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Another Turning Point: Pre-1997 Election Bear Traps and Labour 'Prudence'

As mentioned at the outset, the squeeze episode described in this chapter was unusually long-drawn-out partly because one party's outline plans for spending restraint and limiting borrowing were matched by a successor in government from a different party, albeit with important changes in the composition of spending. Indeed, that party convergence may help to explain why spending actually fell in that election year.

The Party convergence came about because after 1992, Labour's electoral strategy involved adopting a 'centrist' stance designed to appeal to swing voters by accepting many of the changes made by the Conservatives since 1979—particularly when Tony Blair succeeded Neil Kinnock as Labour leader in 1994 and rebranded the Party as 'New Labour' to signify a political stance somewhere between the Conservative and harder left positions. And in fiscal policy the Labour leadership in the run-up to the 1997 election was at pains to avoid risking a repeat of the Conservatives' successful 'Labour's tax bombshell' election tactic of 1992 in response to Labour's shadow budget of that time. Lavish promises to increase spending on public services might run the political risk that the Conservatives would counter with dramatic estimates of the tax costs of such promises.

Accordingly, even although Labour was well ahead of the Conservatives in the polls in the run-up to the general election, its Shadow Chancellor, Gordon Brown, promised early in 1997 that Labour if it won government would broadly match the aggregates of the Conservatives' announced spending plans for its first two years in office—a promise reiterated in the 1997 Labour manifesto.[1] Brown also committed Labour to matching the Conservatives' inflation target and to following a so-called 'golden rule' of borrowing only for 'investment' over the course of an economic cycle (a 'rule' that left it unclear how precisely 'investment' or 'economic cycle' were to be defined and by whom). Moreover, the Labour manifesto promised not to increase standard or higher rates of income tax during the following Parliament (whereas the Liberal Democrats proposed an extra one per cent on the standard rate of income tax to fund improvements in education and a new 50 per cent top rate of tax for top earners). Indeed, some of the Labour leader's statements during the election campaign were construed as meaning there would be no tax rises at all if Labour won government.[2]

In the event, as already noted, Labour won the May 1997 general election with its greatest ever landslide in terms of parliamentary seats. But far from relaxing fiscal squeeze, the new government tightened it on the tax side as well as continuing restraint on public spending increases over the next two financial years which in the event meant rather lower spending on health and education than the Conservatives had planned. Gordon Brown, the new Chancellor, announced a five-year deficit reduction plan in his first budget two months after the election. That plan was designed to give effect to the Party's announced intention to meet current spending from taxation over the economic cycle, to correct what Brown described the following year as 'a substantial structural deficit in excess of 2 per cent of national income'[3] that the Labour Government had inherited, and to achieve budget balance by 2000.

On the tax side, following the Party's election pledges, no changes were made to the basic or top rates of income tax, and VAT on domestic energy bills was cut from the 8 per cent imposed by the Major Government in 1994 to 5 per cent (said to be the lowest rate compatible with European Union legislation). In addition, the main rate of Corporation Tax was cut from 33 to 31 per cent—the lowest rate since the tax was introduced, and lower than equivalent rates in France, Germany, Japan, and the United States. But overall tax revenue was substantially raised in several ways, producing a hard revenue squeeze in the new government's first financial year (1997/98).

One of those ways, foreshadowed in Labour's 1997 election manifesto, comprised a one-off 'windfall' tax on profits made by the privatized utilities in the first four years after privatization, intended to raise nearly ?5bn over three years and to fund a new welfare-to-work programme. A second comprised removal or reduction of tax allowances, including a further reduction of tax relief on mortgage interest payments, which disappeared altogether in the 1999 budget. The most notable tax offset to be removed in 1997 applied to pension funds, which until that time could claim back tax on dividends they received from UK companies, to offset the Corporation Tax those companies had already paid on their profits.

