Labour’s Brexit stance is as untenable as their tax pledge

 

In my last post about the prospect of Labour breaking its tax pledge, I did something I don’t often do, which is indulge in some ‘I told you so's. In doing this I was reminded that there was one other major criticism I had of Labour’s initial economic strategy besides their underestimation of how much taxes they would need to raise, and that was their position on Brexit. Labour’s basic position on Brexit is that it has ruled out not only rejoining the EU, but also joining its single market, or even its customs union.

It should be said that there are important discussions going on that will ease the cost of Brexit in specific ways that are important to particular areas of the economy. But these initiatives, even if the EU plays ball, will not amount to very much in terms of the aggregate economy. It remains the case that if Labour want to undo the economic damage caused by Brexit in a significant way, they need to either rejoin the EU’s customs union or its single market (or both).

Labour’s rhetoric towards the EU is also a lot more friendly than their predecessors. Rhetoric is important, particularly in countering the populism of the right. It remains the case that one of the most potent attack lines Labour and other political parties have against both Reform and the Conservatives is that these are the parties that brought us Brexit.

It is potent because most voters, including many Conservative and Reform supporters, think Brexit has failed the economy. A recent YouGov poll showed that only 11% of voters thought that Brexit had so far been more of a success, while 62% thought it had been more of a failure. Even among either Conservative or Reform voters, more thought it had so far been a failure than thought it had been a success. According to the same poll, the main reason for this verdict is an accurate belief that Brexit has damaged the economy.

Yet even in terms of rhetoric, Labour’s position is still not as strong as it could be. This is because Labour continue to talk in a vague way about the Brexit deal that the Conservatives did, rather than the basics of Brexit itself. Rachel Reeves recently talked about a “rushed and ill-conceived Brexit”. That is fine in attacking the Conservatives, but it allows Farage a simple get out clause, which is that it wasn’t his deal but Boris Johnson’s. Labour cannot respond by saying Farage also wanted to leave the EU’s customs union and single market and that is what has caused most of the economic damage, because Labour also appear committed to exactly that type of Brexit deal.

In policy terms, it is very hypocritical of Labour to say that it focused on growth, and at the same time ignore two policy changes that would have a really substantial positive effect to promote growth. Of course both Starmer and Reeves know this. The eventual 4% reduction in GDP assumed by the OBR is well known, but over two years ago I noted that work by John Springford implied that 4% was an underestimate. A new NBER working paper suggests the same, saying that productivity may already be 4% lower than it would have been without Brexit, and GDP 6-8% lower. This chart helps show why that might be the case (HT‪@davidheniguk.bsky.social). ‬

The reason Labour have ruled out rejoining the EU’s customs union and single market is not because they discount the economic benefits of doing so, but because they (and/or their political advisers) believe that to do either would be politically dangerous for Labour.

There are two reasons why it might be politically dangerous, and it is important to distinguish between the two. The first is that voters would not appreciate the government spending time and energy embarking on a major negotiation with the EU, and the internal debate that this would provoke, so soon after the years in which tBrexit appeared to paralyse UK politics. The second is that rejoining the EU’s customs union and single market, although perhaps popular with most voters, would still upset some of its own (2024) voters in key Labour constituencies (e.g. the red wall).

If the first reason was the most important, then Labour could be honest with voters and simply say that now is not the time. By saying sometime but not now, Labour could also be honest about the damage being outside the EU’s customs union and single market is doing. Many may not agree that the time is not right to make such a major step back towards being part of the EU, but at least the conversation would be about when, not if, and the costs of delay could be discussed more explicitly.

However I suspect the second reason is more important for Labour. This is just one part, albeit a very important part, of their conviction that they must on all accounts not upset socially conservative Labour voters. It goes hand in hand with adopting much of the right’s rhetoric, as well as adopting pointlessly cruel or harmful policies, on immigration. This, at least as much as the tax pledge, is this government’s original sin.

Should Labour see Brexit as part of their attitude to socially conservative voters, or is there something in addition which is special about Brexit? A good way to answer this question is to listen to Anand Menon’s recent masterly talk on the subject. But a key point must be that there has been a rise in right wing populism around the world, including Europe. This strongly suggests that Brexit was essentially a manifestation of this growing popularity, rather than a cause of it. Whether you view this rise as due to the economic consequences of neoliberalism or not, Brexit can be seen as just one of the many manifestations of the growing popularity of right wing populism.

