Escaping a spending pledge ‘black hole’

In a speech that is likely to have infuriated physicists, UK chancellor Jeremy Hunt claimed last week that there is a £38bn ‘black hole’ in the tax revenue raising measures behind Labour’s proposed spending commitments over a four year period to 31 March 2029. 

The chancellor’s premise is that Labour would need to raise more in taxes or break their fiscal rules in order to plug this apparent gap in funding. To say this writer’s knowledge of astrophysics is limited would be an understatement but isn’t a black hole inescapable and incapable of being filled? That would be an entirely different political accusation to make so perhaps ‘black hole’ wasn’t the best choice of metaphor in these circumstances.

As it stands, Rachel Reeves is yet to swing back in this particular rally and there may be some reticence for her to do so. Given Jeremy Hunt’s propensity for flattery through imitation, Ms Reeves may have concerns that any new policies she announces might provide inspiration for the chancellor to cut National Insurance contributions (NICs) further ahead of an election. 

There will inevitably be detailed scrutiny of the funding plans supporting both major parties’ manifesto pledges in due course. The difficulty is that there are now very few places that Mr Hunt and Ms Reeves can realistically turn to in order to generate further tax revenues. 

An increase in income taxes or NICs is unlikely to be palatable to voters. A rise in VAT rates could be inflationary and regressive, having a greater impact on those at the lower end of the income scale. Both parties appear to believe corporation tax has risen as far as it should, and fuel duty has been frozen for 14 years.

It leaves a dwindling list of taxes, and all paths appear to lead towards capital gains tax (CGT), the largest remaining source of tax revenues. CGT revenues have risen to record levels in recent years, in part fuelled by speculation that rates may rise which has driven disposals. The latest figures from HMRC suggest CGT revenues were a little over £15.4bn in the year to 31 March 2024, down from £16.9bn from the year before. 

The shadow chancellor doesn’t appear to want to go in that direction from previous statements made but there is likely to be increasing pressure for her to do so. The economist Arun Advani, whose research helped inform Labour’s thinking on non-doms, has previously suggested that aligning CGT rates with income tax rates could raise as much as an additional £16.7bn annually. The temptation based on those figures is plain to see.

The danger is that extra CGT revenues could prove to be a mirage. A significant proportion of CGT revenues are paid by a small minority of CGT taxpayers. As a result, a change in rates could easily shift behaviours and in turn, the level of CGT receipts. The chancellor appears to be laying breadcrumbs for his counterpart to follow and Ms Reeves may be wise to be wary of where they lead.