UK Faces Affordability Crisis: New Chancellor's Economic Dilemma

As Keir Starmer found, it takes more than words alone to warm a tepid bath. Voters reserve the greatest punishment for the politicians they think acted too little, or too late, to prevent them getting poorer. For Andy Burnham, much will now depend on whether he has got the right ideas, and in John Healey the right chancellor, to address Britain’s growing affordability crisis: not least as the new prime minister sets out new measures today to give people “some breathing space”.

Before Rachel Reeves took office, the average family was set to be worse off in 2029 than they had been in 2019. That’s not supposed to happen. The norm is for household incomes to rise by about £5,000 (2026 prices) every five years. Never before on modern record have they fallen across an entire decade.

Given the scale of the challenge, the last chancellor ultimately failed to move the dial either far enough or fast enough. That means Healey will inherit essentially the same outlook for living standards as Reeves did. Only this time, there is next to no time to prepare, and he will have barely half as much time to act – before having to defend his record at the ballot box.

To make matters worse, the economic situation is even more complicated now too. Household and business spending is drying up, and crying out for replenishment through interest rate cuts or government support. But at the same time, inflation and borrowing costs are already elevated, just as fresh price pressures from the conflict in Iran start to penetrate supply chains.

So if anything, the Bank of England is more likely to raise interest rates higher – and reduce economy-wide spending further – than it is to cut them. Any government that intervenes too clumsily in support of living standards now risks even higher borrowing costs for itself, families and firms.

It’s hard to overstate the seriousness of this triple bind faced by the new chancellor: a politically non-survivable outlook for household incomes, little time to respond and a “natural” macroeconomic trap, where a wrong move could only make things worse.

The key problem to solve is how to provide the right support for families now, without provoking higher interest rates. The answer: lower inflation directly by pushing down on essential prices, especially for low- and middle-income families; and pay for it with slightly higher tax contributions, or a small amount of foregone profit from investment income such as capital gains, dividends and rents.

Take two examples: energy and renting a home. On the first, today’s temporary VAT cut on electricity is a good signal of intent, but the government will need to upgrade again soon. The Joseph Rowntree Foundation has recommended an “affordable energy guarantee” that reforms the Ofgem pricing system to provide a basic portion of cheaper energy for everyone – with larger portions for those with lower incomes or greater energy needs.

Energy support of this kind could replace the less well-targeted VAT cut in future years, but retain a focus on electricity to support net zero transition. It can be designed to fit a range of price tags for government, and the revenue could be raised by closing the gap in tax treatment between capital gains (and other forms of investment income) and earnings from work – thus ending the current unfairness whereby a quarter of people with incomes above £10m year pay a lower effective rate of tax than the average employee.

On the second – renting a home – government should intervene to slow the growth in rents nationally, while allowing mayors to opt out or go further so measures can be tailored for local housing markets. This should be accompanied by a rebalancing of landlord taxation that allows mortgaged landlords to fully tax-deduct their interest costs, paid for by charging national insurance on any remaining income instead.

Because mortgaged landlords typically have far lower profits than those who own outright, the latest evidence shows that the combination of rent controls and tax reform of this kind could actually reduce the number of landlords in financial distress overall. This is important for maintaining house prices and the supply of new development into the market, which has been the traditional concern with rent controls.

New modelling shows how a package built around proposals such as those above (on energy, rents and tax) could return real incomes to growth for a majority of households – more than making up for both the fall in incomes from the last parliament and the anticipated effects from conflict in the Middle East as well. These measures could also reduce inflation by half a percentage point, easing pressure for higher interest rates.

There is also good – albeit often overlooked – evidence that improving household economic security in this way helps to drive longer-term economic growth as well. When people are more financially secure, they are both more productive at work today and more likely to risk the move to a better job tomorrow.

Of course, considerable challenges remain. Healey will need to sort the wheat from the chaff from a plethora of competing demands, and the noise from those losing out from tax reform will need to be managed too. Ultimately Burnham is right to make “breathing space” from the cost of living his early priority. The question is whether, and by when, Healey can deliver it. Voters were promised a “change” chancellor once already – both they, and the new prime minister, really need one now.