Autumn Budget preview

Has the government met its fiscal rules?

Fiscal forecasts from the Spring Statement, portray a general picture of adverse but improving deficit and debt metrics over the forecast horizon (Figure 1). In terms of the targeted measures, the OBR assessed that the stability rule was on track to be met with relatively little headroom of £9.9bn. The margin against the investment rule was slightly greater, at £15.1bn. But the picture now looks less rosy than in March 2025.

Specifically, and despite faster-than-expected GDP growth, the latest data show that the deficit (PSNBx) for the first five months of the financial year is running ahead of the OBR’s March forecasts by something like £1.9bn per month. The ‘current budget’ shortfall, the metric used for the stability rule, currently exceeds the forecast by £2.7bn a month. These outturns include a favourable restatement recently by the ONS which account for an adjustment to VAT inflows.

But the greatest obstacle to the Chancellor avoiding the need for a tightening in fiscal policy is the OBR’s view on productivity growth further ahead. The issue is that the watchdog’s outlook for productivity growth drives its medium-term GDP forecasts and therefore its projections of fiscal metrics. In March, the OBR’s view was that productivity growth in the longer-term would equal 1.25% per annum. However it has acknowledged that its track record here over recent years has been poor and that it has consistently overestimated future productivity growth, which has averaged closer to 0.5% per annum since the aftermath of the global financial crisis. Figure 2 shows the evolution of the OBR’s medium-term (i.e. five-year ahead) productivity growth forecasts. The point is not to criticise the OBR – most forecasters have found themselves in the same boat – but that a recalibration this time around could leave the expected level of productivity in 2029/30 much lower than previously envisaged, with a corresponding fiscal forecast that looks materially worse than it did seven months ago.

Figure 1: OBR Spring ‘25 fiscal forecasts, £bn (figures in brackets are % GDP)
 

* Central government debt interest net of APF
Source: Office for Budget Responsibility

Figure 2: OBR productivity forecasts have been optimistic for some time
 

Source: OBR, Investec Economics

Productivity assumptions are key to how much fiscal tightening is needed

Figure 3 outlines some scenarios of potential downgrades that the OBR could make to its productivity forecasts and the consequent impact on the current budget position in 2029/30, i.e. the fiscal headroom. Firstly, in what we would put as the worst-case scenario, the OBR could simply throw in the towel and conclude that average annual productivity growth will equal 0.5% over the forecast period; consistent with the post-GFC period so far. Compared with the OBR’s forecasts in March, this would result in the level of productivity being 3.0% lower at the end of the forecast period and crucially wipe £54bn off the fiscal headroom. In other words, a downgrade to productivity growth on this scale on its own would result in the Chancellor requiring fiscal savings of £44bn to hit her principal fiscal rule (without any headroom). Indeed, even a more moderate (but still hefty) 0.5% per annum downgrade to the current forecasts would leave a current balance of close to -£30bn which the Chancellor would need to fill.

Figure 3: Productivity assumptions (output per hour)
 

* Output per worker. ** Based on current policy.
Source: OBR, BoE, Investec Economics

But there is a legitimate question as to why the OBR is choosing this particular moment to downgrade its productivity growth assumptions. Although the productivity performance in the UK has been weak for over a decade, current evidence could be pointing to the long-awaited upturn in the trend. Firstly, in its latest Monetary Policy Report in August, the Bank of England actually upgraded its productivity forecasts, noting that some of the previous weakness in the productivity numbers has been overstated. Indeed, for 2026 and 2027 its output per worker growth assumptions have been upgraded to 1.25% (yoy) and 1.0% (yoy) respectively, both from 0.75% (yoy) back in May. Now these forecasts are not dissimilar to the OBR’s forecasts in the Spring, and keeping the Bank’s 2027 forecast of 1.0% productivity growth constant until the end of the forecast period would on our calculations cause a deterioration in the current balance by a more modest £16bn. Indeed although the Bank’s forecasts measure output per worker and so are not strictly comparable to the OBR’s (based on growth in output per hour worked), slashing its existing assumptions would ask the question as to whether it was a little too hasty.

