As John Healey prepares to deliver the Budget this Wednesday, it’s already clear that Labour are looking for ways to keep on borrowing and spending more. Last week, a new report from the Centre for Policy Studies warned that Labour could use a loophole in the fiscal rules created by Rachel Reeves to borrow more off the books – by increasing funding to Public Financial Institutions, known as PuFins.
And, lo and behold, the FT promptly reported that £20 billion more would be allocated in the Budget to the British Business Bank and the National Wealth Fund. The CPS report’s author Tim Dier wrote for CapX about why the Government needs firm fiscal management and budgetary restraint – not an increasing reliance on financial wheezes. It’s my piece of the week. Find out more below.
We also featured Sean Ridley, the energy and environment researcher for the CPS, on why the Government can’t rest on its laurels after approving the Jackdaw field in the North Sea and should now approve drilling in Rosebank as well. James Price also urged the Government to reopen the North Sea and permit fracking to avoid the growing threat of blackouts.
Daniel Herring, Head of Economic and Fiscal Policy for the CPS, looked at the latest International Tax Competitiveness Index, which ranks the UK 30th out of 38 countries. To improve our ranking, he argues the Chancellor should focus on tax simplification, broadening the tax base and removing exemptions. A new wealth tax, by contrast, would push us down to 35th place.
Meanwhile Harry Phibbs analysed whether family firms can survive Labour’s reported plan to close a tax loophole – by almost doubling the tax rate for passing a family business on to your children compared to selling it to a stranger. With three-quarters of SMEs in Britain family-owned, it’s probably not the best idea.
What could be more damaging to the social as well as the economic fabric of the nation than to single out family businesses for punishment? Yet that seems to be the idea
Elsewhere, Nigel Biggar encouraged us all to stand up for our islands’ history and help preserve the valuable traditions and institutions we have inherited. Mel Stride warned that Healey’s Budget will be built on sand, with too little headroom and spending plans that won’t survive contact with reality. And in his latest column, John Penrose argued for getting rid of benefit cut-offs and tax cliff edges for both high and low wage earners.
On The Capitalist this week, CapX’s editor Marc Sidwell sat down with David Frost, who led the UK’s Brexit negotiations and later served as Brexit minister under Boris Johnson. Lord Frost argued that the campaign to keep Brexit’s freedoms needs to start now, and explained why he thinks neither the Conservatives nor Reform UK are yet going far enough, and what it would take to make the Civil Service serve ministers again.
Oscar Gill-Lewis
Deputy Editor, CapX
Labour need to stop using smoke and mirrors accounting
Tim Dier
Imagine borrowing £10,000 from the bank, lending it to a friend, then telling everyone the debt’s gone – because your friend owes you the money.
That’s obviously nonsensical – you still owe the same £10,000 to the bank, regardless of what you did with the money. But that’s Labour’s approach to our public finances. Let me explain how it works.
In his first Budget, John Healey will likely use PuFins to bury even more borrowing, channelling billions into Labour’s pet projects
Public Financial Institutions (PuFin) are publicly-funded bodies that invest taxpayer money via loans, equity investments and guarantees – with the aim of encouraging or ‘crowding in’ private capital, driving policy goals such as green energy or other infrastructure investment.
As I explain in my latest research, prior to 2024, borrowing for PuFins showed up in public sector net debt excluding Bank of England (PSND ex BoE), just as borrowing to build a road would. This handbrake kept the Government honest and meant PuFins were used sparingly.
But in Rachel Reeves’s first Budget, she changed the fiscal rules, from considering PSND ex BoE to considering public sector net financial liabilities (PSNFL).
This meant that the ‘investments’ that PuFins make could largely offset the debt taken on to fund them. Almost like magic, the debt all but disappears from plain sight and barely registers against the fiscal rules.
In fact, had the old PSND target been kept, the October 2024 Budget would have broken the debt rule by £5.8 billion. Under the new PSNFL target, it passed with £15.7bn of headroom. This ultimately allowed the Government to spend more. Needless to say, PuFins have become the Government’s favoured instrument.
Louise Haigh MP, one of Prime Minister Andy Burnham’s principal strategists, doesn’t hide her desire to circumvent the fiscal rules. Writing in Renewal, she argued: ‘we should enable the newly established National Wealth Fund to borrow against their existing balance sheet outside of the fiscal rules.’
The problem is that we’ve been here before. As The Restorationist magazine pointed out, it has all the hallmarks of the Private Finance Initiative (PFI).
Under PFI, accounting treatment kept borrowing off the books, with grave long-term financial consequences for taxpayers. Tony Blair and Gordon Brown, who were responsible for the overwhelming majority of PFI deals, used them to pay for schools, hospitals and other infrastructure worth around £60bn, but taxpayers were handed a bill of nearly £200bn.
The desire to use PFI was driven by accounting smoke and mirrors. History could be repeating itself with PuFins. In his first Budget, Chancellor John Healey will likely use them to bury even more borrowing, channelling billions into Labour’s pet projects.
The state has a poor track record of picking winners at the best of times. With National Wealth Fund capital earmarked for a plethora of projects from green hydrogen through to carbon capture, the taxpayer may never see that money again, let alone any investment return that exceeds the cost of 10-year Government borrowing, which is now over 5.4%.
One case where a PuFin might make sense is financing a fleet of standardised, gigawatt-scale, multi-reactor nuclear power stations. Creditors would recognise the economic value of plentiful energy, and the plants could be sold once operational to pay down the borrowing.
But that’s not what’s happening. The British Business Bank, another PuFin, instead focuses on asking applicants to demonstrate gender and ethnic diversity at all levels of their business, and views organisations with a clear commitment to diversity and inclusion more favourably in its investment decisions. Investment returns on taxpayer money are clearly of secondary importance.
The National Audit Office flagged another risk, warning that overlapping PuFin mandates could concentrate exposure in particular areas, crowding out private investment. Quite an irony, given that one of the arguments in favour of PuFins was that they help mitigate market failure.
The more pressing reality is that this kind of overly complex financial engineering through PuFins does nothing to fool the UK’s highly sophisticated international creditors or bond traders. All it does is demonstrate an increasing determination to deny financial reality and shy away from tough choices – which further undermines the UK’s financial credibility.
What the Government needs now is to demonstrate financial common sense, firm fiscal management and budgetary restraint – not an increasing reliance on financial wheezes such as PuFins, designed to keep clear liabilities away from headline borrowing totals and meet overly flexible fiscal rules.
Hiding debt doesn’t make it disappear – it just encourages massive over-spending, weakening our public finances even more. We need to find ways to balance the budget, cut debt and ensure the state takes up a smaller share of the economy than it does now. It’s time to clip the PuFins’ wings before it’s too late.
And if you want more…
– How Britain lost its energy edge (Sebastian Charleton)
– Why small business has lost faith in Westminster (Robert Colvile)
– I’m on PIP – and I want welfare reform (Luke Murfitt)
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We’ll be back on Monday.
Tim Dier's £10,000 loan analogy explains the PuFin issue more clearly than most Treasury briefings would. Switching the target from PSND to PSNFL turned a £5.8bn breach in October 2024 into £15.7bn of headroom, which tells you how much work the accounting choice is doing. The PFI comparison seems apt, since around £60bn of assets ended up costing taxpayers close to £200bn once the bills came due. A fresh £20bn for the British Business Bank and the National Wealth Fund may well back some useful projects, but the state's record of picking winners is mixed at best, and markets tend to notice when headroom is manufactured. Add a possible wealth tax and the change on passing down family firms, and Wednesday could be a rough day for investment. Curious whether the OBR flags the PuFin route explicitly in its forecast.