Meanwhile, the UK is looking forward to the next Budget. At the same time, the OBR has set out the very real fiscal constraints that remain. Chancellor of the Exchequer, Rachel Reeves, has responded to criticisms noting the state of the country’s coffers. She pointed out a dramatic loss of headroom, the cushion to pay for unanticipated costs, in recent years. The headroom peaked at over £80 billion in 2014. By March 2025, it had fallen to a mere £9.9 billion, constant from Reeves’ prior Autumn fiscal statement.
This headroom represents a radical departure from prior budgets. In her first budget speech, Reeves budgeted £9.9 billion. Recent Institute for Fiscal Studies assessments show that this has crashed to just £4.2 billion, considered history low standards. This decline of 9 percentage points is quite dramatic. Before November 2022, Chancellors would have tried to keep a buffer of £20 billion to £30 billion.
The OBR’s recent forecasts show a rapidly worsening fiscal situation. The report unveiled a particularly egregious finding. Without the recent mini government U-turns on welfare and winter fuel payments, the buffer would have fallen to minus £3 billion. This tenuous state of affairs highlights the difficult road ahead for Reeves as she charts a course on taxes and spending.
In her pre-Budget speech, Reeves lamented the UK’s escalating productivity crisis. She warned that this trend would have dire consequences for public finances. And she pushed back on DOA’s failure to make the hard decisions to fiscalize in the face of these challenges.
The tax policy decisions are making the current financial climate even more difficult. Extending the freeze on income tax and National Insurance thresholds for a further three years costs £8 billion in lost revenue. This decision will shape our financial environment for years to come. Yet the total tax increases add up to £26 billion. This modest change aims at economic stabilization to the extent possible with narrowing fiscal space.
Prof David Miles, an economist with insights into the fiscal situation, commented on Reeves’ approach and the context of her statements regarding the UK’s finances.
“I don’t think it was misleading, for my own view, for the chancellor to say that the fiscal position was very challenging at the beginning of that week.” – Prof David Miles
Miles acknowledged that the fiscal outlook is not all bad news, such as not having a deficit to fix. He stressed that the big picture remains dicey.
“This is very, very good news; there is no hole to fill – as people were saying.” – Prof David Miles
He cautioned that Reeves still faces a “very difficult Budget and very difficult choices” ahead. This lowered headroom puts her in a tremendously difficult position to introduce positive policies and achieve fiscal balance at the same time.
No surprise then that the OBR’s forecasts didn’t catch last month’s government U-turn on cuts to welfare payments and scrapping of the winter fuel payment. This huge oversight distorts our understanding of the overall fiscal picture. Miles called the current buffer “paltry at best.” This just underscores how little buffer room the country has before hitting a budgetary wall.