than expected. I have to say, although obviously wage growth is a, all of us regard that as a good thing, right? I'm sort of, it's sort of interesting, just, I'm sorry to do more, another digression here, but it's always interesting to me when that's a bit of good news. Whereas if we were talking about interest rates at the moment, and we were talking about wages growing faster, we'd be worried that the Bank of England would see that as a sign of underlying inflation and they wouldn't bring any interest rates down. But in this context, faster than expected wage growth is a good thing because when wages are not only growing faster now, but are expected to continue to grow faster, what that means is all of us are paying more tax, right?

10:38And so what I'm being briefed is that tax revenues now are coming in at a faster rate than the Office for Budget Responsibility and the Treasury had been expecting and are going to continue to come in faster than they all expected. And, you know, one of the things they tried to do was say, actually, some of this is to do with, you know, last year's budget. And I sort of refrained from pointing out that because they didn't have the guts last year to put up income tax and they put up national insurance for employers, actually that has depressed the labour market and led to more people being out of work but i didn't didn't have that conversation then but they wanted to somehow take credit for all the tax rises in the last budget anyway that means that this budget hole 30 to 35 billion right they're now saying is going to be in the region of i don't know a bit over 20 billion right so it's a big it's that's a massive move right it's still a big hole i mean and we should be and And therefore, there is still an argument that says, actually, it would still be cleaner to fill that hole with an income tax rise.

11:54But what appears to have happened is they've just panicked. You know, this is a government that's not feeling confident. We talked on the last episode about the calamity of the prime minister, you know, briefing about leadership challenges. You know, they're still claiming the prime minister did not authorize the briefings against his health secretary, West Streeting. But he definitely authorized the briefings that said two things. One is that if he faces a challenge from anybody, he's not going to go quietly. He will fight on and try and see off any challenger. And he also authorized the briefing, which in the circumstances now seems slightly comic, which is that markets would collapse.

12:44You know, bond prices would collapse. Confidence of investors would collapse if he and Rachel Reeves were pushed out. given the chaos we saw on Friday when porn prices collapsed, wouldn't collapse, but they fell very sharply. Let's be absolutely clear, at least part of the reason why they dropped this intention to put up income tax. And, you know, let's be clear, you don't do what the Chancellor did, which is call an unprecedented press conference in Downing Street, gather people like me and all those sort of senior political journalists together and signal an income tax rise. Unless you're planning to put up income tax, you don't do it for a laugh.

13:32I mean, that was an astonishing and unprecedented press conference. And now they've gone in the other direction because they're not a confident government and they didn't want, they were frightened of the backlash. And that is probably the main reason why investors sold UK government debt on Friday, because what we saw was a manifestation of a government not only not being able to make up its mind, but just not sort of strong enough to push through difficult but necessary changes against a backdrop where they've got the most enormous parliament. majority and when bond when when bond investors see a combination of a government that ought to be really strong but still can't make tough decisions they just think what on earth is this government about yeah and to the lay person it looks like incompetence and so whenever you know these decisions are made rachel reeves always says to us doesn't she i will do what's right for the country and not go for politically easy choices and then as soon as there's any kind of dissent to it like for example with the winter fuel allowance or the welfare reform and then the backbenchers kick off about it so there's a u-turn and now with income tax there's a u-turn and yes you can dress it up as well there's a bit less of a problem with the debt than we thought there was there's still a huge problem as you've rightly pointed out and you've made the first step of the announcement just carry on with it to you know be confident in the decision you've made every time you backtrack it just looks like you don't know what you're doing and you're giving into the pressure around you it's not a strong leadership leaders have to make tough decisions all the time that's how you run a successful organization by making tough decisions but you make them and you stick with them.

15:34Occasionally you can U-turn if there's a massive change in the data you've got or something extreme happens. But on the whole, once you make a decision, you should stick with it because otherwise you look incompetent. You used a phrase I really liked. You said, to the lay person, it looks like incompetent. Can you find me somebody who's not a lay person who doesn't also think it's incompetent? You just look at it and you think, what on earth is going on yeah what on earth is going on here like you and i this time last year we're talking about how much of a tough job um whoever was you know it's taking on the the debt that we have and you know new government coming in whatever your political flavor it was irrelevant they were going to have a big job on their hands we knew that we then the chancellor obviously made out that she didn't know it was as big as it was but what we all i think thought as business people as journalists as you you know, just normal members of the public, was that, oh, well, we're going to get stability.

