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Economic reality risks ruining the party games

Inflation down (3.2 per cent), wage growth up (6 per cent) and economic growth restored (0.6 per cent GDP growth over Q1) – so are champagne corks popping in Downing Street? Put the bubbly back on ice. Firstly, “we’re no longer in recession” isn’t the rallying cry some people think it is, and the rapid pace of wage growth – while undoubtedly good news for workers – is actually ringing alarm bells in some quarters given the impact it might have on inflation and, therefore, interest rates. The UK unemployment rate is also ticking steadily up, with the hundreds of thousands of long-term sick now almost certain to become Labour’s problem. The government’s message is understandable; stick with us, the plan is working, don’t risk it by letting Labour back in. The problem is, this approach is akin to standing in the middle of a biblical flood and telling everyone that you think the sun is beginning to burn through the cloud. They might be pleased to see it, but they have more immediate concerns. 

In 1997 the opinion polls were clear that John Major was facing electoral defeat, with Tony Blair’s New Labour poised for power. The fact that Major could point to an economic rising tide made no difference to his fortunes and he ultimately bequeathed one of the best economic legacies to his successor. The data might have painted a decent picture but the public were in no mood to reward the Tories. They’d been in power for too long, they were riddled with internal divisions, their Prime Minister (despite electoral success in 1992) was gravely weakened, the party’s reputation for economic competence had been undermined by events and the mood of the country had shifted. Is history about to repeat itself? 

It’s even possible that a narrative of economic revival benefits the opposition more than the government, adding to a sense of renewal and a change of direction rather than shoring up the incumbents. But other than some modest GDP growth and a more temperate inflationary environment, what kind of economy would a Labour government inherit?

That the Conservatives have made some economic missteps is not in doubt, but none have been as consequential as the cost of the pandemic. We don’t like to talk about it these days, but the government’s pandemic response came with a price tag approaching £400bn. In 2020/21 the state spent £200bn more than it had budget for. This is to say nothing of the cost to the Treasury from the wider economic collapse, the loss of growth and the deep economic scarring, and it doesn’t take into account the many tens of billions then spent in response to the global energy price shock. This is real money and the consequences of such unprecedented expenditure will be felt for decades, most immediately in the form of higher taxes – regardless of who wins the election. 

So, while the Tories can forget about voters rewarding them for a modest uptick in public finances, so too can Labour dismiss the idea that they’ll be able to turn on the spending taps the moment they take office. After the 2010 general election the outgoing Chief Secretary to the Treasury left a note for his Conservative successor; “sorry there’s no money left.” The current occupant of that office might very well end up reaching for the same sentiment.

Given that Labour has ruled out any hikes to income tax, the smart money says they’ll be looking at raising revenue through relatively less politically sensitive reforms in areas such as wealth, property, inheritance, dividends and capital gains. All governments sneak in stealth taxes. Gordon Brown was famous for it and the current government has allowed fiscal drag to do the heavy lifting. If Labour do target wealth, capital and dividends for tax increases will they do it without fanfare or instead seek to benefit from the political dividing line that such moves would open up? 

As the election approaches the Conservatives will continue to treat the economic recovery like a Ming vase – “don’t let anyone else touch it” – but we also know they’d like to make a big retail offer on tax cuts, whether ahead of the election or as a future aspiration. Chancellor Jeremy Hunt dipped his toe in these waters with hints about a potential abolition of National Insurance at some point in the future, but the idea has allowed Labour to warn about the “black hole” such a move would produce in the public finances. In short, we’re starting to see the coming economic debate take shape, but we should all keep a close eye on the details and take any pre-election promise with a pinch of salt. The parties may feel liberated by the rush of political battle but they will be constrained by economic reality.

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