As the day of the budget nears, the chancellor has very publicly changed her mind on raising taxes Labour pledged in its manifesto not to raise—from saying she would make such “necessary choices” to indicating that she probably won’t.
There are clearly desperate pressures on the UK’s taxpayer funds and public debt. Last month, speaking at her Regional Investment Summit in Birmingham, Rachel Reeves also referenced her challenging “choices”, insisting she would make “the right” ones in order to “unlock the power of investment”. She then nodded to the government’s new Industrial and 10-year Infrastructure strategies as setting the direction on that front. Given the prospect of a £30bn black hole in the government finances which had forced Reeves’s hand on tax rises (and back again), both strategies rely heavily on funding by the private sector.
But it is a fallacy to expect that the private sector will “step in” and provide funds when the government decides it cannot afford to.
In 2002, seeking to explain New Labour’s aggressive adoption of Private Finance Initiatives (PFI) and Public Private Partnerships (PPP) , Tony Blair told the party’s annual conference that “there is no way government through the general taxpayer can do it all”. Most of the investments under these schemes were in defence, education and health where there are no explicit incomes from users. The cost of that borrowing was always going to be paid out of future taxation, because the investment was never going to result in revenue. In 2023-24 annual payments on PFI contracts made two decades earlier were running at £10.5bn. The bottom line is that whenever government “crowds in” private finance for an investment that is not commercially viable, the state pays private market borrowing costs on the portion of the debt that it is not financing itself with sovereign debt.
The government’s Infrastructure Strategy mentions three principal mechanisms for harnessing new private capital for public spending: pension funds; government-sponsored intermediary institutions (or “banks”); and the creation of new propositions in which to invest. Let’s start with pensions. Signatories to the government’s Mansion House Accord this year pledged that, by 2030, they would invest 10 percent of their portfolios “in assets that boost the economy”, such as infrastructure, property and private equity. This was reinforced by the establishment of Sterling 20—“a new investor-led partnership between 20 of the UK’s largest pension funds and insurers”—in October. It is not obvious why this will be much different from what has gone before. Pension funds have always had the opportunity to make these investments, and in any case, the text of the accord is clear that “this ambition is subject to fiduciary duties and the Consumer Duty”.
The second important part of the government’s proposals is the creation of government-sponsored, public finance institutions, including the National Wealth Fund, British Business Bank, National Housing Bank and Great British Energy. These have been (or will be) established by the endowment of capital (which will have increased the national debt by the corresponding amount). They are all public companies wholly owned by the government. All their constitutions require them to make a financial return for the government over the long term. By definition their mission is to lend to projects that the private sector would not. But while this can include projects that are known to not be commercial, the portfolio must yield the required return as a whole. These institutions will have to publish annual accounts and demonstrate that they continue to be going concerns.
The National Wealth Fund says that it helps “local authorities understand and navigate the challenges and financing barriers they face in delivering … ambitious infrastructure projects that tackle climate change and support economic growth.” The British Business Bank will specialise in small companies and start-ups that have difficulty raising finance. The National Housing Bank talks of boosting housing supply on “otherwise unviable large and complex sites, and support[ing] land assembly, remediation and up-front infrastructure delivery such as utilities and schools”. These all speak to higher risks and lower financial returns than the private sector would take on. The British Business Bank, founded in 2012 has more than 600 staff and posted a statutory loss of £122m in 2023/24. What are the disciplines that will stop them becoming channels for taxpayer subsidy to avoid the embarrassment of insolvency?
The PFIs and PPPs introduced by New Labour, common for defence, hospitals, schools, prisons and transport, typically involved 30-year contracts, competitively procured, between public authorities and private providers. The public authority paid an annual service charge and the private provider could use that as a basis for financing the private sector borrowing needed to pay for the initial investment. In effect, this was a vehicle for borrowing on behalf of the public sector.
Importantly for the 1997 government, the borrowing was classed as “off the public balance sheet” so it appeared to offer a way around self-imposed restrictions on total public borrowing. Of course, it was not free capital: the annual payments were always going to have to be paid out of future taxation (or additional charges to the extent that there were any) over the years of the contract.
However, the implicit borrowing under such schemes is at a market, risk-bearing rate that is significantly higher than what is available on the alternative of conventional public borrowing. The very long-term contracts are inflexible if needs change; they are costly to both public and private sectors to negotiate; they have to be fully monitored and enforced, which can also be costly and difficult in practice.
And yet, the new 10-Year Infrastructure Strategy reintroduces this idea. A National Audit Office review this year found that avoidance of artificial public borrowing constraints should not be a reason to use such public-private partnerships. The strategy says the lessons of the review will be observed.
Crucially, it must be understood that there are legal liabilities for future taxpayers, and nobody should be surprised by the portion of current budgets that are pre-committed to the repayments. Whatever the technicalities of the rules on the public accounts, the liabilities will be taken into consideration by the international capital markets when they assess their risks in taking on UK sovereign debt. This will affect the cost of servicing the UK national debt.
New public projects for investment, funded out of new user charges, would help attract private funds too. This will not work in cases like defence, policing, prisons or schools, because it would be difficult to charge users for these services. But there are several services which are uncharged or under-charged at the point of use as a matter of policy in the UK—most notably the National Health Service, the largest employer in the economy. New charges could fund new investment.
One such is the road network, which is the UK’s most important physical asset and crucial for economic growth. It also happens to be in need of maintenance, repair and enhancement. Since it is not explicitly charged for it cannot benefit from private investment (with the important exceptions of the few directly tolled facilities). But the total of Vehicle Excise Duty and Fuel Duty (£33bn in 2024-25) signals that the asset has a high underlying social and financial value.
The strategic road network in England currently has a governance structure under National Highways that would be relatively simple to reform into something that would attract investment. Other countries have been doing this though a variety of tolling, ownership and concession arrangements for many years.
Local roads (98 per cent by length in England) are under the stewardship of local authorities. The government’s current proposals for devolution of local government offer creative investment opportunities for roads and any number of other local infrastructure investments providing they are allowed to raise the necessary cash.
So devolution could create the opportunity to generate the new income necessary to fund some of the infrastructure we need. The English Devolution and Community Empowerment Bill contains powers for mayoral combined authorities to raise additional revenues from local tax payers. The Greater London Authority already has these powers to levy precepts. There would be considerable scope for new, local financial institutions to handle locally raised funding and to manage the funding and financing of local transport infrastructure.
The prognosis is gloomy. A couple of months after publication of the infrastructure and industrial strategies the cost of borrowing to the UK government, largely determined by global pension funds and international insurance companies, was rising sharply. Already, three quarters of new borrowing is spent servicing our existing national debt.
Yet more public borrowing would be imprudent. For the nation to put more resources into investment for the future it will have to divert some domestic consumption to investment in the near term. The government’s infrastructure investment proposals look implausible unless it can persuade the public to tolerate new charges or specific taxes. There is no free lunch.
