Journalist Jeremy Warner recently argued that further tax rises under the current Labour government would exacerbate the UK’s economic woes. While his critique captures the frustration of many, it is rooted in faulty economic beliefs—particularly those that treat taxation and spending as intimately linked within a fixed budgetary framework. Such ideas might hold sway in a fixed exchange rate system, but they fail to account for the monetary realities of a floating currency like Sterling.
Here’s the article he should have written:
Sluggish Economies Need More Spending, Not Less
When in a hole, stop digging. Unfortunately, the government seems determined to reach for the shovel, doubling down on economic missteps instead of addressing the underlying issues.
Economics isn’t complex: if an economy is stalling, the last thing it needs is dampening demand through austerity or ill-conceived tax hikes. Yet we’re witnessing just that—a perpetuation of flawed fiscal rules and a failure to understand monetary dynamics. It’s not just misguided; it’s counterproductive.
The government’s fiscal rules stipulate that revenues must balance day-to-day expenses and that debt, measured as public sector net financial liabilities (PSNFL), must fall as a percentage of GDP within five years. While these rules might seem sensible, they’re based on misunderstandings of how money and taxation work in a modern floating exchange rate economy.
Capital Spending: The Key to Balancing the Budget
Here’s the reality: government spending drives taxation, not vice versa. Every pound the government spends circulates through the economy, generating taxation along the way. Roughly 85% of expenditure returns as tax revenue, while the remaining 15% is saved by individuals or businesses, showing up as the government’s so-called “deficit.”
Given this, balancing the current budget—day-to-day spending versus revenue—is not a challenge if the government shifts its focus to capital expenditures. Investments in infrastructure, housing, and public services not only avoid the current budget calculation but also stimulate economic activity, creating jobs and driving the very tax revenues needed to satisfy fiscal rules.
Reassessing the Role of the Private Sector
Concerns about the flight of capital—wealthy individuals moving abroad—are overstated. Sterling-denominated assets cannot leave the economy; they merely change hands. And considering the lack of substantial investment from the ultra-wealthy over the past decades, transferring ownership to those more likely to spend or invest productively could actually revitalise economic activity.
The same logic applies to businesses. The government’s decision to increase National Insurance may lead some firms to release staff, but this isn’t a crisis—it’s a reallocation of resources. Public sector spending, which has increased by 4.8%, will absorb many of these workers, either directly or in firms servicing the public sector. This deliberate shift reflects voters’ priorities: stronger public services and investment over business tax cuts.
The Myth of Fiscal Headroom
The idea of “fiscal headroom”—the gap between revenues and spending as a measure of affordability—is an illusion. Governments with monetary sovereignty, like the UK, are not constrained by revenue when it comes to spending. The true constraints are physical: Do we have the workers, materials, and infrastructure to deliver the desired projects?
For example, increasing capital expenditure to build housing or upgrade transport networks doesn’t just create jobs; it enhances the economy’s capacity, generating long-term growth. This is where the focus should lie—not on arbitrary fiscal targets but tangible improvements in the country’s productive capabilities.
Why Fiscal Rules Are Performative
The fiscal rules are little more than political theatre. History shows they are revised or abandoned whenever they threaten to constrain necessary action. They exist to appease markets and critics, but they’re not binding in any meaningful sense. Instead of adhering to these artificial constraints, the government should prioritise reality-based decision-making.
A sound economic policy would abandon these rules entirely and focus on the fundamentals: do we have the people, resources, and processes to implement the projects that will improve lives and drive growth? If so, spend. If not, invest in building those capacities. Anything else is a distraction.
A New Path Forward
To escape the current malaise, the government must embrace an investment-led recovery. Public spending on infrastructure, healthcare, and education isn’t just a moral imperative; it’s an economic one. These investments create jobs, stimulate demand, and lay the groundwork for sustained prosperity.
Correctly targeted, such investments will “crowd in” private sector investment. By increasing overall demand and reducing economic uncertainty, the government can create an environment where businesses feel confident to invest. Reduced risk and higher potential returns incentivise private enterprises to participate in the economic recovery, further amplifying growth.
The UK’s fiscal framework should reflect this reality. By recognising the dynamic relationship between spending and taxation and leveraging the flexibility of a floating exchange rate system, the government can meet its fiscal goals without undermining the economy.
In times of economic stagnation, the solution isn’t to tighten belts but to invest boldly. The question isn’t whether we can afford it—it’s whether we can afford not to.
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