IFS: budget will be ‘work of fiction’ without clear plan to cover UK’s £35bn spending pressures

The Institute for Fiscal Studies is warning John Healey not to present spending plans that depend on cuts he does not really intend to make. Inflation has reduced what existing departmental budgets can buy, while Healey has pledged to increase defence spending to 3% of GDP by 2030. Together, these pressures create a funding gap of about £35bn.

Healey could leave cash totals unchanged, but that would mean accepting real cuts to the quality or quantity of public services. He could instead provide more money, funded through higher taxes or increased borrowing. The IFS says he need not detail every decision before the next spending review, but he should set credible overall spending limits.

The warning matters because bond markets are already unsettled and borrowing costs are rising. Helen Miller said that simply pencilling in cuts the chancellor would never deliver would make the budget “a work of fiction”. The IFS wants realistic plans at the 28 October budget, not decisions endlessly postponed.

A fiscal rule is a limit or target the government sets for managing public finances. In this case, Labour’s main rule is to balance day-to-day public spending with revenues in 2029-30. Day-to-day spending covers the regular cost of running public services, while revenues mainly come from taxes. The rule is intended to show that routine spending is financially sustainable.

If tax revenues match those costs, the government does not need to borrow continually to pay for ordinary services. A shortfall would require difficult choices, such as higher taxes, lower spending, or more borrowing. The article describes this balance as the chancellor’s main fiscal rule and measures his available headroom against it.

The rule does not remove wider pressures. Rising debt interest costs can reduce the buffer available against the rule, even as inflation raises some tax receipts. The IFS therefore says Healey must publish spending plans that remain credible, rather than relying on unannounced future cuts.

The figures describe three different pressures on the public finances. The IFS estimates that compensating for higher inflation and funding Healey’s pledge to raise defence spending to 3% of GDP by 2030 would require about £35bn. This is the extra money needed to protect public services and meet the defence commitment.

The former chancellor Rachel Reeves left a £24bn buffer against Labour’s main fiscal rule at the spring statement. That buffer is the room available before the government breaches its target. Meanwhile, higher borrowing costs could add £10bn to debt interest spending in 2029-30. More money would then be needed simply to service existing debt.

The figures interact rather than forming one simple bill. Higher inflation may increase tax receipts, limiting the headroom loss to about £4bn. But inflation also reduces departments’ spending power. The IFS says focusing only on the fiscal buffer risks overlooking the much larger pressure on public services.

A cash budget shows how many pounds a department receives, but inflation changes what those pounds can purchase. When prices and wages rise, the same allocation buys fewer supplies, contracts, and staff hours. The department therefore loses real spending power even if its nominal budget has not been reduced.

For example, if a department receives the same cash while service costs rise, it must provide fewer services or reduce their quality. It might also seek efficiency savings, but the IFS warns that these may not fully offset the inflation shock. Protecting services would require the Treasury to increase departmental budgets.

The article says higher inflation linked to the Middle East could blow departments’ plans off course. Leaving spending totals unchanged would implicitly mean accepting chunky real cuts. The government would need to raise taxes, borrow more, or tolerate weaker public services, especially if defence spending also rises.

If the government cannot cover higher inflation and the planned defence increase, it cannot preserve every existing commitment at its current level. Inflation would make departmental budgets less valuable, while defence would claim a larger share of available resources. The central choice would be between reducing services and finding additional money.

The IFS identifies several routes. Departments could accept real-terms cuts to the quantity or quality of services. They could search for efficiency savings. The Treasury could raise taxes or allow borrowing to increase. The government could also use benefit cuts to help fund the extra needs. None of these options avoids a political trade-off.

The pressure is especially serious because Healey has pledged to raise defence spending to 3% of GDP by 2030. The IFS says increasing defence within existing spending totals would make other departmental cuts larger. It urges Healey to show credible spending envelopes rather than postpone the choice.

Fiscal headroom is the buffer between the government’s forecast position and its fiscal rule. When government borrowing costs rise, interest payments on debt become more expensive. That increases future borrowing needs and pushes the forecast closer to the rule, reducing the room available for new policies or unexpected shocks.

The article gives a possible example. Higher debt interest costs could add £10bn to borrowing in 2029-30. At the same time, higher inflation could boost tax revenues, because some tax receipts rise when prices and incomes increase. The Treasury would therefore recover some money through taxation.

The IFS says those higher receipts might limit the headroom reduction to about £4bn, rather than the full £10bn. But that does not solve the wider problem. Inflation also weakens public-service budgets, so the chancellor may face a smaller fiscal buffer and roughly £35bn of broader spending pressures.

Spending envelopes are overall amounts that the government makes available to departments or public services for a future period. They do not necessarily specify every individual programme. They establish the boundaries within which departments are expected to operate and help show whether the government’s wider fiscal plan is realistic.

The IFS says Healey need not publish every detailed decision for the next spending review at the budget. But he should set envelopes he would genuinely accept. If inflation raises costs and those limits stay artificially low, departments would face implicit cuts to services. The government would then be claiming fiscal discipline without explaining the real consequences.

That would weaken the credibility of the budget, particularly while bond markets are unsettled. Helen Miller warned that assuming everything can be postponed until next year risks undermining Healey’s credibility. Realistic envelopes would show financial markets and departments that the fiscal rule is backed by deliverable plans.