Chancellor John Healey is preparing to deliver his first budget on 28 October against a backdrop of bond market volatility that has already eroded up to half of the fiscal headroom left by his predecessor, Rachel Reeves. Despite Andy Burnham's rhetoric about radical change, early signals suggest a cautious, steady approach, with key decisions on defence spending likely to be deferred.
Budget Priorities and Defence Spending
Healey will give a speech on growth policy on Monday, less than six months after Reeves's Mais lecture, leaning heavily on her favourite themes of investment and devolution. The speech is expected to be followed six weeks later by a budget that defers key decisions, including when the UK will reach its 3% of GDP defence spending target.
When he resigned in June, Healey was adamant about setting a "headmark date" of 2030 for the 3% target. Treasury sources now indicate he has not changed his mind, but he intends to defer setting out a timeline until next year's spending review. This suggests Reeves's promise of one major fiscal event a year has been abandoned.
Fiscal Headroom Eroded by Market Volatility
Higher interest rates on the Treasury's debt pile have already wiped out up to half of the £24bn headroom Reeves left against her fiscal rules. Up to another £4bn is expected to have evaporated due to lower-than-forecast migration, and Burnham's VAT cut on electricity bills will also need to be funded.
Healey has just returned from the G20 finance ministers' meeting in Asheville, North Carolina, where volatility in government bond markets was a hot topic. He has stressed that banks' fundamental role is often overlooked, suggesting a windfall tax on banks, as urged by the Trades Union Congress, is not on the cards.
Challenges in Meeting Spending Pledges
Last year's spending review was predicated on generous increases for key departments like the NHS and defence for Labour's first two years, followed by a much tougher three years. According to Helen Miller, director of the Institute for Fiscal Studies, "things are so tight that if the government knows for sure, for example, that they want to increase defence spending to 3% by the end of the parliament, that would mean that to stick within the current plans, you'd have to hold all other departments, including the NHS, flat." She adds, "that seems pretty unlikely".
Miller suggests that if the government wants to avoid that, "you probably want to find the money now, for the spending review next year. If you really want to get defence to 3%, that is a real challenge … the budget is the right time to be making preparations that would allow that to be possible."
Welfare Reforms and Tax Dilemmas
There is more to be done on reforming welfare, as Alan Milburn's forthcoming review is expected to recommend, encouraging more young people into work. Lord O'Donnell has also argued that the triple lock pensions promise should go. However, these measures are unlikely to provide the £10bn-ish additional spending needed to reach 3% of GDP, let alone the 3.5% Labour has promised by 2035.
As the Resolution Foundation pointed out this week, the 3.5% target looks impossible to meet without tax rises on middle-earners. Burnham's choice of Healey as chancellor read like an endorsement of 3% defence spending by 2030, but postponing the decision will only unleash another six months of destabilising speculation. Healey should take the tough decisions now at the budget.