As noted earlier, Norman Lamont had cut these tax credits from 25 to 20 per cent in 1993, and Gordon Brown's first budget abolished them entirely, arguing that they distorted firms' incentives to invest and were not needed for pension saving because many pension funds were in surplus at that time, with numerous employers taking 'holidays' from their pension fund contributions at a time of booming stock markets. The removal of those offsets (a classic 'stealth tax', unintelligible to laypersons, not foreshadowed in the Labour manifesto and buried in the small print of the budget statement) reduced pension funds' income by a figure widely claimed by lobbyists and media reports to be around ?5bn a year but which was estimated by the Pensions Policy Institute (2005) as no more than ?3.5bn. Along with a stock market collapse in 1999 the tax change was used by many companies to justify closing their defined-benefit (final salary) pension schemes, though the removal of this major tax offset did not increase the tax take by that amount because Corporation Tax was reduced at the same time.

A third category of tax increases in that first Labour budget comprised higher indirect taxes, including continuing and increasing the 'escalators' on road fuel tax and tobacco tax initiated by the previous government (that is, annual tax rises well above the rate of inflation), and increasing stamp duties on higher-value real estate transactions (the tax payable to make transfers of ownership of property valid in law). All the taxes in that third category were increased in the first two New Labour budgets, and together with the pension fund 'raid' mentioned above, led to repeated opposition accusations of 'stealth taxation'. More dramatically, after the raised road fuel tax accelerator had helped to produce a 40 per cent increase in fuel prices between early 1999 and mid-2000, the fuel tax rises led to a tax revolt in the form of direct action by fuel tanker drivers in 2000. The protestors blockaded six of the UK's eight fuel refineries in September of that year, causing half of the country's filling stations to shut and leading the government to announce a freeze of fuel taxes.

The new government's pledges to match Conservative spending plans also led to numerous political tensions. On the spending side, one of the 'bear traps' that the previous Conservative Government laid for Labour ahead of the 1997 election was to announce a plan to abolish a higher single-parent rate of income support and child benefit for future claimants if those claimants did not seek work. In the face of this challenge to show it was not 'soft' on welfare claimants, the Blair Government chose to stick to this planned cut, despite (or perhaps because) of Labour backbench protests, with some forty-seven Labour MPs voting against this measure in November 1997 in the first significant backbench revolt of the Labour Government (Brown 1997).

The Labour leadership had also agreed a year before the 1997 election to develop rather than abolish the previous government's creation of a 'jobseeker's allowance' benefit that linked unemployment benefits to demonstrable search for work, a principle that was taken further in the welfare-to-work 'New Deal' programme to be funded from the windfall tax on the privatized utilities and which also entailed a controversial review of disability benefits and the possibility of linking such benefits more narrowly to willingness and ability to work (Peck 1998).

Another notable policy change on the spending side in 1997 related to university funding and charges. Labour's 1997 election manifesto had included a declaration that 'the costs of student maintenance should be repaid by graduates on an income-related basis', and in response to a report on the subject commissioned by the Conservatives in government but published after the election, the new Education Minister (David Blunkett) announced the scrapping of maintenance grants for university students, which government had provided since the early 1960s, to be replaced by means-tested student loans, with maintenance grants only for the poorest students. Blunkett also announced top-up fees for university tuition (of ?1000 a year but subject to means testing on the basis of parental income, such that only two thirds of students would pay). The leading Conservative Sir Keith Joseph had proposed such a change but failed to enact it as Education Minister under the Thatcher Government in the mid-1980s.

After the fiscal squeeze in the early new Labour years, a move to greater largesse for the years 1999-2002 was signalled in 1998 with a 'comprehensive spending review' announcing plans for major increases in future spending on electorally sensitive public services such as health and education,[4] and in the following year, the government announced that the double lock on retirement pensions (linking rises to earnings as well as prices) that the Conservatives had abolished in 1979 would return in 2000, as well as lowering rates at the bottom end of the income-tax scale. So by the time of the 2001 general election the fiscal squeeze was over and the government's agenda had shifted to improving the quality of public services and getting 'more for more'.

  • [1] 1997 Labour Party manifesto, 'New Labour because Britain deserves better',
  • [2] (William Hague), HC Deb 17 March 1998, c.1113.
  • [3] HC Deb 17 March 1998, c.1099.
  • [4] 'Modern Public Services in Britain: Investing in Reform', Comprehensive Spending Review: New PublicSpending Plans 1999-2002, Cm 4011 1998, London: HMSO.
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