The Promise That Became a Cage
In March, the Office for Budget Responsibility calculated that the government’s first fiscal rule would be met with £23.6bn of headroom. The Budget on 28 October is being written around what is left of it.
John Healey will deliver his first Budget as chancellor on that date. He will set out the government’s tax and spending plans to MPs in the House of Commons. The Treasury will publish, alongside the statement, the detail of each measure and what it costs. The independent Office for Budget Responsibility will publish its own assessment of the public finances and its forecast for the economy.
Healey has refused to rule out tax increases after acknowledging that government borrowing costs are at “historic highs”. [1] Borrowing costs are the interest a government pays on money it has already borrowed and spent. When they rise, a larger share of each year’s budget goes to interest and a smaller share goes to anything a voter can see.
The squeeze meets a promise. Before the 2024 general election, Labour promised not to increase three big revenue earners: income tax, National Insurance and VAT. Income tax is charged on wages and on the profits of the self-employed. National Insurance is charged on earnings, and on some profits. VAT is charged on most goods and services at the point of sale.
Two self-imposed rules narrow the space further. The first: do not borrow to fund day-to-day public spending by the end of this parliament. Day-to-day means pay, running costs and benefits, as opposed to building things. The second: get government debt falling as a share of national income (the total income earned in the economy) by the end of this parliament.
Both rules were set out by the previous chancellor, Rachel Reeves, and the new leadership has vowed to follow them. The distance between a rule and the outcome is what Westminster calls headroom. It is a margin, held deliberately, so that a worse forecast does not push a chancellor through his own rule.
In March, the OBR calculated that the first rule would be met with headroom of £23.6bn. KPMG believes it could have fallen to £12bn, mainly because government borrowing costs rose this year. [1] The Institute for Fiscal Studies also forecasts that debt interest will significantly reduce headroom. But it adds a counterweight: higher inflation could push up tax revenues as pay rises drag people into higher tax thresholds. The IFS estimates the buffer could still shrink, but to a comparatively less severe £20bn. [1] So the range runs from £12bn to £20bn against a March figure of £23.6bn. At the bottom of that range, roughly half the March margin is gone. At the top, most of it survives. That trade has a price. A thinner margin leaves less room for error in a year when borrowing costs are already high.
Where the Revenue Could Actually Come From
The first place to look is the banks. UK banks have reported bumper profits. Two levers exist, and they work differently.
The first is a 3% surcharge on profits. A surcharge is an extra layer of tax charged on top of the standard rate. This one was lowered from 8% under the previous Conservative government, which means it can be restored without inventing anything new. Returning it to 8% would more than double that extra layer, from 3p in the pound to 8p. The second is the bank levy, charged on the size of a bank’s balance sheet rather than on its profit. A balance sheet is what a bank owns and what it owes. Taxing the balance sheet is a tax on scale; taxing profit is a tax on results.
Fuel duty has been frozen since March 2022. The freeze began under the Conservatives and was continued afterwards. In May, a planned 3p increase that had been due in September was pushed back to the end of this year. Healey has identified the Budget as the moment to deal with rising petrol and diesel costs, without saying whether the freeze will be extended again. A freeze is a decision not to collect, and its cost is measured against the increase that was never applied.
The High Value Council Tax Surcharge — widely called the mansion tax — was announced in last year’s Budget. It applies to properties in England valued above £2m, from April 2028. There had been speculation about extending it to properties worth more than £1.5m. That extension has been ruled out. On all four of these fronts the same pattern repeats: the headline rate is left alone, and the base, the threshold or the collection point is moved instead.
An Economy Growing While Bills Climb
The backdrop is better than the Budget arithmetic suggests. In the first three months of the year the UK economy grew by 0.6%. In the April-to-June quarter it grew by 0.5%. In August it grew by 0.1%, after 0.4% in July. Both of those monthly figures were stronger than expected. The quarterly and monthly numbers are not the same measure and cannot be set side by side; the monthly pair is the timelier of the two. Analysts say the UK economy is proving resilient in the face of energy price shocks caused by the US-Israel war with Iran. Resilient is not the same as unaffected. It means the growth did not stop. It does not mean the cost did not arrive.
The shock has a physical location. The conflict led to the effective closure of the Strait of Hormuz, a key waterway for the oil and gas trade. Closing a chokepoint removes supply, and removing supply raises the price. Oil prices jumped sharply. That jump has fed through into higher energy prices and higher fuel prices. That is how a war in one region becomes a line on a bill in another. Economists expect UK growth to slow in the months ahead as those costs continue to weigh on households and businesses. The delay is the point. Growth held up through the summer. The bills that will test it arrive later.
Prices are still rising faster than the Bank of England wants. Inflation hit 3.1% in the year to August. That is the highest rate in five months, and it is a full 1.1 percentage points above the Bank’s 2% target. The driver was higher petrol and diesel prices. A target exists so that wages and prices can be set without everyone guessing what money will be worth next year. Missing it by a little is still missing it.
Household energy bills are set to see their biggest rise in four years in January. A typical annual bill is forecast to jump by £276. That forecast is the most direct route by which the Hormuz closure reaches a household that has never thought about the Strait of Hormuz. There has been speculation that Healey is planning energy bill help for households on certain benefits, to be designed and paid for in the Budget.
Further details of the Your First Home scheme are also expected. The scheme would let first-time buyers in England buy a new-build home with a deposit of 2.5%. It would provide them with a loan worth 20% of the property’s value to help pay for the purchase. The repayment terms are among the details the Budget is expected to supply. So the Budget answers two questions at once: who pays, and when. The Treasury’s costings will say who pays now. The January bill will say who pays later, and whether the £276 forecast holds. The £276 forecast is the figure to watch when the January bills arrive?
Sources
Mentioned organisations (context, not sources)
- House of Commons — Organisation (homepage)
- HM Treasury — Organisation
- Office for Budget Responsibility — Organisation (homepage)
- Labour Party — Organisation (homepage)
- Conservative Party — Organisation (homepage)
- KPMG — Organisation (homepage)
- Institute for Fiscal Studies — Organisation (homepage)
- Bank of England — Organisation (homepage)