As I and almost everyone else has said repeatedly over the last several months, Labour’s strategy (the McSweeney/Blue Labour strategy) of adopting populist right positions on socially conservative issues might have been sensible in opposition but it does not work for Labour in government. When in opposition, most social liberals would still vote Labour where it mattered because the primary goal was to defeat the Conservative government, and in most constituencies Labour were best placed to do that. Now that they are in government, Labour taking socially conservative positions worries social liberals much more, which is one reason why Welsh nationalists replaced Labour in a recent by-election and why the Greens are advancing in the polls.

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While this is the general reason why Labour’s current stance on Brexit is untenable, there are two specifics that relate to their Brexit pledge. The first is the size of the boost to growth that either joining the EU's customs union or single market would give. This is likely to be bigger than anything else this government could do to increase living standards. Once again, the fact that Labour are now in government rather than opposition is critical. To see the importance of incumbency on voter decisions, look at the swing from Trump in 2024 to the Democrats in recent elections, a swing that is all about the economy. A little of that swing may be due to Trump's tariffs, but fundamentally it is that the cost of living remains a problem, and voters blame whoever is in government for that.

The second specific reason Labour’s Brexit position is untenable is that, like the tax pledge, it was very likely to constrain Labour not just after the 2024 election, but in future elections as well. Using the last Labour government as an example, Labour were always likely to find it harder to get elected the longer they were in government. If this is the case, both the Brexit pledge and the tax pledge would in effect bind Labour until they got voted out of government, because the electoral arguments for making these commitments would only increase over time.

For both tax and Brexit this is an impossible position for Labour to put themselves into. With tax, because health costs trend up over time (as they have done in almost every country over the last few decades) and with a commitment to increase defense spending as a share of GDP, major taxes just have to rise at some point over the next decade [1], even if you ignore the arguments for increased public spending now.

Equally with Brexit simple demographics mean that the number of voters who are opposed to Brexit will only increase over time. As a result, Labour’s pledge not to fundamentally alter the terms of Brexit is not tenable over the next decade. Labour, and to be honest much of the country, are in desperate need of stronger economic growth right now, and so it would make sense [2] for Labour to follow the abandonment of their tax pledge with initiating discussions on how Great Britain could rejoin the EU’s customs union. [3]

[1] The best way of trying to reduce this upward trend is to spend more on preventative health, as the IPPR argues here. However that takes a lot of investment and is unlikely to yield quick benefits.

[2] Of course it making sense does not mean that it is what Labour will do. It is Labour's fiscal rule that is forcing it to (probably) break its tax pledge. With Brexit there is nothing similar to overcome a misguided strategy and force Labour's hand. 

[3] As I argued here, it makes sense in political terms to rejoin the EU’s customs union before its single market.

UK Productivity and the Budget

 

Most people reading this will know that one of the Chancellor’s big problems that she will have to tackle in the November Budget is a downgrade to expected productivity growth. You might have read that lower productivity growth implies lower overall growth, which means less growth in incomes and spending and therefore less growth in taxes. Because the Chancellor’s key fiscal rule states that expected future taxes have to match expected future current spending, that means taxes will have to be increased in the budget. [1]

So how might the Chancellor increase taxes? Before the previous budget I looked at various options to tax the more wealthy while sticking to the pledge not to raise the big three: income tax, employee NICs and VAT. In the last few weeks the Prime Minister has failed to insist that this pledge still stands, and this has led to a lot of speculation that the Chancellor may be forced to raise tax rates for at least one of these big three. Faced with not just a productivity downgrade, but the need for more headroom and ending the two-child limit, the Chancellor needs to find a lot of money.

There are some obvious things to say about this. First, it would have been better to do this earlier. I’m not going to resist the opportunity to say this isn’t just hindsight on my part. When, shortly after gaining power, the Chancellor discovered the state of public finances was even worse than she expected and ended (temporarily it turned out) the winter fuel allowance, I wrote

“I still fear that Labour are underestimating the extent of money they are going to need to spend to restore public services. Promises they made during the election also limit the amount of taxes they can raise. Yesterday was the ideal opportunity to say that those promises had been made on the basis of false information. It was now clear that cuts to national insurance contributions over the last year were unaffordable, and that they would be reversed by Labour. That opportunity has been missed.”

Further political opportunities arose after the election of Donald Trump and his subsequent obsession with tariffs. Before the previous budget I wrote

“The problem the Chancellor has is that an increase in taxes of the order of magnitude required to end austerity is very hard to achieve while keeping her commitment not to raise income taxes, employees NIC or VAT.”

