The balancing act

Chancellor of the Exchequer Rachel Reeves will issue her first Spring Statement on 26 March, alongside updated economic and fiscal forecasts from the Office for Budget Responsibility (OBR).

The UK’s major fiscal document, the Budget, is now issued in autumn. The Spring Statement serves as a 'mini-Budget', providing progress updates and allowing for minor policy adjustments.

This spring, however, the Chancellor faces an especially challenging balancing act, juggling conflicting objectives. 

Firstly, she must convey confidence and stability to voters and businesses – especially to investors. After a long period of political turmoil, the economic value of stability cannot be underestimated.

Conversely, it is evident that the UK’s strategic position has shifted quickly and significantly since the Budget. The world now appears far more volatile, growth remains stalled and borrowing costs have risen. 

It seems that the government’s stated fiscal goals will now be even harder to achieve. Adhering to previously announced policies may appear stubborn, rather than principled.

Tough policy choices

The Chancellor’s decisions will be steered by the forecasts from the OBR. While we don’t yet know what the OBR will report, recent economic news suggests their outlook may be more pessimistic than before. 

Last week, the Treasury informed the OBR of its planned “major measures”, which will help to develop the OBRs fiscal forecasts.

There are no “easy” policy options for the Chancellor, all are likely to face criticism from some quarters. Her options boil down to three, either used alone or in combination:

•    borrow more
•    raise more tax 
•    spend less

The Chancellor’s own fiscal rules dictate that day-to-day spending must be funded by taxes, with borrowing reserved for investment only. This may rule out expanding borrowing, leaving tax increases and spending cuts as the only two levers.

We know the government aims to boost defence spending, quickly. Some funds have already been diverted from foreign aid, but this will not suffice – additional resources must be found.

The 2024 Budget introduced significant tax increases, particularly targeting businesses. There is evidence that it had a “chilling” effect on the economy, with changes to National Insurance drawing widespread criticism. 

(Note that some Budget changes take effect only from April 2025, meaning any new measures will be announced before all the previous measures have taken effect).

Raise more tax

Wages for many workers - though not all - continue to outpace inflation, leaving them better off in “real terms”.

This situation may create an opportunity for the government to employ “fiscal drag” to increase government income. This involves not increasing income tax thresholds in-line with wage growth, thus moving more workers into higher tax bands. 

With pensions also rising, pensioners might also see their incomes moving above threshold levels, making them into taxpayers as well as welfare recipients.

Thresholds for other taxes, such as capital gains and inheritance tax, might also be maintained, though these tend to impact fewer people each year compared to income taxes.

Fiscal drag is a well-established method for increasing tax receipts over the long-term and has historically been relatively easy to “sell”, politically.

It requires the Chancellor to take no action, making it a (relatively) straightforward choice.

Spending cuts

Some spending cuts may also be necessary. Achieving significant savings will require focusing on the largest areas of expenditure. 

In the latest Budget, the three biggest expenditure items account for about 60% of spending in 2025-26 (social security 28%, health 21% and education 11%). Major savings will need to come from these areas. 

The government has already expressed concern over the rising number of people claiming out-of-work benefits, particularly younger adults and those in poor health.

Plans to reform the benefits system and to manage bills more effectively have been hinted at. Shabna Mahood, the Justice Secretary, discussed this on the Radio Four Today programme last week. 

Liz Kendall, the Work and Pensions Secretary, has also spoken publicly, and other MPs have been vocal in voicing their concerns.

IGD anticipates further focus on reforming out-of-work benefits and encouraging more people who are currently inactive to re-enter the workforce. This would create a double benefit – lower spending and higher tax income.

Market impacts

Increases in tax and / or reductions in benefits, should they happen, may be fiscally necessary, but from an economic position, it is hard to see them as helpful. Consumer incomes would be affected.

Consumer demand is already very weak in the UK and further pressure on incomes would aggravate this.

If anticipated changes occur, we would expect to see demand depressed and the food and drink market would not escape from this.

IGD will provide further insight when the Spring Statement and the OBR report are published.