The Institute for Fiscal Studies puts headroom on the Chancellor’s main fiscal rule at about £20bn, against £24bn in March. The bigger problem, it says, is departmental budgets that higher inflation is eroding.
John Healey’s first Budget, on 28 October, will be judged less on how much room he has under his fiscal rules than on what he does about public services that rising prices are squeezing. That is the main message of the Institute for Fiscal Studies (IFS), which published its annual Green Budget on 12 October.2
The IFS expects the margin by which the Chancellor meets his main rule, known as headroom, to shrink only modestly, to about £20bn in 2029–30 from £24bn in the Office for Budget Responsibility’s (OBR) March forecast.12 But keeping departments’ budgets at March’s real-terms level while funding a bigger defence budget could need a top-up the IFS puts at £20bn to £35bn a year by 2030–31.2
The Middle East conflict is behind the shift. The closure of the Strait of Hormuz has pushed up borrowing costs worldwide, the IFS says, and the OBR warned in March that the conflict could have “very significant” effects on the economy.12 Inflation cuts both ways for the Treasury: it lifts tax receipts and benefit bills together, but shrinks what departments’ cash budgets can buy.2
The March forecast, which Healey inherits, showed a current-budget surplus of about £24bn in 2029–30, the year the rule is tested.1 In the IFS’s central case, higher borrowing costs add about £12bn and other spending, mostly benefits, about £10bn. About £19bn of extra revenue offsets most of it, leaving headroom near £20bn.2
The range is wide. Whether the OBR raises its earnings forecast, and by how much, moves headroom between £13bn and £37bn, the IFS calculates; it adds that the OBR has been gloomier on earnings than other forecasters.2 EY, a consultancy, puts headroom at about £11bn on its own forecast and says a longer conflict could push it negative.5 The IFS cautions against leaning on any one number: a £5bn swing is small against revenue of about £1,490bn.2
Interest on 10-year gilts was about half a percentage point higher in September than in March, the IFS says, and EY says yields have reached their highest this century.25 Inflation rose to 3.1% in August from 2.9% in July, with motor fuels the largest upward contribution, the Office for National Statistics (ONS) said.3 The Bank of England held Bank Rate at 3.75% on 17 September by six votes to three, the minority wanting 4%, and said risks to inflation are “tilted to the upside”.4 Noodle News reported the August inflation figures on 27 September and, on 11 October, that borrowing was running above the OBR’s forecast.
The less visible effect is on departments. Government sets most budgets in cash, so when prices rise faster than planned the same cash buys less. Holding March’s real-terms generosity would need £12bn more day-to-day money in 2029–30, plus £3bn for capital, the IFS calculates. It adds that more generous pay settlements are already squeezing departments.2
The IFS scenarios show how quickly the sums grow. If health spending rises 2.7% a year in real terms, as planned at the last Spending Review, and defence stays at 2.7% of GDP, all other departments would still face real-terms cuts of 0.9% a year unless the Treasury tops them up by about £9bn in 2030–31. Raising defence to 3% of GDP by 2030, an ambition Healey held as defence secretary, would cost about £11bn more that year. Inside existing totals, it would deepen the cuts elsewhere to 2.0% a year.2
A top-up is a choice, not a given. Departments could absorb pressures through productivity gains, accept worse service or stop some services, the IFS says, but the Chancellor should say which. “A ‘steady-as-she-goes’ Budget is not an option,” IFS director Helen Miller said on 12 October.6 The totals he sets will also be allocated at next year’s Spending Review, so under-stating them now would give an unduly favourable picture, the IFS argues.2
Raising money is hard. Taxes are already about 40% of GDP, the International Monetary Fund (IMF) said on 16 October, and Rachel Reeves’s two Budgets made this the biggest tax-raising parliament on record, according to the IFS.72 Debt interest takes £1 of every £13 the government spends.2 EY says many revenue-raisers are ruled out by manifesto pledges or politically difficult.5
Healey has warned of a “tough Budget” and kept the inherited fiscal rules.75 He is reported to be weighing a higher tax on bank profits; the Treasury has not commented on the record.7
The TUC wants the bank surcharge, cut from 8% to 3% under Jeremy Hunt, set at 16%, saying it would raise £24bn over four years. Its general secretary, Paul Nowak, said the Treasury “has already lost £6 billion in revenue”.7
The IMF’s Helge Berger said it “wouldn’t recommend increasing the labour tax” and urged restraint on spending. UK Finance says a bank tax rise would weaken competitiveness. The Conservatives say Labour “raised taxes by £66 billion in its first two budgets”.76
Which earnings forecast the OBR adopts, which sets headroom anywhere in the IFS’s range. How much of the cost-of-living help announced since March the OBR will score. Whether Healey sets spending totals above the inherited plans or leaves that to next year. The IFS figures are illustrative arithmetic, not forecasts or plans.
The ONS publishes September inflation on 21 October, the last reading before the Budget.3 Healey delivers the Budget on 28 October, with the OBR’s new forecast showing how much headroom he has and what spending totals he sets.6 The Bank of England decides on Bank Rate on 5 November; it has said policy may have to tighten if the conflict persists.4 The totals set at the Budget will then frame next year’s Spending Review, which allocates money between departments.2