16:36So, yeah, there's going to be some tough decisions. And it was a bit of a hard hit when businesses were hit with these massive tax rises. And it's really certainly put up the cost in our business. But again, you have to assume and hope that the people in charge of the economy know what they're doing. And then because we'd had this terrible time of constant changing leaders, various ministers constantly changing. changing and you know the mad list trust episode and and all of that and we all thought well at least we're going to get stability even though there's going to be tough decisions and and now it feels really precarious again it feels like you know you don't know who's going to be in power in a couple of weeks and it that feels really dangerous for the economy again it makes us look like we don't know what we're doing on the world stage as well and it's embarrassing It is embarrassing.

17:31Let's pick up in just a couple of minutes after the break.

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19:06Hello, welcome back to The Rest is Money. So we laid out why there was the big U-turn on Friday in terms of putting up income tax by 2p in the budget. That's now not going to happen. We're going to talk in a minute about the things that look like will happen in it. But of course, that's open to change, given we're still a week or so away from the budget yet, which is going to be on the 26th of November. In the meantime, Robert, lots of eyes on what's happening with the bond market, which as we've talked about loads on the show, is how the government borrow money is from investors through gilts.

19:43And we saw the price changes, as you explained, on Friday, getting more expensive, basically, for the government to borrow money. So what's the feeling now, do you think, amongst investors about how credible we are as a country in terms of being able to pay our debt? And as the economy, you know, growth and everything else, what are they thinking? So there is a sort of paradox here, which is investors are very critical of the U-turns that the Chancellor has done. I think it is fair to call it a U-turn. Normally, a U-turn is when you announce something and it's very much in the public domain and then reverse it.

20:22But, you know, these were sort of private U-turns, but nonetheless, they were U-turns on the basis of how, you know, journalists had been briefed and how they wanted to condition the market. So it is a U-turn and therefore it does create tremendous instability. But the paradox is that when I talk to really big investors, they are frightened, anxious about who might replace Starmer and Reeves. they are critical of them in the sense that they share a view that is widespread that they haven't done enough of a you know coherent sort to get the growth rate of the economy up and that's got to be the imperative if you want to raise living standards and so they are critical of that but They do believe that they are committed to hitting the so-called fiscal, to standing by the fiscal rules.

21:20And therefore, they do believe that both Starmer and Reeves are committed to trying to get the debt under control. and they are just very anxious that if either or both were thrown out, one, there would then be a period of sort of chaos and uncertainty because there are obviously quite a lot of Labour MPs who hate the Office of Budget Responsibility, want that reform. They hate the fiscal rules, want that reform. So, you know, among bond investors, there is anxiety that they just won't know for a period whether or not we'll get a government that is committed to managing the debt in a sustainable way.

22:02So there's the sort of more chaos fear. And then there is just a fear which I think is misplaced, but it is nonetheless what investors fear, which is that whoever might replace Starmer and Reeves will be significantly on the left. And I personally don't think they would be significantly on the left, but they think that they would be significantly on the left and therefore would definitely borrow a hell of a lot more, which is not what investors want. So this weakness of the government, a source of enormous anxiety in the markets, there's a sense in which, however incompetent you might think Starmer and Reeves are, the markets fear that what may follow them from their point of view will be even more incompetent.

22:53I mean, this is just so... I mean, if you're, if you're, if you are, you know, like us, wholly committed to this country and just want the best for this country, that's pretty depressing. But basically, you know, you've got you've got the nation's creditors saying, well, this lot may not be much good, but the alternatives could be worse. You're just thinking, wow, that is that is what you know, that is awful. It is. It's not good. I wonder, though, if they're worried about someone being extreme left coming in and therefore scrapping the fiscal rules and then borrowing to pay for day-to-day spending and also borrowing to invest.

