Good morning from New Economy Brief.
Next week the Treasury will publish the 2025 Spending Review, which sets departmental spending for the next three years. It seems set to be a tight settlement, especially on day-to-day budgets, with many frontbench ministers reportedly still fighting with HMT to secure the funding they believe they need.
It’s been a bumpy road to get to this point, with economic headwinds and self-imposed constraints – on tax, fiscal rules and spending commitments – limiting the government’s room for manoeuvre. So far the government has responded with cuts to disability benefits, foreign aid and the Winter Fuel Payment, with political fallout including the resignation of a minister and poor local election results.
This week’s New Economy Brief looks at how these challenges are likely to keep playing out in the coming weeks and months, and explores the case for a fiscal reset to put the government on a better economic and political trajectory.
The fraught politics of the Spending Review
The Comprehensive Spending Review (CSR) is a multi-year allocation of both day-to-day (RDEL) and investment (CDEL) spending within the overall envelope set out in Labour’s first budget back in Autumn 2024. Many departments have already locked in their spending limits for the majority of the remainder of the parliament, but the latest reporting suggests that some cabinet ministers (Angela Rayner and Yvette Cooper) are still holding out. Perhaps unsurprisingly, their departments are responsible for hot-button political issues – housing and policing – in which serious spending and investment is needed to meet the government’s manifesto commitments.
Zero-sum spending negotiations make for zero-sum politics. Spending Reviews are always politically tough, not least because they force the government to reveal its political priorities (as noted by Ed Balls, who was at the centre of this process under New Labour). That is hard enough when portioning out a growing pie, but particularly treacherous when choosing where to make cuts. The government is firmly in the latter position on day-to-day-spending, where all departments other than health and defence look likely to face real-terms cuts from 25/6 onwards.
This is partly why the government has tried to shift attention to capital investment, where it has a more positive story to tell as it allocates the £113bn in additional investment programmed at last year’s Autumn Budget. But even here, commitments to increase defence spending – and the frontloaded increases in 2024/5 – leave surprisingly little room for new investment elsewhere.
Escaping the economic doom-loop.
As a reminder, all of these spending and investment decisions are being made within the framework of the overall choices the Chancellor has made at recent fiscal events, in order to keep within her self-imposed fiscal rules. So what are the prospects for a tight settlement now to unlock better economic outcomes – and pave the way for more generous spending – further down the line?
Last month, the National Institute for Economic and Social Research (NIESR) forecast lower growth prospects, weakening tax receipts for the government and leaving the Chancellor “£57bn short of her commitment to balance the current budget” by 2029/30. This means that without tax increases or changes to the fiscal framework there is a risk that the Chancellor will have to announce further spending cuts to meet her fiscal rules every six months, when the OBR publishes its twice-yearly forecasts.
NIESR’s Stephen Millard has called for a rethink of the fiscal framework, arguing that the “self-imposed and arbitrary” fiscal rules have “led to a situation where twice a year the chancellor has to either find further departmental savings or announce politically unpalatable tax rises … the uncertainty created by this leads to low investment and lower growth, the precise reverse of what the government wants to achieve”. So how does the government get out of this situation?
IMF verdict on UK fiscal strategy. The world’s fiscal watchdog, the International Monetary Fund (IMF), gave its annual assessment of the UK economy and the government’s fiscal strategy last week. It concluded that the Chancellor has the right balance of investing for growth whilst maintaining fiscal sustainability. However, IMF UK Mission Chief Luc Eyraud also warned that global instability will make it difficult for the Chancellor to avoid breaching fiscal rules. Meanwhile, according to Isabelle Mateos y Lago, chief economist at BNP Paribas bank, the strictness of the UK’s fiscal rules “actually damages the UK’s credibility because they have to hurt themselves so much to meet them”.
What are other nations doing? While the UK reverts to spending cuts, governments in Germany and France are exploring new fiscal policies to allow them to protect their economies from global instability. Germany is reforming its notoriously stringent fiscal framework to invest nearly a trillion euros in defence, energy security, transport and green infrastructure. The French are exploring taxes on wealthy individuals to ensure higher defence spending doesn’t come at the expense of other social priorities.
Refinements to the fiscal framework to avoid further cuts.
With spending pressures rising, slower global growth expected to reduce the UK’s fiscal space further, and mounting political opposition to further cuts, the government will be in search of an alternative. This is likely to mean reassessing the fiscal framework and/or increasing taxes. The government should take succour in this from the IMF, which last week recommended ‘refinements’ to the framework to make for more stable and effective policymaking, and said there was ‘scope’ for increasing tax revenues. These include putting less emphasis on exact estimates of headroom, assessing compliance with the rules only once per year at the time of a fiscal event (allowing for breaches to be solved via tax rises instead of only spending cuts, as we saw at the Spring Statement), and establishing a formal process to prevent small rule breaches at other times from triggering corrective fiscal consolidation.
Extensive support for fiscal reform. The FT’s editorial board has already endorsed the IMF recommendations and reports that HMT is “always [having] discussions about how we can improve the fiscal framework”. Recent polling reveals a clear majority of Labour MPs also favour a reset of the government’s fiscal policy, with nearly two thirds (65%) thinking the government should either reform its fiscal rules (32%) or raise taxes (11%) to create space for investment and spending, or both (22%). As the Guardian’s Polly Toynbee observed earlier this week, the Prime Minister is fond of observing that “The world has changed.” Yes, indeed. And so must the government on tax and spending…If ever there were a time to uproot old habits, it’s now.”
The care expectation gap. Many of us underestimate the care we will need in the future and how much it will cost, according to a new report by the Joseph Rowntree Foundation (JRF). For example, the research found that only 19% of the public correctly guessed that professional home care can cost more than £1,000 per week. It also found significant support for government-funded care and higher incomes for carers.
Privatisation of childcare. UK councils paid over £200 million last year to Witherslack, a major private provider of children’s care and education owned by Abu Dhabi’s sovereign wealth fund, Mubadala, according to journalist and foster carer Martin Barrow. Despite reporting losses, the company paid out £77 million to banks and investors, including Mubadala and two private equity firms. The accounts also reveal sharp increases in the fees charged to local authorities.
Bank of England and climate risk. Former Bank of England staff have told the Financial Times that the bank has deprioritised climate risk in recent years, cutting resources and limiting supervisory work. Staff hours on climate were reportedly reduced by a third between 2022 and 2024.
Unlocking the pensions review. Simply growing pension funds won’t solve their underinvestment in UK infrastructure and productive assets, argues a new Common Wealth report. It highlights pension funds’ current overreliance on low-risk government bonds and stresses the need for structural changes to better mobilise retirement savings for economic growth.
Child poverty strategy. A new report co-produced by IPPR and families in the Changing Realities project urges the UK government to remove the two-child limit and benefit cap, and to restore child benefit rates in real terms. It emphasises that increasing household incomes is essential to reducing child poverty and calls for lived experience to shape policymaking.
