Spring statement: A changed world calls for a changed course

A challenging context 

When Rachel Reeves delivered her first budget in October, she knew that she faced an incredibly tough inheritance – low economic growth and stagnant living standards, public services on their knees after decades of under investment, and high public expectations on both fronts. The Conservatives also made a series of irresponsible tax cuts in the lead up to the election.  

The chancellor rightly made a number of tax increases to address the urgent situation across public services, raising significant additional revenue. This was necessary to give the government even a narrow path to tackle the most urgent failures. She also took bold decisions to update the UK’s fiscal rules, which gave her some space to invest (in growth, clean energy and infrastructure).  

But the chancellor used most of the headroom created by these changes to start investing in growth and fixing public services. The limited fiscal headroom left at the last budget means that the government has been left at the mercy of events to meet its fiscal rules. And, if, as looks likely, higher borrowing costs and lower growth forecasts wipe out this headroom, the chancellor faces a new and stark set of choices in 2025: cut planned spending, increase taxes, and/or borrow more. 

In that context, the government decided to fund its immediate commitment to increase defence spending to 2.5 per cent of gross national income (GNI) by slashing the aid budget. This may have largely taken defence out of the equation at the spending review, but the government has no room in the budget to fund further defence spending increases should it need to do so sooner than anticipated.  

So far, the government has signalled that it will face these challenges with spending cuts – to aid to fund defence, and to health-related benefits to rebuild fiscal headroom. It also looks likely that next week’s spring statement will further reduce the envelope for the upcoming spending review, with unprotected departments facing further budget cuts.  

The cost of cuts 

Making cuts to public expenditure to meet the fiscal rules is risky for both public finances and living standards.   

First, it may simply be impossible to sustain, even within the CSR period 2026–29, and especially if the government’s headroom is still limited. If welfare reforms do not deliver the expected savings, if the economic outlook worsens further, or if defence spending needs to rise faster than planned, then the government will find itself back at square one and facing near-impossible decisions about health, education or criminal justice. And cuts in one part of the state often end up driving costs elsewhere.

Second, effective efficiency savings rarely come up-front. The government is right to focus on how to deliver better value for money for the taxpayer. Public sector productivity is low and reform can generate savings. But those savings will be an outcome of the hard-yards reform, not more sticking plaster politics. Demanding savings up front – and cutting whole functions – makes it harder to deliver a more effective and productive state.    

Third, cuts will likely inhibit growth and damage living standards, and risk deepening regional divides. Under-investment in infrastructure hobbles regional economies and stymies business growth, which will in turn hold back national prosperity. Welfare cuts will mean an immediate and direct cut to household disposable incomes. The government has yet to publish the impact assessment of this week’s welfare announcements, but it seems inevitable that many thousands of low and middle income households will be significantly worse off as a result.

And, finally, there are significant political risks to making cuts, as the government found out with the cut to the winter fuel payment. Moreover, as made clear by IPPR’s polling with Persuasion UK, the main thing voters will judge Labour on at the election is the state of public services even if this requires higher borrowing or taxation. Further cuts now, after so many years of austerity, will make it very difficult indeed for the government to meet the public's expectations.

Changing fiscal rules now to borrow more is not the answer 

The changes that the chancellor made to the fiscal rules at the budget were a welcome recognition that low levels of public investment have long held the UK back. However, another fiscal rule change so soon after the last could hit government credibility. Moreover, the main challenge now is meeting the government’s ‘current spending’ rule rather than its capital rule, which would mean increasing borrowing to meet day to day spending.   

Of course, Rachel Reeves could temporarily break her fiscal rule, in the hope that an improved outlook would later restore the headroom. But this would be risky in a very uncertain international and economic context. If she were to do this she would need to send a clear signal of willingness to bring forward measures to close the gap in the autumn budget.

The government is going to need to return to tax 

This leaves tax. There are obvious risks in raising taxes, including for growth, business sentiment, and living standards. But these risks can be mitigated by focusing on targeted measures which put tax burdens on those who can best afford them – and by seeking to reform taxation to help rather than hinder economic growth.  

There are also political challenges, with voters sceptical of further taxation without seeing improvements in services. The government is rightly nervous about breaking manifesto promises at a time when trust in politics is low. But Rachel Reeves has revenue-raising options which would be consistent with Labour’s manifesto commitments. These include:  

• tightening loopholes in share-transaction levies that largely benefit high-speed traders and hedge funds (up to £2.4 billion per annum. according to Intelligence Capital when adjusted for the latest levels of transactions) and a levy on the share buybacks of firms passing excess profits back to their shareholders rather than reinvesting them (with a high-end revenue estimate of £2 billion per annum. according to IPPR analysis)
• increased levies on the profits of online gambling companies (up to £2 billion per annum according to IPPR analysis)
• ending the 50 per cent exemption of AIM shares from inheritance tax (up to £550 million per annum according to the IFS)
• the introduction of rebasing on arrival into the UK, and deemed disposal on departure in capital gains tax or a so called 'exit tax' (up to ~£1 billion per annum) ahead of later pro-growth reform on both the rate and the base
• introducing tiered reserves on Bank of England holdings (which would raise up to £13 billion per annum from banks). 

Some combination of these measures – alongside strategic, long-term reform to public services and social security – could help the chancellor to meet her fiscal rules and reduce spending pressures on unprotected departments. 

As Tony Blair once said, albeit in very different circumstances, “a new dawn has broken, has it not?”. The world has changed since the budget last year and the chancellor must change her plans to respond. Making further cuts in order to stick to commitments and plans made in a different world is a high-risk choice. She has other options available.