IFS issues initial response to Chancellor’s Budget

Responding to the Autumn Budget 2025 delivered by the Chancellor earlier today, Helen Miller, Director of the Institute for Fiscal Studies (IFS) said: 

This was a big Budget, but not in the way people were necessarily expecting. Yes, there was a big tax rise: today’s £26 billion isn’t far short of last year’s £32 billion. Yes, there was an increase in ‘headroom’: more than doubling the buffer against the fiscal rules to £22 billion has much to commend it. But there was also a sizeable increase in borrowing in the short term, mostly due to spending pressures outside direct government control, which the government is choosing to accommodate. To bear down on borrowing in later years and deliver that increase in ‘headroom’, the Chancellor is relying heavily on tax rises towards the back end of the parliament. More borrowing for the next few years, then a sharp adjustment. Spend now, pay later.

The surprising piece of news relates to the OBR forecast. Alongside a widely-expected, but fairly modest, downgrade to the forecast for productivity growth, a higher inflation forecast pushed up the forecasts for spending on benefits and the state pension. The considerable pressures from rising special educational needs spending are also being acknowledged more transparently in the forecast. Luckily for Rachel Reeves, these upwards pressures on spending were largely offset by higher tax receipts. These higher receipts were driven by the interaction between higher inflation, faster wage growth, and an array of frozen tax thresholds, but also by a shift in the composition of economic activity towards areas which are taxed more heavily.

Bring all that together, and the upshot was that the OBR did not hand Rachel Reeves much of a fiscal repair job. Before accounting for any policy changes, she would have had a small current budget surplus of £4 billion in 2029–30. After accounting for the policy U-turns since the spring, it would have been a very small deficit. It certainly could have been worse for the Chancellor.

In the face of a small deficit, Rachel Reeves chose to raise taxes. In part, this was to increase her ‘headroom’ to £22 billion, a sensible move for which the Chancellor deserves credit. By providing greater insulation against economic turbulence, the additional buffer will reduce the risk of playing out this year on repeat in 2026. Though, relative to the uncertainties involved, it’s still not that large a buffer. Taxes also went up, in part, to pay for additional discretionary spending – most notably on universal credit through the scrapping of the two-child limit, as well as welfare more generally due to U-turns earlier in the year. That’s a perfectly reasonable choice – but it is a choice. The key point, again, is that the tax rises are promised for the future, but the spending is coming sooner.

Turning to tax, the Chancellor found a way to cobble together a sizeable package without increasing the main rates of National Insurance contributions, VAT or income tax. The package was skewed towards raising more from those with high incomes. That’s also true of the largest single measure, a three-year extension to the freeze in personal tax thresholds which raises £8 billion in 2029–30 and £13 billion in 2030–31 – though a 1 percentage point increase in all rates of income tax would have raised a similar amount while bringing in more from those at the very top. Because it includes a freeze in National Insurance thresholds, it also breaches the government’s manifesto tax promise not to increase National Insurance – as does the cap on salary sacrifice. And, as the Chancellor acknowledged, it clearly represents a tax rise on working people. A range of other tax increases – on pension contributions, unearned income, business investments and capital gains – weaken incentives to save and invest.

A grand tax-reforming Budget, this certainly was not. The Chancellor continues to show no real appetite for using tax reform to boost growth. One bright spot was the decision to do something on the taxation of electric cars, for which the government does deserve credit, though levying a motoring tax which bears no relation to congestion is far from ideal. When it comes to property, we now have a council tax system based on 1991 values, with a new complicated bolt-on for high-value houses based on what the house is worth today. There’s a reasonable case for levying more high-value homes, but the design of this tax leaves much to be desired.

Zooming back out, a key issue for this Budget was whether the Chancellor’s consolidation package was viewed as credible. It’s one thing to promise a reduction in borrowing, and another to actually deliver it. One year on from her first Budget, Rachel Reeves is choosing to spend more and borrow more than she previously said she would. To stress: borrowing will be higher in each of the next three years. Only after that point, from 2029–30, will borrowing be lower than previously planned, due to a set of back-loaded tax rises and promises of spending restraint in the next Spending Review period.

The additional spending and borrowing in the short-term is readily believable. The future restraint, just before the next election? One could be forgiven for treating that with a healthy dose of scepticism.”