23:35But what if they have a growth plan as well? What if it's someone who comes in with a, yeah, we're going to have to borrow more in the short term, but we've got a plan for growth and that's going to increase productivity. it's going to increase GDP and therefore we'll have higher tax receipts and more people will be in work and what if they come in with that then isn't there an argument that you should break the fiscal rules to be able to borrow to grow if you then could kind of tangibly set out a forecast and a plan which leads to growth and an increase in productivity then would the markets be like okay well hang on yeah they're going to borrow more they're going to get in a bit more debt but they're going to get out of it eventually and so therefore let's let's not increase the you know the the yield let's let's just you know trust them on this or am i just in a dreamland they are not in a dreamland but i think it's all a question of sequencing is what i would say that um whether you're on the left or the right, it is undoubtedly the case that your priority ought to be to come up with a credible growth plan, as you say.

24:44But what you've got to do, which is, see, Liz Truss's huge mistake, Quasi Quarteng's huge mistake, was to cut taxes without finding savings elsewhere and without pushing through other things they said they wanted to do, you know, like, for example, get a lot more building going, deregulating to an extent that might have encouraged more investment. In other words, they did the unfunded tax cuts before they'd made the economic reforms that might have got growth up. I think that anybody coming in from either the left or the right who can prove that they have taken steps to get the growth up, I think at that point, actually, investors would cut them a lot of slack.

25:35I think at that point that you could say, well, maybe we'll have some extra borrowing in the short term. But it's all about the credibility. You have to sequence it. Once you've persuaded investors you've got a credible growth plan, then they will allow you a bit more flexibility with your borrowing. What you can't do, I think, in the current really febrile global conditions, because, you know, we are not the only country whose debt is considered large and potentially rising in an unsustainable way. You could make the same case about America. You can make the same case against about France. you know we're in an ugly contest and you know any country that wants to get out of this debt trap has to just convince investors of the credibility of a growth plan and at that point when you've convinced them of the credibility of your growth plan then I think investors will be a bit more tolerant if in the short term you push up borrowing a bit but it's all about the short term because unless they can see how the growth will then feed through to lower borrowing in the future, they're just going to basically say, no, this is more, you know, short term is, you know, essentially, it's a sugar rush.

26:53It's not getting fit. Isn't it mad? I'm just sitting here listening to you thinking, isn't it mad that we're talking about someone else potentially running the country? It's really shocking. But anyway, let's move on to what, you know, budget is, you know, A few days ago, let's just run you through the three or four measures and then you can unpick them a bit. But the three or four measures that we think are coming, or five in total, actually, but of sort of big measures, we'll stick with the sort of easy one first, which is it now looks absolutely certain that the way they'll fund the ending of the two-child limit on universal credit is to do what Gordon Brown recommends, which is an additional tax on the big gambling companies.

27:36companies, and in particular, try and tax. They're really quite big profits from those gambling machines, which many people think are addictive. And anyway, look, I don't know whether you want to talk about this on another occasion, but I think we can come back to the rights and wrongs of the gambling levy. I personally think it's a perfectly good case for that, but we can come back to that. The other big measures, which will be much more controversial, is there is a very weird convention. It's called the salary sacrifice convention where employees sort of pretend that their salary is lower than it actually is.

28:17They are absolutely clearly going to abolish that. It just means basically a hidden way of putting up income tax and national insurance for anybody who's making a pension contribution. It also puts up the cost a little bit for companies. My concern about it is we need people to save as much as possible into pensions because people are not making enough provision for their retirement. And if in the end what this leads to is people saving less, that will be a bad thing. But it's a backdoor tax rise. It is still an income tax rise and national insurance rise for lots and lots of people. and then there are three other things one is with the growth and growth of electric vehicles it means over time the government gets way less duty from petrol and diesel sales much less from fuel duty so they're going to come up with a new road pricing scheme so if you've got an electric vehicle you're going to have to pay a tax on your mileage then there is another hidden income tax rise which is they are going to extend the current freeze on thresholds, the thresholds at which people pay different rates of tax.

29:26They're going to extend that for another couple of years. And what it means is that as people's wages are increased by inflation, they are tipped into a higher tax band, either the 40p band or the 45p band. And then finally, there is this plan which we've talked about a bit, and I'm less clear about the detail of this but it looks as though they are going to impose some kind of new higher charge on owners of more expensive properties. We'll dig deeper into it as we go on with these episodes as more comes out and of course when the budget happens we'll be able to deep dive on all of it. So yeah, loads more to talk about.

30:08Who knows how many U-turns we'll have done by the time we next speak to you. hopefully it will get calmer but that's unlikely. But anyway thank you for listening to us on The Rest is Money. Bye bye. All the best. Goodbye.