Please note this bulletin is for general information purposes only and should not be considered personal financial advice. Investments carry risk and you may get back less than you invest. Past performance is not a guide to future performance and the value of investments may fall as well as rise.
Speaking in Downing Street’s rose garden earlier today, in front of a placard stating ‘FIXING THE FOUNDATION’, Sir Keir Starmer made a speech about the state of the nation.
At best, the tone could be described as ‘gloomy’. His comments about the forthcoming budget seemed especially ominous, if not massively surprising.
“I will be honest with you - there is a budget coming in October, and it’s going to be painful.”, he said, before trotting out the eternal line, coined by George Osborne, and repeated ad-nauseum by every Chancellor since… ‘Those with the widest shoulders should bear the heaviest burden’. Which in my experience is usually political speak for ‘anyone in the higher rate tax band and above’.
The reported cause for this early-doors about-face on tax policy, is the mess that the previous government made of the public finances. Such allegations are nothing new of course. David Cameron and George Osborne spent years dining out on the alleged financial mismanagement of the previous Labour government. So it seems only fair that the Tories get a taste of their own medicine.
But what’s different this time, is that it’s been given its very own strapline - Rachel Reeves’ much-vaunted ‘£22bn black hole’. What’s raised many an eye brow, is that this so-called ‘black hole’ supposedly escaped notice, until after the election had been won, and the keys to number ten had been handed over. And yet, much of the information was already available. Hmmmm…
So what exactly is this black hole? How did it come into being? And is it a fair cop to use it as an excuse to raise taxes?
Whilst accurate information is difficult to come by, it’s fair to say that responsibility can be divided between the political parties, and the shortfalls of the current government spending system.
The Conservatives were not entirely clear with the electorate about the state of government spending, and no doubt left the incoming administration with plenty of issues to deal with. However, Labour would have been well aware of many of these issues, and also skirted around them in their campaigning and manifesto pledges.
Part of the issue is down to how government spending reviews work. A government spending review is a vast and complicated process, forecasting the future costs of running the country, whilst allocating over a trillion pounds in taxpayer money (around half of the UK’s income), across a huge range of government policies and departments. Understandably this is not the work of a moment, and getting things entirely accurate is all but impossible, as different government departments, and British life in general, are in a constant state of flux.
The current system was introduced at the end of the 1990s in an effort to add more structure to the management of the public purse. Rather than doing things ad-hoc, it required the government to set out multi-year spending plans, to provide greater certainty, and encourage long-term planning. All sensible. This was also designed to provide flexibility, enabling spending to be moved between years. However, whilst intended to enable government departments to plan strategically, it was also a system that was open to manipulation, if the incumbent government needed to conveniently push costs into one year or another.
The chart below shows the spending reviews held since the system was introduced, and the periods of time they covered. On average, a major spending review would usually cover a three to five year period, except during exceptional circumstances, like the unexpected outcome of the Brexit vote, or the Covid pandemic.
As we can see, the last spending review was carried out in 2021, and due to last for a three year period, until the 2024 election year. This also must have seemed sensible at the time. However, the problem here is that inflation has had a huge impact on the cost of everything in the past two years, with lots of knock-on effects, that might not immediately be apparent.
One of the biggest complaints from the chancellor, is that the full extent of public sector pay increases wasn’t budgeted for. In a normal inflationary environment, like that during which the last spending review was set, a 2% annual increase could be considered appropriate, to ensure worker pay keeps track with CPI inflation. However, when you consider the huge spike of inflation seen in 2022 and 2023, it’s not hard to see that a 2% per annum pay increase for public sector workers, wasn’t going to be fair or feasible.
The other key complaint of the chancellor, was the estimated £6.4bn cost of supporting asylum seekers, which is well in excess of that originally budgeted for. But given that war in Ukraine began unexpectedly in 2022, plus other rising geo-political tensions around the world, it again seems obvious that the expected figures drawn from 2021 would need some revision.
So it could be argued that these issues don’t really form part of a black hole. They were issues that should have been apparent to anyone reviewing the headline numbers and doing a little reading between the lines. They were largely driven by inflation and geo-politics, that could not have been predicted back in 2021, when the last spending review was conducted. This was an issue that both parties should have been aware of, but both apparently brushed them under the rug to use for their own political ends.
However, there is a twist in the tale where Rachel Reeves may have cause for complaint. It turns out, that the treasury reserve fund – which in theory should have been able to absorb some of these costs – had already been depleted. This is a contingency fund that is supposed to be maintained to cover unforeseen emergencies. It appears that this was already spent, mopping up unbudgeted costs in previous years, funding several high profile public enquiries, and supporting the ailing railways, as commuter levels failed to return to pre-Covid levels. Whether this was made known prior to the change of government is unclear.
Conclusion
So, to conclude, both sides of the political divide must have known about some of the big issues with public spending. It seems that the Conservatives may have been guilty of playing down the extent of the problems, as the wheels began to fall off their political support wagon, whilst not being open about the fact that the reserve fund had run dry. Labour meanwhile would have surely seen where the major issues lay, but chose to keep quiet about it until after the election. Plausible deniability perhaps?
Maybe the new chancellor kept her head down, assuming that much of the overage could be mopped up by the treasury reserve fund, only to find it had already been spent. Whilst the overspend on public sector pay increases and asylum cases appears obvious, finding that there was no contingency fund remaining may have been a genuine shock. Moving forwards, she has proposed a two year spending review and greater powers for the Office for Budget Responsibility, which should help balance the need for certainty, with greater accuracy and accountability.
Is it fair or accurate to blame forthcoming tax rises on the conservatives, for somehow concealing some unknowable £22bn spending black hole? I don’t think so. But they haven’t exactly showered themselves in glory, and it seems ironic that the cost of their last-minute unexpected NI cut - that they hoped would woo the electorate (and failed) - was around £20bn…
Returning to Keir’s speech, in light of the above, one line seemed especially laden with meaning. ‘Those who made the mess should have to do their bit to clean it up’. After letting it hang in the air, he went on to refer to the water regulator and companies dumping toxic waste. It doesn’t seem like too much of a stretch, to suppose this was also a not-very-hidden message to his political opponents.
‘I’ll have to turn to the country and make big asks as well. Short term pain, for long term good. A difficult trade-off for the genuine solution.’, were his closing comments on the forthcoming budget. What this really means is unclear, but all eyes are now set on the 30th of October, when Rachel Reeves will make her first budget statement as chancellor. Whilst we can predict some key areas in which we are likely to see changes – capital gains tax and inheritance tax - we cannot foresee the details, or how broadly the budget will impact other areas, such as pensions and buy-to-let property.
Rest assured that as usual, our budget commentary will be hot off the press, as we aim to bring you a detailed commentary on all the key financial changes, within 48 hours of the chancellor's statement. We’ll then be on hand to discuss if any changes may impact your own financial plan, and advise if we need to make any adjustments to optimise your financial position and ensure your goals remain on track.
In the meantime however, when you next hear about the £22bn black hole, you could be forgiven for feeling at least a little scepticism.
