The federal government finds itself in a challenging fiscal environment. That places ever greater onus on Rachel Reeves, the Shadow Chancellor, to come up with a radical, game-changing Budget next month. The Institute for Fiscal Studies (IFS) has urged Reeves to take decisive action to avoid future tax increases and spending cuts, highlighting significant challenges facing the government.
Helen Miller, another leading economist at the IFS, has warned against ushering in what she called a “fiscal groundhog day.” She added that ensuring this situation doesn’t turn into a twice-a-year tradition is an enormous test for Reeves. As she crafts her fiscal plan, she must confront this challenge directly.
In the last election, Labour pledged to not increase National Insurance. They pledged to not increase the income, nor the value-added tax (VAT) above their current levels. As the IFS has emphasised, these options are the easiest ways for the government to raise revenue. This would pose a problem for Reeves, who has made her fiscal guardrails “non-negotiable.”
The government’s fiscal framework includes two main rules: not borrowing to fund day-to-day public spending by the end of the current parliamentary term and ensuring that government debt decreases as a share of national income by the same deadline. Despite these limitations, the UK government has already wired £10 billion of fiscal headroom into its budgetary system.
Miller noted that the focus on headroom has turned into a fixation. This shift in focus has overshadowed a more urgent conversation about policy and tax reform. She pointed to pressing fiscal realities from higher borrowing costs and declining expected growth. Furthermore, new spending commitments after the spring have placed the federal government in an uncomfortable fiscal state.
“When choosing to operate her fiscal rules with such teeny tiny headroom, Ms. Reeves would have known that run-of-the-mill forecast changes could easily blow her off course,” – Helen Miller.
The IFS thinks there is plenty of justification for Reeves to find ways to boost the headroom even further. They propose that this be more than the current £10 billion cap. By addressing new revenue needs in the business community, the government can sidestep any deviation from the fiscal high ground while honoring its clearly defined guardrails.
Reeves even admitted the need to elevate these challenges in her forthcoming Budget. She has even already suggested that raising taxes could be included in her plans as an independent strategy to get closer to a balanced budget. The IFS commented that she’ll have to go further to make up a shortfall to meet her own fiscal rules.