After the last budget I wrote

“However, the political danger of moving gradually, in part because one hand is tied behind your back (no tax rises on working people), is that you disappoint those who are naturally impatient to see improvements in public services across the board. A political environment where voters know taxes are rising but where problems in public service provision (including child poverty) continue to fill the headlines is not a comfortable one for any government, because it raises issues of competence in voters’ minds (where is the money going?). Equally risky is continuing to try and flatter the marginal voter (or petrol user!) when you are in danger of losing your political base. I suspect, once the immediate and rather predictable political controversy is over, this budget will be seen as the minimum that could have been done, and that something bolder might have been less risky in the longer term.”

I hope these quotes make clear that, when it comes to breaking their tax pledge, the phrase ‘better late than never’ applies. It is far better to break the tax pledge now than in a budget nearer the election, both from a political and economic point of view. The politics are obvious, but the longer the Chancellor appears wedded to this tax pledge, the more it will be asked whether this overrides her commitment to meet the fiscal rule involving the current deficit.

Furthermore, a downgrading of UK productivity growth reflecting recent poor performance can reasonably be blamed on Labour’s inheritance. Some will argue that the OBR’s reassessment is long overdue, and if it had occurred under the previous government then its cuts to employee NICs may well have been untenable. While it is impossible to know exactly why recent UK productivity growth has been so bad, one plausible cause is Brexit, and it may well be that the OBR’s previous assumption of an eventual 4% hit to the level of productivity from Brexit may be too low.

If the Chancellor does break the tax pledge, then I hope it will involve a rise in income taxes rather than a rise in VAT or personal NICs. A rise in VAT seems unlikely, given a recent statement from the Chancellor about wanting to reduce cost of living pressures and allowing interest rates to fall further. As the Resolution Foundation notes, internationally the UK stands out for its low personal income taxes. Higher income taxes are preferable to higher employee NICs because they hit all incomes, not just earnings.

From a political point of view, one way to soften the damage caused by breaking their tax pledge is for the government to both increase and reduce some of the big three taxes. The government is considering exempting electricity bills from VAT altogether (currently taxed at 5%), and this could be combined with higher income taxes. [2] Of course the net effect would have to be to raise revenue, but nevertheless the Chancellor could argue that she wanted to cut energy bills, and the only way she could do that in the current situation was to break her previous pledge.

Another possibility, suggested by the Resolution Foundation, is to cut personal NICs and raise income tax. This could be done in a way to leave most workers no worse off, but it would raise revenue because income tax applies to all income (including pensions) while NICs only applies to earned income. It’s an option that is attractive to many economists, because having two different taxes on earned income with different allowances and exemptions is messy and therefore inefficient.

What also seems clear from a political point of view is that if the Chancellor is going to break her tax pledge, she should do so in a big rather than small way. Labour will be attacked for breaking its pledge whether it does so in a big or small way, or to use economic jargon, there is a large fixed cost element in breaking the pledge. What she wants to avoid at all costs is finding herself in the same situation in a year or two years time.

Of course it is possible that all the talk of breaking the tax pledge is just the government managing expectations, and that when the Budget is announced Reeves will tell us that she has managed to raise enough taxes without breaking Labour’s commitment on the big three. This might avoid some short term political costs, but at the significant risk of much higher costs later on. As the quotes above make clear, it would be repeating the mistake the Chancellor made last year.

[1] If the Chancellor focuses on tax increases rather than spending cuts, this will mean that the expected share of public spending in GDP will rise a little. As regular readers will know, I think that if we are to get back to levels of public sector provision that we saw under the last Labour government, then the share of spending in GDP needs to rise substantially. This gets us a little way towards that. If you like using the austerity word, it means a bit less austerity.

Now lower GDP but unchanged public spending need not make us better off. Crucial here is what happens to public sector productivity. Lower private sector productivity will mean, other things being equal, lower private sector real wage growth. If the downgrade to total productivity is confined to the private sector, and if public sector real wages follow private sector real wages, then existing public spending plans will have room to employ more public sector workers and therefore raise levels of public sector provision.

[2] A zero VAT rate for electricity bills is a classic example of a measure which is easy to understand (and therefore politically attractive) but is also problematic in economic terms. It obviously discourages fuel economy. It gives most help those with high electricity bills, and therefore fails to concentrate help on those that need it most.