Indeed, evidence from various official labour market statistics points to a mixed picture of UK productivity trends. Official ONS numbers show productivity growth to be running at -0.8% (yoy) in Q2 this year. However these are calculated using the discredited Labour Force Survey (LFS) employment data. These show material increases in both employment and hours worked, which runs against the grain of most other evidence showing a loosening in labour market conditions. If one uses Real Time Information on payrolls from HMRC in place of the LFS data, productivity (measured by output per worker) is up by 1.7% on a year ago. An LFS measure based on the same basis shows a 1.0% decline (Figure 4).

Figure 4: The strength of productivity growth depends on the data used
 

* LFS: Labour Force Survey, RTI: PAYE Real Time Information, SE: Self-employed data from the LFS.
Source: ONS, Investec Economics.

Overall although there is a clear case for the OBR to downgrade its productivity assumptions further ahead, it is not clear that it should take a chainsaw to them, especially as it is basing its decisions on LFS figures. Nonetheless a smaller downgrade would of course still put pressure on the Chancellor to take corrective action – a rule of thumb is that a 0.1% per annum cut in productivity growth forecasts over the forecast horizon raises the deficit in 2029/30 by £9.0bn.

Internal opposition to spending cuts has added to the fiscal challenge

There have also been a number of post-Spring Statement policy changes which need to be taken into account. These include a) the decision not to scrap the Winter Fuel Payment for the majority of pensioners, at a cost of close to £1.0bn; ii) the U-turn on the Welfare Bill, £2.5bn); iii) an increase in ‘core’ defence expenditure from 2.6% to 3.5% of national income, which by 2035, the target date, could come to £30bn a year (although its impact on the stability rule is unclear, bearing in mind that a proportion of the additional spending is likely to be investment); iv) the likely scrapping of the two-child benefit cap (£3.5bn), although this has not been formally announced yet; v) a freezing of duty on petrol and diesel for a further year. This has not been voiced either (yet) but these duties have not been raised since 2011 and seem set to remain frozen again rather than indexed with inflation, with the 5p cut also extended, at a cost of £2.6bn. In aggregate, even when excluding extra defence spend, these policy moves could come at a cost to the Exchequer of some £9.6bn in addition to impact of the OBR’s changes to its productivity projections.

At last autumn’s Budget, the Chancellor raised the government’s medium-term spending commitments by £74bn per annum. This was partly to accommodate the cost of new programmes, especially investment, but also to provide cash to maintain existing commitments to public services, bearing in mind that the previous government had not held a Spending Review to allocate cash to departments beyond 2024/25. Some talk over possible spending cuts has emerged recently. Paring back on investment plans or cash for the NHS now however would be completely incongruous with the government’s broader economic objectives. It might be possible to make inroads on certain elements of welfare spending. Indeed new Work and Pensions Secretary Pat McFadden recently remarked that welfare reform ‘must happen’. We suspect that in time, it will. The scope of savings that might be found at this point though remains to be seen, especially given the scale of the backbench rebellions that accompanied the government’s attempts to limit Winter Fuel Payments, Personal Independence Payments and the health-related element of Universal Credit – reneging on the ‘triple lock’ in breach of the manifesto would therefore seem out of the question.

With more borrowing off the table, higher taxes are the only way out

So, if spending needs are higher and scope for additional borrowing is not available under fiscal rules that Chancellor Reeves has vowed to maintain – not least to keep markets onside – the only path to balance the books is through higher taxation. There are multiple options for this; we discuss the key ones below. There, too, though, constraints apply.

One of these is political. If at all possible, which in practice means if the productivity forecast downgrade is not prohibitively large, the Labour government will want to stick to its manifesto commitment of ‘no tax rises on working people’, explicitly ruling out rises in National Insurance, income tax rates or VAT: this would demonstrate to the electorate that its word can be trusted which, so the calculation surely goes, bolster hopes of holding onto power in the next election. These taxes together, though, along with corporation tax – the main rate of which the government has also committed not to raise – together account for around three quarters of the central government tax take (Figure 5). This has not fully boxed the government in, but it does require either some creative interpretation of these constraints or some larger changes in some of the smaller taxes to raise enough extra revenue – or potentially both.

