Andy Burnham – spend now, tax later?

The newly appointed UK Prime Minister, Andy Burnham, scored his first success as leader by managing to keep his cabinet picks under wraps prior to the official announcements. Indeed, the naming of the Chancellor took all by surprise, with former Defence Secretary John Healey appointed as the Treasury head instead of Shabana Mahmood, who the press had previously reported to be ‘nailed on’ to get the job. Ms Mahmood will instead stay on as Home Secretary, while Ed Miliband, another name previously rumoured for the Chancellor role, was elevated to Foreign Secretary. Joining them in cabinet are Wes Streeting, the new Defence Secretary, Yvette Cooper in Health, Lucy Powell in Education, Pat McFadden who stays on as Work and Pensions Secretary and Angela Rayner who was brought back as Housing Secretary. The new team met for their first cabinet meeting at lunchtime today.

In terms of Andy Burnham’s broad agenda, much of what he said yesterday was already outlined in his speech in Manchester in late June, which we covered in a note: Andy Burnham: Labour’s man with a plan? Clearly devolution, i.e. transferring more power over decision-making from Westminster to local and regional levels, will be at the heart of his agenda. However, since he has become Prime Minister, it has become apparent that Mr Burnham is also committed to eliminating rough sleeping, reforming social care (he has actually gone as far as promising not to leave office without resolving the issue) and boosting defence spend. He also indicated he was reconsidering personal income tax thresholds. None of these will be done overnight, and therefore, as he had hinted at in June, Mr Burnham announced a near-term sweetener to all households, by temporarily removing the 5% VAT charge on electricity bills, from 1 October. This makes a good headline, but in reality, it is relatively small beer: it will save the average household just £45 a year and is only funded until the end of the financial year in March 2027. Any changes beyond that would be part of the next Budget. Indeed, at the moment it looks likely households will not see any reduction in their bill from October at all: without the VAT cut, household energy bills would rise by £97 a year from October onwards, as per the latest EDF estimates that incorporate the recent Iran-related jump in wholesale gas price futures. It is questionable whether many voters will give Burnham credit for reducing that increase rather than actually cutting bills. Mr Burnham has said though that more policies to help reduce cost-of-living pressures will be set out “over the coming days”, with some guidance as to how to pay for them.

On defence spend, the appointment of John Healey as Chancellor naturally raises questions as to whether Mr Burnham intends to boost this beyond what the existing Defence Investment Plan envisages. Healey will certainly be under some pressure from the armed forces to do so, given just six weeks ago he resigned from his role as Defence Secretary due to a dispute over what he saw as an inadequate level of funding being assigned to defence. In his resignation letter he also called for a 2030 deadline to raise defence spending to 3% of GDP – the OBR had previously calculated that this would cost an additional £17.3bn a year by 2029-30. We are acutely aware though that priorities can often change once a different hat is put on – it is possible that Mr Healey’s steadfast commitment to sharply higher defence spend is watered down once he faces the tradeoffs required to fund such a pledge.

The key question now is of course how the wider government’s plans are to be funded. Buried deep in this morning’s monthly public finance statistics were £4.2bn of downward revisions to (current budget) borrowing over April and May. This provides somewhat more breathing room than looked to be the case a month earlier, a welcome gift to the Burnham government. But with higher oil and gas prices that make the OBR’s inflation forecast for the rest of the year, and therefore its assumptions for interest due on index-linked debt, look optimistic, relief may only be short-lived. And the proof will lie in the pudding whether Burnham’s push to cut the number of young people currently not in education, employment or training delivers the reduction in the welfare bill he hopes to achieve. Certainly, it looks unlikely this alone can and will be the answer to all funding needs.

This is all the more so as the government’s shopping list is growing, with some big-ticket items on it. Naturally that raises concern. To reassure markets, Burnham reiterated once again yesterday that he plans to meet Rachel Reeves’ fiscal rules. But, he said, he would ‘use obviously any flexibility within them’. The fiscal rules have two principal components: the ‘stability rule’, also known as the fiscal mandate, which stipulates that the current budget (so revenue less day-to-day spending) should be in surplus three years into the future; and the ‘investment rule’, which requires the ratio of debt relative to GDP to fall in three years’ time (also on a rolling basis).

Two points look crucial to us here: first, the fiscal mandate poses no constraints on borrowing for investment, only on day-to-day spending; and second, the investment rule does not specific a maximum level of the debt ratio but only relates to the change in the debt ratio at an ever-shifting future date. So to the extent that extra spending can be classified as investment – we imagine that much of extra defence spending or council house building, for instance, could fall under that umbrella – the ‘flexibility’ of the fiscal rules could be used while spending is ramped up. This is certainly a path that is being pursued in Germany, where the introduction of the extra-budgetary 12-year €500bn infrastructure fund in 2025 was explicitly designed to sidestep its otherwise much tighter and constitutionally binding fiscal rules. Back in the UK, we note a heavily front-loaded step up in borrowing for investment purposes could help the ‘investment rule’ being met too.

That said, the ultimate yardstick that matters is the market’s judgement, not whether any particular set of fiscal rules is met (of which the UK has had seven different versions since 2010 in any case). When fiscal credibility is in doubt, borrowing costs can jump and threaten the sustainability of public finances directly. So, fiscal credibility with the market will have to be nurtured and maintained, a message that the slight wobble in gilt markets yesterday drove home again. Still, markets look calm again today, so implicitly they seem to be taking Burnham at his word for the time being when he promised never to take risks with the economy.

Borrowing, in any case, is not the only option to fund spending; the alternative is higher taxation. This would necessarily create some losers. Options are constrained by Burnham’s promise to uphold the manifesto commitment not to raise ‘taxes on working people’ and specifically not to increase ‘National Insurance, the basic, higher or additional rates of Income Tax, or VAT’ or corporation tax. These last four are the key source of current tax revenues. However, that leaves a number of alternative options on the table. There is for instance the possibility of adding a further top income tax band – by saying it would be ‘premature’ to look at raising the top rate of tax, Burnham did not rule this option out. Capital gains tax, stamp duty and potentially a new wealth tax could all be studied too for their potential to add tax revenue. And exemptions, thresholds and categorisations could all change even if tax rates do not.

All these though are not questions for now but for the Budget. Press reports have suggested this could be coupled, ambitiously, with a Spending Review too, to reshape public finances more substantially. The countdown to that is certainly on, and businesses, households and markets will no doubt have plenty of speculation about upcoming changes to consider in the interim. As for when the Budget will take place, there is no official word as yet, but speculation is that it will be during October – which in any case would be the minimum to meet the 10 weeks’ notice the OBR requires to run through the Budget process. The hope has to be that the Budget will be announced as soon as possible, to keep the period of uncertainty for businesses and households to a minimum. In already uncertain times for geopolitical reasons, adding even more unknowns on domestic fiscal settings into the mix would be especially unwelcome.