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The next Labour government will have to find at least £26bn in new tax rises if it wants to end austerity, invest in infrastructure, reverse social security cuts and live within its own budgetary rules, according to Financial Times research. 

The brutal maths of the public finances mean that shadow chancellor John McDonnell’s plan for £250bn of increased public investment over 10 years uses up all of the wriggle room in Labour’s fiscal credibility rule. The UK opposition party has pledged to keep public debt lower as a proportion of national income at the end of a parliament than at the start. 

The Office for Budget Responsibility, the official fiscal watchdog that Labour wants to strengthen, is unlikely to find much capacity for additional borrowing above Labour’s plans for extra capital spending. 

Robert Chote, chair of the OBR, told the FT: “On our current outlook for the economy, a government of any colour would not be able to increase borrowing by more than around £25bn a year if it wanted to keep the debt ratio falling.”

Mr McDonnell said the party’s programme would “end austerity, eliminate in-work poverty and drive up living standards across the UK economy”.

With British politics in turmoil over Brexit and the chances of a snap general election fast increasing, the Financial Times is this week examining the consequences for the UK economy of a Labour government.

Mr McDonnell’s commitments since 2017 will need to be backed with additional tax increases — unless the party decides to loosen its fiscal rules, or disappoint its millions of followers with a more limited plan of commitments. 

At the 2017 election, Labour backed plans for additional public spending of almost £50bn a year, including ending student loans, with proposals for the same level of tax increases, although many experts said the assumptions underlying its calculations were over-optimistic. 

Since then, the list of spending proposals and commitments has increased, with Mr McDonnell saying in July that the 2017 manifesto proposals had been “radicalised”. 

Some of those manifesto commitments, such as the cost of abolishing university tuition fees and reinstating maintenance grants, have become more expensive. Mr McDonnell has expanded his pledges to reverse the social security cuts imposed since 2015. Both the shadow chancellor and Jeremy Corbyn, Labour leader, have repeatedly pledged to end austerity in public services. And there are also additional costs for the public sector to bear from an ageing population over the next five years. 

In total, these limited aims would add at least £26bn a year to the total cost of Labour’s 2017 spending pledges, according to FT calculations, based on cautious assumptions by the end of the next parliament. The assumptions are much more modest than a Labour Party dossier last year, which priced the bill to end austerity alone at £42bn a year. 

But Labour’s spending plans are only one element of what Mr McDonnell has promised to be a “fundamental reshaping” of the way the economy works under a Labour government as he pursues his goal of eradicating poverty. 

McDonnell’s vision 

Mr McDonnell has been circumspect in his commitments. He has welcomed a series of radical proposals from think-tanks on the left — ranging from a wholesale shake-up of the use and governance of land, to a rewrite of the Bank of England’s mandate and a trial of a universal basic income — but has given only broad-brush hints on which measures might become official party policy.

Yet the scope of the shadow chancellor’s ambition to drive change is clear. In a speech at the Resolution Foundation in July, he mapped out three ways in which a Labour government would act: by reshaping the economy, transforming public services and redistributing wealth to eradicate poverty. 

As he looks to reshape the economy, Mr McDonnell wants to use the power of the state, with an agenda incorporating reforms of labour markets, corporate governance and ownership, and industrial policy. 

He argues that plans for workers to receive a higher minimum wage, stronger bargaining rights and representation on company boards will not only give people more control over their working lives, but will also boost productivity. 

McDonnell’s three pillars

  • Reshape the economy
  • Transform public services
  • Redistribute wealth 

The party’s proposed nationalisation of rail companies, utilities and the Royal Mail is part of a broader shake-up of ownership, in which employees would receive a stake in the companies they worked for and co-operatives would be a favoured model. 

The state would also play a much more active role in directing investment — with Mr McDonnell framing this as a government-led “green industrial revolution” to tackle climate change. The £250bn transformation fund would support the transition to green energy — especially in job-intensive areas, such as retrofitting homes to make them energy efficient. 

Much of the action would be at local level, with a network of regional development banks channelling a further £250bn of private sector lending. Mr McDonnell quips that he “cheered Mark Carney up” with plans to relocate Bank of England staff to Birmingham, and says he will also be “splitting up No 11” by moving teams from the Treasury to the north to ensure it receives its share of infrastructure investment. 

Limiting costs to the exchequer

Much of this structural agenda carries no necessary direct cost to the exchequer. 

Labour would have to issue debt for its extensive plans for nationalisation and the cost of that programme is heavily disputed, but the money borrowed will purchase assets, which could be sold again in future. Just as a privatisation does not always improve public finances, nationalisation does not necessarily worsen them. Everything will depend on how they are run under public ownership. 

The same logic applies to Labour’s plans for regional development banks. In the analysis of the public finances, the FT did not include any costs from nationalisation. 

For Mr McDonnell, structural transformation is the priority precisely because it is not simply about redirecting tax revenues. In a swipe at the policies pursued by New Labour — and eroded by the coalition government that followed — he said it was “a rejection of the belief that it’s OK if your local factory closes, as long as you have cash transfers from the finance sector in the south east”.

Alfie Stirling, chief economist at the New Economics Foundation, a think-tank, describes the agenda as “a transformation in how the economy rewards those who have a job and those who own capital”. Mathew Lawrence, director of the newly created think-tank Common Wealth, says that as in 2017, Labour’s programme remains “much more around institutions, ownership — much more around how you can reshape the economy to be more equitable and productive by design — than about saying ‘we’re going to spend loads of money’”.