Figure 5: Income tax, NICs, VAT and corporation tax dominate the tax take
 

Source: ONS, Macrobond, Investec Economics

With regard to the former, the Chancellor announced at the Autumn 2024 Budget her intention to let the tax threshold freeze expire as planned. This had been introduced by the Conservatives with effect from April 2021 and extended subsequently by them to last until April 2028. Yet a further extension has the potential to add substantially to the government’s coffers: by tagging an extra two years of frozen income and NICs tax thresholds onto this, the government could raise some additional £10.4bn p.a., as per IFS estimates. With a bit of verbal gymnastics, such a ‘stealth tax’ might be portrayed as no tax rate rise on working people, and in any case as the continuation of an existing policy. It therefore looks to be the most obvious low-hanging fruit for delivering extra tax revenue.

This would come with its own issues. For instance, those relying solely on the (full) state pension to fund their retirement might, for the first time, find their income exceeding the personal allowance and therefore become liable for tax. Naturally, it would only be the share of income in excess of the personal allowance that would be taxed, and then only be at the lowest marginal tax rate, so the extra tax revenue raised may not be all that substantial, but the political cost might be large. The government may think about whether to introduce some extra allowance for pensioners to avert hitting this particular group of voters.

Yet foregoing even a modest amount of extra revenue might be hard, so it is quite feasible they decide to allow this broadening of the tax base despite the political cost. Indeed, for the same reason, it has been mooted whether National Insurance could start to be applied to non-wage income such as rental income. And those of an age where they can access their pension savings – glossing over whether some of them are still ‘working people’ – might also be targeted by a reduction in the lump-sum tax free allowance that can be drawn, for instance.

In a similar vein, it is possible the government could offer tax relief for pension contributions only at the basic, not the additional rate, of income tax. This though would incentivise less pension saving by higher-rate taxpayers as, in contrast to others, they would be taxed twice: both at the point of saving into pensions (at a net 20%/25%) and again when withdrawing their savings, potentially at another 40%/45%, if they remain in the higher tax brackets.

Turning to some of the other taxes, one of the more radical options being discussed is whether the Chancellor will reform property taxation by replacing Stamp Duty Land Tax (SDLT) with some sort of property sales tax. In the 2024/25 tax year Stamp Duty charges on the purchase of residential properties raised £10.3bn in revenue. Property experts and economists tend to criticise the current way of taxing property, arguing that it acts as a constraint on housing market activity. One suggestion to unclog the housing market is therefore to move away from a lump sum tax charge on the purchase of primary residences towards a tax on the sale of a property. This would be to the benefit of first-time buyers purchasing homes over £300k, but to the detriment of those downsizing. One idea that has been floated as a replacement to SDLT is to charge an annual tax on homes valued over £500,000, to be paid at the point of sale. The idea of this is to reduce barriers to moving, such as through a smaller upfront cost, and promote fluidity in the housing market. There has also been speculation over a potential ‘mansion tax’, targeting high-value properties, possibly valued over £1.5 million. This is essentially a specific form of wealth tax, where wealth tied up in property is targeted. Broader wealth taxes, similar to those included in the Green party’s manifesto, have also been mooted. This seems unlikely however, with Chancellor Reeves’s views on the matter clear. In September she said that "We already have taxes on wealthy people; I don't think we need a standalone wealth tax".

Among the smaller taxes that could shore up the public finances, the ones where pushback is likely to be minimal look most attractive. An increase in gambling taxes is one such example, although it would far from solve the Chancellor’s fiscal woes: in FY 2024/25, the 15% tax rate raised £3.6bn in government revenue, so even substantial rate rises would alone be hardly transformative for the public finances. Higher taxes on banks, either through an increase in the surcharge on Corporation Tax (currently 3%) or the bank levy, are also likely to be in the potential basket of measures, as they have been at past fiscal events. Although chief executives in the financial sector might protest, arguing that it will discourage investment in the UK’s banking industry and put it at an international disadvantage, there is likely to be little aversion amidst the public to such rises.

