(Bloomberg) -- UK Chancellor Rachel Reeves could use an imminent review of Labour’s fiscal inheritance to justify tax increases of up to £25 billion ($32.3 billion) in the upcoming budget, according to former Bank of England policymaker Michael Saunders.
Saunders, who is now senior economic adviser at Oxford Economics, expects Reeves to “kitchen sink” all the bad news to “allow her to announce corrective measures to return the public finances to a sustainable path and blame it all on the failings of her Conservative predecessors.”
That would give her cover to announce £10 billion to £25 billion of tax rises, largely on wealth and inheritance, he said in an analysis that adds to speculation over what Labour will do in its first budget, which is expected to be held in October.
The Treasury said only that the assessment will be presented before Parliament rises for the summer recess on July 30.
Reeves has promised to level with the public about the “difficult decisions” that lie ahead since winning the election on July 4. She has described the legacy of 14 years of Tory rule as the worst since World War II - with the national debt at its highest in over 60 years high, the tax burden last larger in the 1940s and public services on their knees.
In her first speech as chancellor, Reeves told officials “to provide an assessment of the state of our spending inheritance so that I can understand the scale of the challenge.”
Alongside the audit, which is being conducted internally by the Treasury, Reeves will also announce the date of the budget. The Office for Budget Responsibility is usually given 10 weeks to prepare a forecast.
The spending plans Labour inherited imply steep cuts to unprotected departments like Justice, where the prisons are full, and Local Government, where councils face bankruptcy. Even protected departments like Health and Education desperately need money for maintenance and new buildings.
The Institute for Fiscal Studies warned before the election that the plans are implausible. Labour signed up to them in the campaign, arguing that growth would come to the rescue.
Saunders said a growth windfall was unlikely for “several years.” As a result, he believes Reeves will use the review for a post-election reassessment that concludes higher public spending and a bigger buffer against the fiscal rules is “more realistic and sustainable.”
He added: “It is also worth considering a scenario in which the review is used to justify significant extra tax hikes, perhaps an extra £10 billion to £25 billion alongside a less aggressive squeeze on public spending and perhaps a tweak to the debt rule. This would be in addition to the revenue-raising measures in Labour’s manifesto, which were worth £8.6 billion per year.”
The strategy of early tax hikes was adopted by Tony Blair’s first government and was followed by two further election victories, Saunders said. In 1997, Labour announced a surprise £5 billion tax hike on dividends that was not in its manifesto.
Saunders said Reeves would target wealth. Aligning capital gains tax with income tax would raise £14 billion, though the revenue would be smaller if inflation indexation was reintroduced as would be likely, he said. Another £3 billion could be raised by limiting inheritance tax relief on agricultural and business assets. Further sums could be generated by expanding national insurance and extending the freeze on income tax thresholds by a year.
Saunders also recommended changing the way the government accounts for the Bank of England’s quantitative-easing program, which “would increase fiscal space by roughly £20 billion.”
To ensure the UK’s growth rate was unaffected, the Bank of England would have to cut interest rates more aggressively, he said. A £14 billion increase in tax would need to be offset by an extra half a percentage point cut in rates. Lower interest rates would give the government another fiscal boost by reducing debt-servicing costs.
(Adds Treasury comment)
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