Mervyn King, the former governor of the Bank of England, has made a dramatic intervention to warn Rachel Reeves that she must increase national insurance in her budget on 30 October.
The Chancellor has an estimated £25bn black hole to fill to meet Labor’s spending commitments, according to the Institute for Fiscal Studies (IFS).
However, in an open letter published IndependentLord King warns him against higher debt.
Lord King, once the chancellor’s boss at the Bank of England, told him: “Keep it simple and be brutally honest with the public.”
And he warned: “Resist the temptation to game the tax system; it’s time to take a proper look at the various schemes introduced by successive chancellors since Nigel Lawson’s last major overhaul.”
However, the Conservatives claimed that if he introduced any form of national insurance as hinted at, it would be a breach of the manifesto promise made to voters; This was a point echoed by IFS’s Paul Johnson yesterday. He said: “It seems to me that this would be a direct breach of the manifesto commitment. I went back and read the manifesto and it says very clearly, ‘We will not increase insurance rates.’ It does not specify the national insurance of employees.”
Mr Johnson has previously warned that the main parties’ tax and spending pledges during the election were a “conspiracy of silence” over the true picture of the country’s finances.
In a warm open letter reminiscent of his days at the Bank as a graduate student, Lord King stated that the baton had now been passed to Ms Reeves and her progeny.
“I remember you told me one day that the reason you liked working at the Bank of England was the opportunity to work with other very bright young people. Now your generation is in charge.
“Be brave, be courageous and ensure that the economic legacy we leave to our grandchildren is one that both they and we can be proud of. “One day, when you look back on your time as chancellor, you will want to remember the far-reaching changes you made, not the political compromises others forced on you.”
He also told Ms Reeves that she should stick to her policy of making tough decisions but do so “addressing vested interests”, including unions, which are still Labour’s main funders.
“The biggest challenge you and your colleagues will face will be tackling vested interests that will resist reform, whether that be the NHS bureaucracy, teachers in schools and universities, planning authorities, unions and many others who will defend their existing interests.” he stated.
But he also believed that national insurance increases should be explicitly aimed at paying for investments in the economy to deliver growth, leading him to encourage people to re-save for pensions.
The significant intervention comes on a day when Prime Minister Sir Keir Starmer again strongly hinted that there could be tax increases through employers’ contributions to national insurance.
During the general election, Labor limited its room for maneuver by promising “not to increase taxes on employees”, including income tax, VAT and national insurance contributions levied on employees. Ms Reeves further limited her options by promising business leaders at the International Investment Summit yesterday that she would also impose a 25 per cent cap on corporate taxes.
There is widespread speculation that Ms Reeves is considering other dramatic measures, but Sir Keir insisted reports that they would increase capital gains tax by up to 39 per cent were “off the mark”.
Other potential moves could include reducing international aid as a share of GDP, as well as reducing wealth taxes, including capital gains and inheritance tax increases.
But after it was reported that Ms Reeves was considering rewriting financial rules to allow more borrowing, Lord King warned markets would not be fooled.
“It is an illusion to claim that stability in public finances will be achieved by changing the debt definition, deficit or fiscal rules,” Dear Rachel wrote in her letter.
“Financial markets know that higher debt means higher borrowing. A new fiscal rule that takes into account public liabilities as well as public assets will not make your job easier.”
He continued: “Avoid slogans such as ‘borrowing for investment purposes’. There is only one logical definition of financial sustainability. “The structure of tax rates will generate enough revenue to allow the debt-to-GDP ratio to fall slowly but steadily in normal years.”
Instead he pressed for national insurance premiums to be increased and called on Ms Reeves to be honest with the public about it.
“It would be honest to say that such a commitment now looks like a mistake and to revert National Insurance contributions to their previous level. You might be surprised how many citizens will accept this kind of honesty; “It is better to resolve the issue now rather than 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 could “suppress private savings”.
He added: “It is also time for a fundamental change in our pension system. Thirty years ago the UK had defined benefit pension systems that were the envy of the world. Today, this has all but disappeared for new entrants into the private sector, due to the unintended consequences of both regulation and low interest rates.”