Of course, the Chancellor will try to offer some giveaways on the tax side too, if not just to water down some of the headlines in the media the next day. A small cut to beer duty is a tried-and-tested sweetener here, and would be particularly relevant given that ministers are currently pushing ahead with plans to extend opening hours at pubs. And of course, as already discussed, it is likely that fuel duty will be frozen for another year. Fuel duty actually poses an additional longer-term risk to public finances though, in the sense that the transition to electric vehicles could eliminate this fairly large revenue stream. This has led to calls for it to be replaced with a new form of road tax, to ensure the continuation of government revenue from driving as petrol and diesel cars are phased out.

The manifesto tax promises ‘stand’ – but will they do so after 26 November?

Yet the overall need is clearly for fiscal tightening. The risk is clear that the sum of all that is politically feasible from the above is not sufficient, and that more substantive revenue rises are required. For this eventuality the government has paved the ground for retreating from its manifesto promises, to bring the bulk of the tax take more fully into play: the latest government line, as per Starmer and Reeves, is that the manifesto commitments ‘stand’ going into the Budget but also that ‘the world has changed’ since these were made and the UK is ‘not immune’ to that. In that case, the government will need to consider which tax rises would cause the least economic damage. (Figure 6 sets out the OBR’s macroeconomic forecasts from the Spring Statement.) Among income and National Insurance and VAT rates, it is perhaps the former that would meet that criterion at this time. This is because VAT rises, though broad, would add to inflation, something the UK in particular can ill afford at a time when inflation overshoots have been so prolonged. Further National Insurance contribution rises on firms would surely risk being piled onto prices too. Income tax rate hikes, on the other hand, would not suffer from that issue. A related advantage is that they would make it easier for the Bank of England to offset some of the pain of fiscal tightening through some more monetary easing, cutting interest rates sooner and further than its current baseline scenario envisages. (The convention is that the Bank only incorporates fiscal policy changes into the assumptions behind its economic forecasts once these have been publicly announced by the government.)

Figure 6: OBR Spring ‘25 macro forecasts (annual % change unless stated)
 

* Includes households and non-profit institutions serving households
Source: Office for Budget Responsibility

The Budget (and its aftermath) is a balancing act fraught with risk

How will markets respond to Chancellor Reeves’ upcoming Budget? With some understatement, we note that fiscal events have been a moment of jeopardy for UK governments recently. Perhaps even more than usual, this Budget is a balancing act. Markets are clamouring for a fiscally responsible Budget that cuts down on borrowing. Voters demand one that secures welfare spending and upgrades infrastructure, all without upping the tax burden on them. The risk that one or both will be disappointed is tangible. The government will be doing its utmost to avoid a damaging loss of confidence in markets like that which followed former PM Liz Truss’s ‘mini’-Budget. But whether it will do enough to reassure on long-run fiscal sustainability and reap immediate rewards of lower longer-term borrowing costs is doubtful given the need to keep voters onside: Reform, the party currently leading in the polls, had – at least until recently – promised not only that voters' wishes can be met but that there is room for substantial tax cuts at the same time. In fending off that challenge, Labour could be pushed away from the fiscally most conservative approach that the markets would prefer.

Politically, therefore, the Budget is fraught with risk. The maximum moment of danger for the PM and his Chancellor could come next year, perhaps after the local elections in May. A poor performance then, fuelled by voters’ Budget disappointment, could put not only Chancellor Reeves but also PM Starmer at risk of being ousted from their positions by their own party. Even though a general election would still be a long way away, a Labour party under a new leadership that would then presumably deprioritise fiscal consolidation, under pressure from Reform, could put the UK back on bond vigilantes’ radar – for all the wrong reasons.

The views expressed are those of the contributors at the time of publication and do not necessarily represent the views of the firm and should not be taken as advice or recommendations.