3 Sep 2025
The Conservative politician RAB Butler (1902-82) was known for his success in achieving cross-party consensus. His memoir was titled The Art Of The Possible. In the end he was famous for never being Prime Minister, despite a long and senior career. Perhaps a clue to that can be found in the character of Margaret Thatcher who once said dismissively that a consensus is “something in which no one believes, but to which no one objects.”
The UK’s public finances are in some kind of crisis. Logic suggests that Chancellor Reeves has three choices, all of which may prove impossible:
In theory she could cut expenditure. But this is apparently politically too difficult. Her own backbenchers all seem to want public spending to rise. There is no Javier Milei waiting in the wings with a chainsaw.
Second, she could borrow more and more. This is politically possible but financially risky if the bond vigilantes demand yet higher interest rates. We are now paying £107bn interest to service debt of £2.65 trillion, or 4%. It will be a struggle to refinance at this rate. This week, the government is refinancing at 4.75% (a new ten year gilt offering).
Third, it looks like she will try to raise taxes. Wise commentators are shaking their heads and using words like inevitable. But is this even possible? Perhaps the country has been squeezed dry.
The Laffer Curve
Arthur Laffer (who is still going, aged 85) drew the attention of the Nixon/Ford administration to the curve in 1974 and it was the intellectual justification for Reagan era tax cuts. As everyone probably knows, it says that after a certain point (the cusp of the curve) tax rate increases have a negative effect on revenues. By contrast, tax rate cuts can increase revenues, (the point popular with right-leaning politicians).
Looking at the reported political leanings of today’s college lecturers, I suspect that the Laffer Curve is not taught at all. Today’s economic advisors appear to think that the only driver of economic policy is to promote fairness via redistribution. If this is a correct interpretation, it is little wonder that the government and civil service have such a struggle to find or even define “growth”.
It seems obvious that any activity that is taxed tends to be discouraged.
The star example in the UK is tax on tobacco. Nobody ever seems to object to this because it can be presented as a public health good and it appeals to the authoritarian streak that lurks in many people.
In the year 2000 a packet of cigarettes carried tax of £1.80. That has now risen by c.400% to £8.92. Over that period tobacco revenue has fallen from £9.5 billion to £7.9 billion. This implies that cigarette consumption has fallen from 5.3 billion to 885 million. Either this a triumph of health policy or smuggling. According to ASH, actual smoking habits over that period have seen a fall from 26.8% to 11.9% of the UK population. This is a decline of 56%, a trend that will be generally welcomed, but far short of the 83% implied by the tobacco revenues.
Given that most smokers in 2025 will come from the “populist” classes, it is interesting to note that evasion or avoidance behaviour is not confined to those that we might regard as financially sophisticated.
Any politician who suggested cutting tobacco tax to the point at which people would be willing to pay it would be summarily cancelled for causing deaths. The truth is dangerous.
It is said that capital gains tax revenues are lower following the rate increases; that raising VAT on private schools will also produce nothing and, as even the government is noticing, the Non-Doms are preparing to flee. Moreover the employers’ VAT tax rises are killing jobs.
My question is – is Rachel Reeves tipping down the Laffer Curve and is there a single tax increase that would actually raise revenue?
So where do we slide from here?
Last year I wrote that betting against impossibility can be profitable. Looking again at the Chancellor’s three choices, it may be that we have a case of three impossibilities.
When the IMF infamously came to Britain’s financial aid in 1976, the then Labour government accepted a loan that was presented as being dependent on the implementation of spending cuts. It may be the case again that Labour would need the excuse of external pressure to try making savings but it is hard to imagine that the government could survive that.
The second impossibility is further borrowing, seemingly without end. The interest bill is already unsustainable. It cannot keep growing.
The third seemingly impossible choice is the topic of this essay. Tax rises imposed on a nation that can’t pay and won’t pay.
As the government staggers from difficulty to botch to failure I predict its collapse in the following way. The centre left, such as it is, will declare a dose of “austerity” is unavoidable. The spending left (probably the majority) will split from its new “far right” friends and will find itself effectively aligned with the Lib Dems and the Greens whose single function is to lobby for fair distribution. This will make a natural coalition to offer to the electorate.
Thus the Labour party will split and pass a vote of no confidence in itself. This could be sooner or later but I have gambled that the next General Election will be in 2027 at the attractive odds of 12-1.
The market still thinks that Labour will cling on grimly until 2029. That looks nearly impossible to me.
Postscript. Today it is reported that the PM, despite already having been rebuffed by his own MPs in June, is again resolved to cut the benefits bill. I have consequently extended my bet to include 2026.