ADDITIONAL ANALYSIS

Public finances:

• The OBR’s much-anticipated productivity forecast downgrade was relatively small, and its effect on the real size of the economy in 2029-30 was negated by higher growth this year. Meanwhile, higher expected inflation and stronger real wage growth led the OBR to revise up their expectations of revenues in 2029-30 by £16 billion even prior to any policy announcements from the Chancellor. Spending forecasts were also revised up, to the tune of £22 billion, in part because of the same inflation pressures pushing through to welfare spending. This meant that the Chancellor faced a £6 billion downgrade from forecast movements – considerably smaller than she might have feared.  
• The fiscal consolidation announced today amounts to a £12 billion reduction in public sector net borrowing in 2029-30, in part coming from £26 billion of direct effects of tax increases, offset by £11 billion of direct effects of net spending increases (including the £7 billion of U-turns since the Spring Statement). Importantly, this fiscal consolidation is heavily backloaded. Borrowing is set to be higher than previously forecast in 2025-26, 2026-27, 2027-28 and 2028-29, before falling below the previous forecast in 2029-30. This means that despite the significant consolidation, total borrowing is expected to be £57 billion more over the five years to 2029-30 than expected in March.
• The Chancellor took several measures to limit the policy volatility and uncertainty we’ve seen in recent years. First, she increased her headroom to £22billion. This is welcome, and is likely to significantly reduce the chance of her needing to come back again with a further fiscal consolidation next year. Second, she has announced that she will only be judged against her fiscal rules once a year. However, with the OBR forecast still in place each spring, the question remains how the government (and the wider world) will react if that forecast shows that they are on course to miss their fiscal rules.

Public spending:

• The government today announced that they would reform SEND funding by moving the risk associated with overspends (which have been persistent and large) from councils to central government from 2028-29. Without reforms to the system, the OBR forecasts that this could add an additional £6 billion per year of spending pressure in 2028-29 – this also greatly sharpens the government’s incentives to introduce reforms that might slow the growth in spending. But with a white paper on SEND reforms delayed to the new year, the government is running out of time for reforms to deliver significant savings in this parliament. Explicitly forecasting these pressures is a welcome step.
• In addition to SEND costs, the OBR have set out a range of further pressures on departmental spending, including asylum accommodation costs and NHS drug costs. Given these pressures, the OBR have now assumed departments will have zero underspend against their day-to-day spending plans in 2028–29, pushing up forecast spending by £6.3 billion. If these pressures are larger than this, it would lead either to squeezing other parts of departmental budgets or would require future top-ups to departmental budgets.
• The government plans to make further efficiency savings between 2028–29 and 2030–31 (the period covered by the next Spending Review), aiming to save £4.9 billion from day-to-day spending in 2030–31. This follows ambitious plans to improve productivity already set out at the Spending Review that already implied historically high productivity growth. Whether savings on this scale can be delivered remains to be seen.
• The abolition of the two-child limit will cost £3 billion per year in 2029-30, benefiting 560,000 families with an average gain of over £5,300. This is one of the most cost-effective ways to quickly address child poverty, and the government estimate it will reduce child poverty by 450,000 in 2029-30. Children in families of three or more children had relative poverty rates of almost 44% in 2023-24, compared to 24% for those in smaller families, and the rise in child poverty seen over the 2010s was entirely driven by larger families.

Tax:

• The overall tax burden is forecast to increase from 36.3% of GDP in 2025-26 to 38.3% in 2030-31. If an election were held tomorrow, the overall tax rises announced in this parliament would exceed those announced in any other since at least 1970.
• Extending the freezes of personal tax thresholds – which were due to end in 2027-28 – for a further three years to 2030–31 is expected to raise £12.7 billion per year (in 2030–31), based on current inflation forecasts. The effect of the freeze as a whole – which began in April 2022 – is now forecast to increase the number of taxpayers by 5.2 million and the number of higher rate taxpayers by 4.8 million in 2030-31. However, the actual revenue yield and the number of taxpayers will be determined by inflation, which is uncertain – it could easily be much larger or smaller.
• It is welcome that the government has finally set out some sort of plan for how electric cars will be taxed in the long term: a per-mile tax. As the take-up of electric vehicles spreads, this is due to become the second-biggest measure in the Budget, raising £7 billion a year in today’s terms by the time all cars are electric. But what the flat tax proposed fails to reflect is the fact that driving at congested times and places imposes much higher costs on society (principally other drivers) than other driving.