Debt, Deficits & the Dead-End of Big Government

ECONOMIC PERSPECTIVES 162 [JUNE 2025]

If Chancellor Reeves, in the wake of her latest ‘spending review’, wishes to salvage a shred of fiscal credibility she will have to announce spending cuts or tax increases – or most probably, both. Either way, her pre-election manifesto promises have proved meaningless, and few still believe that the underlying economic growth she trumpeted will ever materialise. No sign of it so far.

There is little doubt that the vast sums of promised government spending will be financed by yet more borrowing – but she will discover, the hard way, that the appetite for taking up UK bonds is languishing, as reflected in the 30-year gilt yield – the rate of interest charged by investors to lend the UK long-term money.

Don’t be surprised – we have been here before, almost exactly 50 years ago in early 1976.

The sterling crisis came to a head during James Callaghan’s term as Labour Prime Minister, and caused the Bank of England to withdraw temporarily from the foreign exchange market. After the defeat of the public expenditure white paper in the House of Commons in March 1976, and the resignation of Harold Wilson, many investors became convinced the price of sterling would soon plummet due to inflation. By June of that year, the pound had reached a record low against the dollar.

The headless chickens now loitering on the government benches in the Commons have no conception of the vacuity of their own ideology. They spout sagely about the inevitability of coming tax rises, as if potential taxable targets exist in profusion, whereas they have already been exhausted; and more borrowing is not possible if there are no lenders or investors who believe that the UK economy is capable of generating the means of repayment. But currently high interest charges reflect the risk of failure.

In the crisis of 2008-2012 “liar” loans, ostensibly secured on collateral in the guise of investment property, proliferated, then duly soured and failed. We are seeing it again today - but rather than the fancy instruments of yesteryear such as collateralized debt obligations (CDOs), we see private equity investors, shadow bankers and hedge funds issuing BNPL instruments (“buy now pay later”) to secure their lending. What next for asset classes? (One wag has even suggested “Collateralized Burger Obligations”, CBOs!) The Chancellor will not be the only one shedding tears!

As for higher taxes, even now Starmer and Reeves haven’t learnt one of the most elementary lessons of state finance: that any tax diminishes its own incidence (Latin for “where it falls”), just as 17^th century window taxes led to the bricked-in edifices still evident in our city centres – an early illustration of the blight of tax-avoidance that follows every unprincipled government levy.

The growth agenda promised by Rachel Reeves has foundered disastrously. This is hardly surprising when her early enactments not only included inflation-busting pay awards for heavily unionised public sector “workers” and raising the minimum wage, but also increased employment taxes on the productive private sector, misleadingly labelling it national insurance charges (NICs). These “jobs” taxes have increased the cost of employing people, reduced the number of new hires, exacerbated unemployment and fed the benefits scourge that epitomises the culture of entitlement - not a misspelling of enlightenment - that haunts our forsaken economy. All utterly foreseeable by anyone capable of logical thinking. The transition from work to entitlement can indeed be rapid.

Funding the public sector

Public sector wages are necessarily funded by taxes – where else? Most public sector activity lacks an obvious, identifiable, measurable economic “product” capable of meeting the criterion of human satisfaction that is evident when citizens gladly spend their own money. The speed at which a town-hall jobsworth can shuffle his papers or push paper clips into trays on his desk can never represent a competitive advantage worth paying for. In any case it’s nigh impossible to measure productivity in a sector that doesn’t produce anything - improved “efficiency”, maybe, but not productivity.

With over 9 million working-age people neither working nor seeking jobs, government should be making it easier for them to support themselves and their families through their own work. If Reeves were serious about fairness she would have started raising tax thresholds again so that people on average salaries do not have to pay the top rate of tax. And if she is interested in economic growth rather than merely growing the size of the state, she would encourage start-up businesses and attract foreign investment with a radical cut in the rate of corporation tax - an excellent move that would re-enact the Irish miracle of a generation ago.

Emile Woolf

__________________________________________________________