How deep is Britain’s fiscal “black hole”?

THE FIRST months of a new British government are precious. Problems can be blamed on ministers’ predecessors, who will struggle for a hearing. Capitalising on that honeymoon can neutralise the political costs of tough choices: George Osborne, a former Conservative chancellor, moved quickly in 2010 to pin swingeing spending cuts on Labour’s profligacy. Britain’s new Labour chancellor is following the same playbook. On July 29th Rachel Reeves presented the results of an audit into the public finances, which she had commissioned straight after the election.

With the stern look of a disappointed head teacher, Ms Reeves decried an “unforgivable” inheritance. Her focus was on immediate pressures in this financial year. Even after accounting for the Treasury’s rainy-day fund and assumptions that some programmes would come in under budget, she told Parliament that a £21.9bn ($28.2bn; 0.8% of GDP) overspend had been uncovered. About half came from inflation-busting pay rises for public-sector workers. Most of the rest came from £6.4bn in higher-than-expected costs associated with the asylum system, with smaller contributions from aid for Ukraine, support for the railways and more.

Ms Reeves expects to fill a quarter of that hole with immediate spending cuts. The single biggest saving will come from means-testing winter-fuel payments for pensioners. That saves £1.5bn in the next fiscal year and the group affected—the better-off elderly—is hardly a core Labour constituency. Further savings will come from axing chunks of Rishi Sunak’s policy legacy. She is ending schemes to send asylum-seekers to Rwanda (worth £1.4bn), to revamp the secondary-school curriculum (£185m) and to sell discounted shares in NatWest to the public (£100m-450m).

More consequential were her cuts on social care (worth £1.1bn) and transport (£785m). The transport cuts are mostly focused on second-tier road and rail projects. Nonetheless, they represent a continuation of previous governments’ tendency to endlessly tinker with infrastructure projects. Ms Reeves condemned “the stop-go cycle of capital investment” in a lecture in March. Back then she called it “the new British disease”. Strikingly, the cuts did not extend to the government’s new flagship initiatives to spend billions in public money on green infrastructure.

If Ms Reeves’s goal was to re-emphasise Labour’s sorry inheritance, she was partly successful. Labour and the Conservatives have been shadowboxing over the state of the public finances since before the election. The Conservatives argue that forecasts from the Office for Budget Responsibility (OBR), a fiscal watchdog, mean the books are now fully open.

But the OBR’s medium-term forecasts, last released in March, did not account for in-year overspends. A row is now brewing over whether it was misleading for the Treasury not to share details of the areas at risk; Richard Hughes, the OBR chief, has announced an investigation. Jeremy Hunt, the last chancellor, parried with a letter querying why top civil servants had just signed off on this year’s spending if the overruns were so unusual. Ms Reeves has set out reforms that should make future cases of this sort much easier to spot.

Focusing on the overall fiscal inheritance also helps Labour to divert attention from the policy choices embedded in Ms Reeves’s statement, such as accepting the recommendations of pay-review boards to raise public-sector wages by more than expected. Doing so is understandable: pay has lagged the private sector since inflation started rising in 2022 (see chart). But it was still a choice. Also consequential is confirmation that Labour will axe Conservative plans to cap civil-service headcount.

Her statement set the stage for the next budget, which will take place on October 30th. Labour was evasive on tax throughout the election, saying it would not raise taxes on “working people” and ruling out increases to the biggest levies. Ms Reeves has since confirmed the inevitable: that some tax rises are coming. But she will be hoping that her show of fiscal sternness will be enough to reduce their political impact—for Labour, at least. ■

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