Maintaining fiscal rules

Yet Mr McDonnell’s pledges on infrastructure alone will make it difficult to fund any further commitments without running up against the limits of the fiscal rules the party set itself in 2017: to eliminate the deficit on day to day spending within five years; and to ensure that government debt falls as a share of national income over the five year term of parliament. 

The Transformation Fund is earmarked for investment, so would not fall foul of the first rule. But it entails additional borrowing of £25bn a year on average — the absolute maximum the Office for Budget Responsibility thinks possible while keeping debt falling as a share of GDP.

Moreover, the focus on structural change does not preclude a big increase in spending on public services, Mr McDonnell’s second pillar for a transformed economy. “Universal public services have always been a key demand of the labour movement,” he said in July, adding that achieving this would “free workers from the fear of not having the essentials in life”. 

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Although Mr Corbyn and Mr McDonnell have regularly pledged to “end austerity”, their own costing of that commitment, at £42bn a year, means that a full reversal of the public spending cuts looks too expensive to be on the cards immediately. 

Instead the FT estimated a much more limited cost of fixing day-to-day public spending in line with national income in all departments, while sticking to plans for faster increases in health spending, costing £19bn a year by 2024-25. 

The estimates deducted the health and education commitments in the 2017 manifesto to avoid double counting, implying a cautious assumption that Labour would be no more generous to the NHS than the current Conservative government. Added to these figures is the OBR’s estimate of the costs of dealing with an ageing population (outside healthcare), which rises to £9bn by 2024-25. 

Increasing the size of the state

As well as relieving the strains on public services, Mr McDonnell’s plans imply a significant increase in the size of the state. The biggest new commitment in the 2017 manifesto was the pledge to end tuition fees and restore maintenance grants for students — which was costed at £11.3bn. But the expansion of student numbers since then means that this has increased sharply, and the latest data suggest a cost of £16.2bn for 2018-19 — on the government’s current accounting rules. 

The Corbyn Revolution

The FT examines the effects Jeremy Corbyn’s economic theory would have on business in Britain.

Part one
The push for systemic reform

Part two
How much will it cost?

Part three
Corbyn’s inner circle

Part four
Employee ownership

Part five
Video: Labour insiders talk to the FT

Subscribers can receive alerts when new content is published in this series by following ‘Jeremy Corbyn’ with myFT.

Explaining his third “pillar” — redistribution of wealth — Mr McDonnell said Labour would introduce a strong social safety net that would help people progress at work, secure dignity and “re-establish the principle of universalism, entrenching social security as a public service for all”, words that sounded as if he was warming towards a universal basic income. 

However, given that the Institute for Policy Research at Bath university estimated that if universal payments were made at the level of current social security benefits, the additional cost would be £288bn a year, the FT analysis took Mr McDonnell’s pledge to be much more modest and entail restoring the cuts to social security imposed after 2015. The Resolution Foundation estimates this would cost £10.7bn in 2022-23. Again, the FT deducted the improvements in welfare already promised in the 2017 manifesto to avoid double counting. 

The grand total of commitments additional to those in the 2017 manifesto — a minimal definition of ending austerity and providing for an ageing population in the 2020s — amounts to £26bn a year by 2024-25, the end of the next parliament if there was an election this year. This leaves a big hole Labour would need to fill if it wanted to stick to its pledge to have a lower burden of debt at the end of the next parliament. 

Taxing high earners

During the 2017 election, the Labour Party suggested it could raise £48bn a year from higher income tax for the top 5 per cent of earners, raising corporation tax rates from 19 per cent to their previous level of 26 per cent, reversing inheritance tax cuts and imposing a long list of anti-avoidance measures. 

This would not be enough to fund the more radical programme Labour is now offering, even while ending austerity across government on the most modest definition. The Institute for Public Policy Research has suggested that more than £100bn a year would be needed to end austerity and introduce policies that would enable “prosperity and justice”. 

£26bn 

Amount per year Labour will need by 2024-25 to meet its spending commitments

“Something has to give,” Mr Stirling said. He advocates fundamental changes to fiscal rules, arguing that governments should be able to borrow more not only in response to economic shocks, but also to avert crises, such as the climate emergency. But he said Labour appeared more likely to look for new sources of tax revenue to fund its ambitions.

Higher taxes are not an impossible demand in Britain today. The public mood has shifted since 2017, with public support for austerity waning, and Conservative ministers making extravagant promises of both tax cuts and higher spending.

But given concerns from the Institute for Fiscal Studies that Labour’s 2017 tax proposals would not raise the sums promised, the more radical programme Mr McDonnell intends will be even more difficult to finance without resorting to general tax increases. 

For now, Mr McDonnell appears to be looking again at the rich and their wealth as a source of additional revenues, something that did not feature strongly in the 2017 manifesto. The lack of a mansion tax then might soon be replaced by a recast council tax, targeting expensive properties and other forms of wealth. 

But the ultimate calculations will be political. In office, chancellors often find costings performed by the civil service are not as favourable as those made in opposition. 

If Labour win an election and Mr McDonnell enters Number 11, he will find it extremely difficult to meet expectations of higher public spending unless he also delivers tax rises for the many. Not everyone will get everything they want from the Treasury and Mr McDonnell’s first task may be to say “no” and disappoint many people on the radical left. 

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