For her next trick… how the Chancellor can make debts appear to disappear as millions brace for a painful October Budget

Gordon Brown bent them. George Osborne adapted them.

Now Rachel Reeves is set to follow the example of previous chancellors by changing the so-called ‘budget rules’ – the government’s self-imposed limits on debt and borrowing.

In the past nine years alone, budget rules have changed six times, notes Lindsay James, investment strategist at asset manager Quilter.

They are intended to reassure financial markets that public finances are stable and sustainable – but they are essentially arbitrary.

Reeves has adopted the rules from the previous government and these determine how much “room” she has for tax cuts and spending in her first budget next month.

As things stand, she says she needs to find £22 billion this financial year to fill a ‘black hole’ she claims she inherited from the previous government.

Reeves has ruled out raising taxes on “working people.” Labour’s manifesto pledged not to increase VAT, income tax, national insurance contributions or corporation tax – leaving wealth tax on capital gains and inheritances in the spotlight.

Millions of pensioners are already paying the price as their £300-a-year winter fuel allowance is scrapped to save £1.4 billion a year.

But Reeves, who has also promised there will be no return to the austerity years of public spending cuts, could easily create many billions more by changing the debt rules – rather than punishing retirees and taxing thrifts.

Here’s how she could do it.

The main budget rule states that net debt as a percentage of GDP – or annual economic output – must start falling within five years.

It currently stands at 100 percent of GDP – the highest level since 1961, although this is not as high as in some other industrialized countries such as Japan.

The easiest way to reduce that ratio is to exclude the Bank of England’s debt from the government’s balance sheet. This can be done in several ways.

The Bank of England is losing money as it sells the huge portfolio of government bonds, or government IOUs, that it has built up through its money-printing program known as Quantitative Easing (QE). Newly minted QE money helped the economy after the 2008 financial crisis and during the coronavirus crisis.

The Bank is now phasing out the program, incurring multi-billion pound losses, covered by taxpayers. If the taper continues at current levels, there will still be a £24 billion burden on the Treasury in 2028-2029, according to the New Economics Foundation think tank – unless the rules are changed, of course.

Reeves will no doubt be tempted to make such big cuts, but critics say this is just smoke and mirrors.

“It would replace one made-up budget black hole with one made-up budget saving,” said a leading economist.

Another option is for it to rein in a so-called ‘stealth subsidy’ to high street banks, which costs taxpayers £40 billion a year.

Lenders are making a fortune from a little-known scheme whereby they receive interest payments on reserves – piles of cash – they are required to keep with the Bank of England. NatWest, Barclays, Lloyds and Santander alone received more than £9 billion in interest on these reserves in 2023.

These reserves – which amount to over £700 billion – have been created mainly as a result of QE. Banks earned virtually no return on this money when interest rates were low.

However, they now achieve a risk-free return of 5 percent, because interest rates have risen enormously and QE is being phased out.

As a result, almost £40 billion a year in interest payments are funneled to the banks, inflating their profits.

Such diverse political figures as former Prime Minister Gordon Brown and Britain’s reform leader Nigel Farage are in favor of stopping or reducing these problems at the banks. But it could prompt lenders to raise mortgage rates or cut savings rates in retaliation.

A third option is for Reeves to reclassify what is considered an “investment.” The current rules only take into account the immediate investment costs, and not the potential long-term profits.

Reeves told delegates at the Labor conference last week. It was her strongest indication yet that the fiscal goalposts could be moved again.

Experts say that if the National Wealth Fund and GB Energy – two new Labor entities set up to boost growth – were taken off the government’s books it would save £15bn on Reeves’ spending.