Chancellor Rachel Reeves’ plan to cut billions of pounds in welfare costs through reforms has essentially gone up in smoke. Following major government concessions on the benefits bill, a forecast £5bn in savings by 2029-30 has been severely dented. Coming so closely after the U-turn on the Winter Fuel Allowance, the government has almost eliminated its £10bn buffer which it wanted to keep the public finances on track.
The government could decide to wait and see if the UK economy grows by more than expected and debt interest costs fall. However, this is a risky move. Part of the reason why Reeves announced the welfare reforms in March’s Spring Statement was because higher debt interest payments and weaker tax receipts had more than wiped out her existing £10bn buffer.
Reeves has literally just announced a Spending Review, with the big winners being the NHS, getting an extra £30bn a year, as well as defence. Other departments fared less well or saw cuts. Going back in and asking ministers to find more savings after just being handed their budgets would not only be disruptive but would make the government look like it is scrambling to regain credibility.
Reeves set out two financial rules when she became chancellor. The first was that day-to-day spending would be paid for with government revenue, which is mainly taxes. Borrowing is only for investment. The second is that debt must be falling as a share of national income by the end of a five-year period. Reeves has repeatedly said these rules are “non-negotiable”. They are aimed at showing that the UK is financially stable after the country’s credibility was shaken by former Prime Minister Liz Truss’s mini-budget in 2022.
The OBR produces two assessments of the UK’s economic and financial outlook a year, coinciding with the Autumn Budget and the Spring Statement. The International Monetary Fund (IMF) has suggested that the OBR report should be limited to just once, at the Budget. The IMF reckons one assessment would “promote further policy stability” and potentially reduce the pressure on the government’s buffer figure, which is often referred to as “headroom”.
Labour has pledged not raise taxes for “working people”, ruling out increases to employee National Insurance Contributions, Income Tax and VAT. On Wednesday, cabinet minister Pat McFadden said the government would stick to that promise but he admitted that there would be “financial consequences” to the decision to water down planned welfare cuts. That leaves Reeves with few levers to pull to replenish the government’s coffers.
One option is to keep a freeze on tax thresholds in place for longer. The policy, introduced under the Tory government, was due to end in April 2028. If Reeves extended it until the end of the parliament, it could bring in nearly £7bn. In reality, this is a tax rise on working people – if your pay rises, you risk being dragged into a higher tax threshold. However, it would be a big fix for a government in desperate need of one.
Reeves has five options to change the financial situation:
1. Wait and see
2. Find new savings
3. Change the financial rules
4. Less frequent financial checks
5. Increase taxes or extend threshold freeze
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