IFS warns against ‘steady-as-you-go’ Budget as inflation not headroom is key

A “steady-as-you-go” Budget would largely continue inherited tax and spending plans. The IFS warns this is not enough because higher inflation will reduce what government departments can buy with their planned budgets. The main danger is therefore the condition of public services, not simply the size of the Chancellor’s fiscal buffer.

For example, maintaining March’s real-terms spending plans could require a £12 billion day-to-day top-up by the end of the decade, plus £3 billion for capital spending. Pay settlements have already squeezed departments, while productivity improvements are also required. Leaving totals unchanged would mean cuts in real terms.

The IFS says Healey must clarify the spending ceiling he is willing to live within. If budgets are unrealistic, the plan to reduce borrowing and meet fiscal rules will lack credibility. Avoiding cuts could require about £25 billion in 2030–31, while broader choices could require tax rises or benefit cuts.

Fiscal headroom is the estimated room between the government’s projected finances and the limits set by its fiscal rules. It is a buffer, not spare cash already sitting in the bank. A larger buffer gives the Chancellor more flexibility; a smaller one leaves less protection against forecast errors or new policies.

The IFS describes a plausible scenario with headroom of about £20 billion in 2029–30, down from £24 billion forecast in March. Higher interest rates on government debt would add roughly £10 billion to borrowing in that year. Inflation would also raise tax revenues, probably by more than it increases benefit spending, partly offsetting the pressure.

The government could still meet its rules because borrowing is expected to decrease in coming years. However, the estimate is highly uncertain. Changes to the earnings forecast alone could make headroom around £10 billion higher or lower, while employment, migration and health-related benefits also matter.

A departmental budget has real spending power only after allowing for changing prices and wages. When inflation rises faster than expected, the same cash allocation purchases fewer staff hours, supplies, construction work and other services. A budget can therefore remain unchanged in pounds while shrinking in practical terms.

The IFS estimates that preserving March’s real-terms day-to-day spending plans could require a £12 billion top-up at the end of the decade. Capital spending would need another £3 billion to maintain its planned level. More generous pay settlements have already squeezed budgets, and departments must also deliver productivity improvements.

Without extra money, departments would need to absorb the loss. That could mean reductions in some budgets and lower quality or quantity of public services. The pressure may intensify if health spending rises by 2.7% annually in real terms, defence plans continue, and inflation forecasts are revised higher.

The extra funding would be substantial because inflation affects both routine services and longer-term investment. If spending totals stay fixed in cash terms while prices and wages rise, departments lose purchasing power. Protecting their real budgets means adding money rather than simply preserving the existing headline allocations.

The IFS estimates that March’s plans could need £12 billion more for day-to-day spending by the end of the decade, plus £3 billion for capital spending. It then says avoiding cuts to both types of departmental budgets could require a combined top-up of around £25 billion in 2030–31. Capital spending includes investment plans.

This is a funding choice, not an automatic commitment. The Chancellor could accept reductions in some services, or raise taxes or cut benefits to provide the money. If higher defence spending is also funded, the IFS says the wider package could require tax rises or benefit cuts of around £35 billion.

Higher inflation affects government income and spending through different channels. When wages, prices and profits rise, tax receipts can increase. Some benefits also rise automatically, but the IFS expects inflation to increase tax revenues by more than it increases benefit spending. That can reduce projected borrowing.

At the same time, departments must pay more for staff, supplies, contracts and construction. Their budgets may not rise enough to match those costs. The result is a split effect: the Treasury may receive more money, while departments have less real purchasing power. Higher interest rates add another pressure by increasing debt-servicing costs.

The IFS therefore expects borrowing to be higher across the next five years than forecast in March, but still falling in later years. In its scenario, debt interest adds about £10 billion to borrowing in 2029–30, while inflation-related tax gains partly offset it. Forecast earnings are crucial to the final balance.

The central choice is how much public service protection the Chancellor is willing to fund. Keeping spending totals unchanged would let inflation erode departments’ budgets, reducing the quality or quantity of some services. This option avoids immediate new taxes or borrowing but creates real-terms cuts.

The alternative is to top up spending. The IFS estimates that protecting day-to-day and investment budgets could require about £25 billion in 2030–31. If the government also increases defence spending to 3% of GDP by 2030, that alone is forecast to cost £11 billion in 2030–31. Health spending assumptions also affect the pressure.

The IFS says avoiding these cuts and funding higher defence spending could require tax rises or benefit cuts of around £35 billion. Substantially increasing borrowing is another theoretical route, but the think tank warns against it because debt remains historically high. Interest costs now absorb £1 in every £13 of government spending.

Fiscal rules are constraints the government uses to judge whether its financial plans are acceptable. In this case, the article highlights rules requiring day-to-day spending to be paid for by taxation and borrowing to come down by the end of the Parliament. The government must set spending totals consistent with those promises.

Borrowing depends on the gap between government income and spending. Higher interest rates increase debt costs, while inflation can raise tax receipts and reduce borrowing. It can also increase benefit spending and departmental costs. The IFS says debt interest could add about £10 billion to borrowing in 2029–30, although inflation-related tax gains may offset that.

The OBR’s forecasts determine whether the rules appear to be met. Its assumptions about earnings, employment, migration and health-related benefits can shift headroom sharply. The expected forecast may show higher borrowing than March, but still falling borrowing and rules being met. Meeting the rules is credible only with realistic spending totals.