Reeves spending audit tees up tough decisions at Labour’s first Budget

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Rachel Reeves pledged to replace “recklessness” with responsibility on Monday, but details of the chancellor’s announcements made it clear that the punishing job of stabilising the UK public finances has only just begun. 

The statement to parliament laid out what Reeves called immediate “tough choices” aimed at tackling an overspend in this year’s government books that totalled nearly £22bn.

Richard Hughes, the head of independent Office for Budget Responsibility, said the £22bn figure may amount to “one of the largest year-ahead overspends” outside of the Covid-19 pandemic.

The biggest contributor was £9.4bn from pay awards that Reeves has made to public sector workers, in line with recommendations from independent pay review bodies.

Reeves’s immediate cuts to help fill the gap included removing the winter fuel allowance from pensioners in about 7mn better-off households and a decision to axe reforms aimed at helping fund adult social care.

She also made cuts to government consultancy spending and recorded savings from the end to the last government’s asylum partnership with Rwanda. The measures will save £5.45bn in the current fiscal year, rising to £8.14bn in 2025-26 as road projects are cancelled.

But as the Treasury itself acknowledged, Monday’s announcements will only go part of the way towards clamping down on the 2024-25 overspend, reducing the “in-year pressures” to £16.4bn.

Reeves said her first Budget on October 30 would involve “difficult decisions” involving “spending, welfare and tax”.

They are likely to include a round of tax increases that could fall heavily on wealth and inheritances given Labour’s decision to rule out increases to a range of levies including income tax, national insurance and VAT. 

Ruth Gregory at Capital Economics said she expects Reeves to lift taxes by about £10bn a year as part of her efforts to fund the £16.4bn funding shortfall, alongside possible additional borrowing to cover the gap.

Yet more fiscal pain lies ahead of that, as the Treasury tees up a multiyear spending review for the spring of 2025. 

Even on the basis of the March Budget, which Reeves said understated the upward pressures on public spending, the Treasury was on track to have debt to fall as a share of GDP in five years by a minuscule margin of less than £9bn. The debt target is a self-imposed rule adopted by Reeves and her Tory predecessor, Jeremy Hunt.

Reeves will need to bolster that fiscal headroom when she delivers the autumn Budget if she is to go into future fiscal years with greater room for manoeuvre and scope for dealing with unexpected contingencies, analysts have said. 

Monday’s announcement does not address the longer-term budgetary pressures faced by the government, as it attempts to control public borrowing while investing in better public services and meeting its tax commitments.

The Institute for Fiscal Studies estimated before the election that under existing plans, the government would need to increase spending by between £10bn and £20bn to avoid real-terms cuts to departments whose budgets have not been promised specific funding boosts, such as justice and home affairs.

And Labour will have to search for further budgetary firepower if it wants to lift public sector investment, instead of announcing yet more cancellations to road and hospital projects as Reeves did on Monday. 

While capital projects are an easy target for governments seeking quick ways of saving significant sums of money, there is a “real risk that it is a false economy” said Thomas Pope of the Institute for Government. 

There is good evidence the UK has not been investing enough in schools, prisons and other areas of the public sector, which hampers efforts to improve productivity and derive greater value for money, he said. 

The “key question” going beyond this fiscal year is how much of the current year’s overspend turns out to be permanent, adding to upward spending pressures for the rest of the parliament, said Ben Zaranko at the IFS.

That will play into the chancellor’s decisions on how big future tax rises will need to be to curb borrowing and meet spending commitments. “There are some grounds to the concern it is worse than they thought,” he said.

Reeves herself warned that the spending pressures are “unlikely to go away anytime soon”.