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Former Bank of England governor Mervyn King has made a dramatic intervention warning Rachel Reeves that she must raise national insurance in her Budget on 30 October.
According to the Institute of Fiscal Studies (IFS), the chancellor has an estimated £25bn black hole to fill in order to meet Labour’s spending commitments.
But in an open letter published in The Independent, Lord King warns her against higher borrowing.
Lord King, who was once the chancellor’s boss at the Bank of England, has told her: “Keep it simple and be ruthlessly honest with the public.”
And he warned: “Resist the temptation to fiddle with the tax system – it is time to take a proper look at the various schemes that have been introduced by successive chancellors since the last major overhaul by Nigel Lawson.”
But the Tories have claimed that, if she raises any form of national insurance, as has been hinted, then it would be a breach of the manifesto promise to voters – a point the IFS’s Paul Johnson echoed yesterday. He said: “It seems to me that would be a straightforward breach of a manifesto commitment. I went back and read the manifesto and it says very clearly, ‘We will not raise rates of national insurance.’ It doesn’t specify employee national insurance.”
Mr Johnson had previously warned during the election that the main parties’ tax and spend pledges represented a “conspiracy of silence” on the true picture of the country’s finances.
In a warm open letter which harked back to her days as a graduate entrant at the Bank, Lord King made a point that the baton has now been passed to Ms Reeves and her generation.
“I remember your telling me one day that the reason you enjoyed working at the Bank of England was the opportunity to work with other very bright young people. Your generation is now in charge.
“Be courageous, be bold, and ensure that the economic inheritance we leave to our grandchildren is one of which both they and we can be proud. One day, you will look back on your time as chancellor and you will want to remember the far-reaching changes you made – not the political compromises that others will urge on you.”
He also told Ms Reeves that she must stick to her policy of making tough decisions but do so by “tackle the vested interests”, including the trade unions, who are still the main funders of the Labour Party.
“the biggest challenge facing you and your colleagues will be to tackle the vested interests that will resist reform – whether that’s NHS bureaucracy, teachers in schools and universities, planning authorities, trade unions, and the many others who will defend their current interests,” he noted.
But he also believed that national insurance rises should be clearly targeted at paying for investment in the economy to achieve growth and pushed her to encourage people to save for pensions again.
The significant intervention comes on a day where prime minister Sir Keir Starmer has again strongly hinted that there may be tax rises via employers’ contributions to national insurance.
During the general election Labour restricted its room for manoeuvre by pledging “not to raise taxes on working people” including income tax, VAT and national insurance contributions from employees. Ms Reeves limited her options further yesterday by promising business leaders at the International Investment Summit that she would also cap corporation tax at 25 per cent.
There has been widespread speculation that Ms Reeves is considering other dramatic measures, although Sir Keir has insisted reports they would increase capital gains tax to as much as 39 per cent are “wide of the mark”.
Other potential moves could see international aid slashed as a proportion of GDP as well as wealth taxes including capital gains and inheritance tax rises.
But with Ms Reeves said to be considering rewriting the fiscal rules to allow more borrowing, Lord King has warned that the markets will not be fooled.
“Pretending that stability of the public finances is achieved by changing the definition of debt, deficits or the fiscal rule is an illusion,” he wrote in his Dear Rachel letter.
“Financial markets know that higher borrowing means higher borrowing. A new fiscal rule – such as taking into account public assets as well as public liabilities – will not make your task easier.”
He added: “Avoid slogans such as ‘borrowing for investment’. There is only one sensible definition of fiscal sustainability. It is that the structure of tax rates will generate sufficient revenue to allow the ratio of debt to national income to fall slowly but steadily in normal years.”
Instead, he pressed for a rise in national insurance contributions and urged Ms Reeves to be honest with the public about it.
“An honest approach would be to say that such a commitment now appears a mistake and to return National Insurance contributions to their previous level. You might be surprised by how many citizens would accept such honesty; better to tackle the problem now and not a year or so before the next general election.”
Lord King also warned that the UK “cannot afford to invest more unless we save more”. He urged Ms Reeves to avoid measures “that might depress private saving”.
He added: “The time is also ripe for a fundamental change to our system of pensions. Thirty years ago, the UK had a defined benefit pension systems that was the envy of the world. Today, because of the unintended consequences of both regulation and low interest rates, it has virtually disappeared for new entrants in the private sector.”
