Britain’s Budget - one and done?

The aim is that there will be no need for another Budget like last week’s. But the margin of error for the government to meet its fiscal target is slender.

Rachel Reeves via Lauren Hurley / DESNZ

Last week’s UK Budget represented a major reset for fiscal policy. In an apparent acceptance of a permanent increase in the size of the state, the chancellor raised taxes, borrowing and expenditure significantly. Taxes are on course to hit a peacetime high as a share of GDP. Public expenditure is set to run at around 45% of GDP through this parliament, four percentage points higher than before the pandemic, and a level that has only been seen briefly, during recessions, since 1948.

The scale of the increases in taxes – the largest for at least 30 years – this Budget was exceptional. The government has portrayed it as a one-off, necessary to stabilise Britain’s public finances and to start to rebuild public services.

In an interview yesterday the chancellor, Rachel Reeves, said that the Budget measures had “wiped the slate clean” after the previous government’s “mismanagement.” Reeves said that “there’s no need to come back with a budget like this. We’ll never need to do that again”, and gave an “absolute commitment” that the government would stick to its manifesto pledge not to raise taxes on “working people” in this parliament.

The aim is that, with this Budget, it is “one and done” for UK fiscal policy. If things pan out as forecast by the Office for Budget Responsibility (OBR), there will be no need for another Budget like last week’s.

But things do not always go as planned. Meanwhile the margin of error for the government to meet its fiscal target is slender. In an economy where GDP runs at £2.9tn annually and public expenditure is £1.3tn, leeway of £10bn to meet the government’s debt rules allows little room for things to go wrong. Just £10bn of fiscal headroom is the second lowest in the last 14 years and about one-third of the average.

Everything hinges on the OBR’s forecasts working out as expected. GDP growth needs to come close to the OBR’s (relatively optimistic) forecasts as must inflation. They also require the tax measures announced by the chancellor to be implemented in full and to deliver the necessary £40bn of revenues, neither of which can be guaranteed. (Some tax measures – such as George Osborne’s famous “pasty tax” – are rescinded due to their unpopularity and not all tax-raising measures, including those aimed at reducing avoidance, yield the expected revenues, partly because of unexpected behavioural changes.)

For the chancellor to hit her fiscal target, the UK also needs to avoid the sort of negative shocks, such as the surge in energy prices seen after the invasion of Ukraine, which have bedevilled western economies in recent years. Meanwhile, a sharp and sustained rise in government debt costs would blow the government’s plans apart.

There is also the question of whether increased expenditure – almost £70bn extra a year in this parliament – will be sufficient to deliver politically acceptable levels of public services, many of which are currently in poor shape. Waiting lists in the NHS and Crown Courts have soared. Public satisfaction with council services is at the lowest levels since polling started in 2010. Since 2020, nine councils have issued Section 114 notices, the local authority equivalent of declaring bankruptcy. Satisfaction with local primary schools is at an all-time low in data that go back more than 20 years.

The Budget recognises these pressures and provides for significant real-terms increases in expenditure on health, schools and capital spending. Overall spending will also rise in real terms, but so-called unprotected departments, including environment, food and rural affairs and culture and transport, face cuts of £8bn in the last three years of the parliament. By the end of this decade, per capita spending on unprotected departments, accounting for one-third of all government spending, will be lower than today and 20% lower than in 2007. The chancellor has said that there will be “no return to austerity,” but, for many areas of government, things will be very tight.

Nor are the challenges facing the NHS, which is getting the largest increases in funding, solved. Responding to the Budget, the King’s Fund, the UK’s leading health policy charity, commented that increased spending on the NHS, “is unlikely to be enough for patients to see a real improvement in the care they receive…the extra [investment] funding…will only be a modest down payment on what is needed to tackle unsafe and outdated NHS facilities…this Budget has been a starting point for the investment and reform that is needed to begin to stabilise the trajectory of NHS performance”.

The fact that the OBR attributes a probability of just over 50% to the government meeting its fiscal rules testifies to the uncertainties. Paul Johnson, head of the Institute for Fiscal Studies, said last week that he would bet “an awful lot” that the chancellor will need to boost spending still further.

Higher spending would entail increases in taxation – which the chancellor appears to have foresworn – or higher borrowing.

The cost of borrowing for the UK government rose in the run-up to and following the Budget. This partly reflects expectations that increased expenditure will boost growth in the short term and keep UK interest rates higher for longer. (Market expectations for UK interest rates at the end of 2025 have risen from 3.6% to 4.0% since the Budget.)

More tellingly, the cost of funding UK debt has risen almost 40bp faster than the cost of funding German or Spanish debt since mid-September. At close of business, the spread between the yield on UK gilts and Spanish bonds was at record levels (the Spanish government can borrow for ten years at a rate that is 1.3% percentage points lower than the UK).

The recent rise in UK yields is dwarfed by the sell-off in gilts in the wake of the Liz Truss mini-Budget in 2022. Nonetheless it speaks to a softening of the appetite for UK government debt.

Even with extra public expenditure of over £70bn a year, it will not be easy to keep a lid on public spending. We will see, in detail, exactly how each spending department will fare over the coming years when the chancellor publishes the comprehensive spending review next spring. Holding to those spending plans while raising public sector productivity will be two of the government’s most urgent – and difficult – challenges.

A personal view from Ian Stewart, Deloitte's Chief Economist in the UK. To subscribe and/or view previous editions just google “Deloitte Monday Briefing”.