UK’s Rachel Reeves faces pain wherever she turns

LONDON — Who’d want to be Rachel Reeves right now?

While Britain’s top finance minister has the full-throated support of her boss, Prime Minister Keir Starmer, it’s been a deeply bruising week for the country’s first female chancellor.

A humiliating government climb-down on a money-saving welfare reform plan was followed by market-moving tears from Reeves in the House of Commons on what she has stressed is a personal matter. With unfortunate timing, the scene — mocked by opposition politicians — came just as Starmer failed to explicitly endorse Reeves staying in post.

He has now very publicly backed her — but the fundamental economic challenges Reeves faces aren’t going anywhere.

Reeves’ self-imposed fiscal rules restrict government borrowing. But, after the latest costly welfare climb-down, the keen chess player’s next move could involve tax hikes toxic to swing voters, spending cuts disliked by her Labour colleagues — or both.

POLITICO courted the views of six wise heads who have been in the political trenches in the U.K. and further afield to gauge where Reeves might turn next.

Don’t appease — Jared Bernstein, former chair of Joe Biden’s Council of Economic Advisers and an architect of ‘Bidenomics‘

Jared Bernstein — who saw Joe Biden lose to Donald Trump despite touting improvements in the economy — urged Reeves not to get too freaked out about public opinion. “If voters are perennially unhappy, they’ll always throw out the incumbents no matter what they do,” he said. “If you try too hard to appease … a deeply unhappy electorate, you won’t have time for anything else.”

Reeves’ head is “in the right place” and she should keep her focus and do what she thinks is right, he added. Acknowledging the U.K. economic data is “quite tough” with an “uncomfortably low growth rate bumping up against uncomfortably high interest rates,” Bernstein argued the math is “pretty straightforward.” 

“You have to cut spending, raise taxes, or some combination of both,” he said.

On the tax-raising front, without breaking manifesto pledges, Bernstein thought there were options “including freezing [income] tax thresholds … for a couple of more years through to 2030.” 

“I’ve seen ideas to raise the private health insurance premium tax, some pension tax reform,” he added. “I think there’s a proposal to reduce the revenue level at which businesses pay VAT. And that has potential … [to] be quite revenue-positive.”

Chair of the US Council of Economic Advisers Jared Bernstein. | Samuel Corum/EFE via EPA

He added: “One has to be mindful of raising the tax burden when growth is already underperforming. But I think some of the suggestions that I just walked through seem pretty marginal to me, so perhaps there’s some action there.”

Manifesto promises could go — Ruth Curtice, chief executive of the Resolution Foundation

Ruth Curtice, the Treasury’s former director of fiscal policy and now boss of a key living standards think tank, said Reeves should consider raising taxes and cutting Whitehall spending — including 2028-29 totals that were set at her spending review just weeks ago. But Reeves should not, Curtice cautioned, touch her fiscal rules.

This is especially true because Reeves’ next budget will have less wriggle room. She’ll be working within a four-year timeline and not a five-year one, thanks to Reeves’ changes to fiscal rules.

The Resolution Foundation has previously branded the freezing of income tax thresholds a “stealth tax,” but Curtice said Reeves should consider more freezes — and even manifesto-breaching rises in income tax, national insurance or VAT.

“She shouldn’t rule out personal taxes, given the sums of money she needs to raise and the economic challenges of raising further business taxation,” said Curtice. “One option is freezing personal tax thresholds, but she might need to be bolder and explicitly break manifesto commitments if she needs big sums of money.”

Curtice reckoned Reeves needs to show her general direction of travel much sooner than the fall to avoid a summer of speculation. “Some laying the ground on tax could be helpful … Speculation all the way from now until autumn could be unhelpful economically,” she added.

Use Bank of England reserves — James Meadway, former economic adviser to Shadow Chancellor John McDonnell

James Meadway — who was once a policy adviser at the Treasury, went on to advise left-winger John McDonnell, and now hosts a podcast called “Macrodose” — suggested Reeves could save billions of pounds a year by moving to a system of “tiered reserves.”

“The Treasury indemnifies the losses that the Bank of England somewhat notionally makes on quantitative easing,” he said. “If you introduced a system of not paying so much interest on the reserves that the commercial banks hold at the Bank of England, you could save several billion pounds a year on this.”

Meadway acknowledged “the City [of London, Britain’s financial powerhouse] wouldn’t like it” — but reckoned it would be “a lot easier than making more cuts, or raising whacking great taxes elsewhere.”

“It would free up billions for the Treasury to spend to get you through what is otherwise going to be an extremely tight budget,” he said, and “keep within the fiscal rules.

“The problem that Rachel Reeves really sharply faces … is that you have pinned everything on the fiscal rules,” he argued. “If you say we are now going to change them, that will provoke a reaction of the kind we have just seen through bond markets.”

Don’t surprise the markets — Rupert Harrison, former adviser to George Osborne

Rupert Harrison — a key Tory ex-aide who is now a senior adviser at investment management company PIMCO — agreed markets would be spooked by any watering down of Reeves’ fiscal rules, with investors already factoring in tax rises. 

“The gilt market has already started to react negatively to news about the welfare bill, with yields rising relative to other countries, but the scale of that reaction has been limited by a widespread assumption amongst investors that the government’s response will be to raise taxes in the autumn,” he said.

“Any suggestions that the government might look again at watering down its fiscal rules would start to risk a more negative market reaction given the U.K.’s well-known fiscal vulnerabilities,” Harrison added. “Markets now assume that cuts to welfare spending and departmental budgets are effectively off the table — if they start to sense that the political will to raise taxes is also lacking then concerns about fiscal sustainability will grow.”

Gavin Barwell, former chief of staff to Theresa May. | Vickie Flores/EFE via EPA

Give MPs a reality check — Gavin Barwell, former chief of staff to Theresa May

Gavin Barwell, in the trenches as the Theresa May government faced huge disloyalty in the ranks over Brexit, thought Reeves needed to be better at forcing members of parliament to say what hard choices they would actually make.

He drew parallels between the current government’s party management woes and the dilemma facing his former boss. “Different people kept putting to parliament different propositions of how to solve the Brexit question, and parliament just kept saying no, but it never had to say what its answer was,” he recalled.

“You’ve got to do a better job of exposing to your backbenchers what the realm of possible options are. You can’t ultimately change the fiscal arithmetic. Does the government try and borrow some more money? It is quite difficult in the bond markets at the moment.

“Does it tax more? If so, who does it tax? Does it cut spending? If you don’t want to cut spending from welfare, where do you want to cut spending?”

He added: “You’ve got to find some way of confronting [MPs] with the reality of the situation, and having some collective decision-making about what are the least bad ways of trying to navigate out of that situation.”  

‘Labour MPs must decide’ — Luke Sullivan, Starmer’s former political director

“Rachel Reeves’ position is significantly stronger than is often perceived,” Sullivan — an ex-aide to Starmer who is now a director at the consultancy Headland — pointed out. The prime minister’s “full-hearted support” and the “notable vote of confidence from the financial markets” to Starmer’s endorsement of her show “Reeves is not only secure in her position, but pivotal to the government’s economic credibility.”

“While some policy adjustments, such as on welfare, may be understandable,” Sullivan said, he warned Labour MPs must not be under any illusion that the government’s ambitions need anything less than “rigorous fiscal discipline” met by “increased taxation, spending restraint, or other measures.”

He added: “None of these choices will be politically easy, but they are necessary and Labour MPs must decide.”