Rachel Reeves should use the budget to reset her fiscal strategy

At the budget on 26 November, the Office for Budget Responsibility (OBR) is likely to be more pessimistic about the UK’s economic situation and the government’s fiscal position than it was in the spring – with reports this week that it is expected to downgrade its key productivity forecast and set the chancellor on course to miss her fiscal rules. 

Changes in the gilt rate, the interest rate paid on UK government debt, have been a big driver of OBR forecast changes in recent years. After a period of very low gilt rates in the 2010s, government borrowing costs have risen considerably. This reflects both global factors and UK specific developments. Since the spring, gilt rates have increased (though less dramatically than in late 2024) and are above the OBR’s previous forecasts. If gilt rates remain where they are now or increase further before the budget, then the government’s planned borrowing in coming years will be more expensive than previously expected.

The other big potential source of change is the OBR’s view on growth and the future size of the UK economy. The OBR has been among the more optimistic independent forecasters in recent years, and its medium-term forecasts since 2010 have, on average, overestimated growth by around 0.7 percentage points.  ⁷ https://obr.uk/docs/dlm_uploads/Forecast-evaluation-report-July-2025.pdf  If the OBR downgrades productivity so that its growth forecast is similar to the Bank of England, or other independent forecasters, this would imply the UK economy will be slightly smaller in future than previously expected, leading to lower tax revenues and a worse fiscal position to the tune of around £10bn. Add in the effects of higher borrowing costs and the approximately £6bn cost of the government’s decision to partially reverse changes to disability benefits and winter fuel payments,  ⁸ The Institute for Fiscal Studies estimates the disability benefits U-turn mean the policy, originally due to save £5bn, will no longer save any money in 2029/30, while the winter fuel payment U-turn will cost around £1bn. https://ifamagazine.com/ifs-changes-to-the-universal-credit-and-personal-independence-payment-bill-mean-no-savings-for-the-chancellor-in-this-parliam… and https://www.bbc.co.uk/news/articles/c79eg2x5qnno  and this could amount to a worsening of the forecast of around £20bn.

This would not be a good time to allow borrowing to increase

A £20bn revision is close to the average since 2010, so it does not suggest a big change in the outlook. Reeves only has headroom of around £10bn against her fiscal rule, however, which means she would be compelled to act if she wanted to stick within those rules.

A big flaw in the operation of UK fiscal rules in recent years has been that it has led to big changes to the fiscal approach in response to modest changes in an inherently uncertain outlook. This was a problem in March, when Reeves ended up making rushed welfare changes (that have since unravelled) to stay within her rules. The big weakness in the current fiscal framework is the razor thin headroom Reeves has maintained against her main fiscal rule – a bigger buffer would make her plans more resilient to medium-sized shocks.

The imperative to act now is not just driven by “self-imposed” rules. Rather it is driven by the reality that: UK government debt is at a historically high level; borrowing has remained stubbornly high – around 5% of GDP – for several years (albeit due to fall by around 1% of GDP this year); and government borrowing costs have risen substantially, meaning any extra borrowing will lead to significant extra debt interest costs in future and the government needs to be cautious of asking investors to absorb yet more debt issuance. If anything, there is a case for a more substantial fiscal tightening to reduce planned debt issuance and increase headroom. 

Further cuts to spending look difficult

It will be difficult for the government to achieve a borrowing reduction through cutting spending. The Spending Review has only recently confirmed plans for departmental spending (around half of all government spending) for the next four years, and those plans look tight already. The government could pencil in tighter day-to-day spending plans for the final year of the forecast, where there are no departmental allocations. But plans are already modest (increasing by only 1% in real terms) and it is doubtful that markets would view such a commitment as credible, especially as such savings have rarely emerged when previous governments have pencilled in vague future cuts.

Recent experience suggests the government will also struggle to save further sums this autumn through welfare changes, given prominent U-turns and the ongoing Timms review on disability and incapacity benefits. 

Tax increases are likely

This leaves tax rises as Reeves’ remaining lever and one which, given the kite flying of various proposals over the last few weeks, she looks likely to reach for.

In an upcoming IfG report, to be published shortly, we highlight the choice Reeves faces as she looks to raise revenue. She could follow many of her predecessors in cobbling together a mix of random low-salience revenue-raisers that allow her to claim she is meeting her tax-related manifesto commitments and keep the fiscal numbers looking healthy enough. However, this approach will leave the tax system in an even bigger mess and make it difficult for Reeves to explain how her approach to tax coheres with growth – supposedly her overarching priority.

We argue Reeves should instead take a new approach. and start to set out a coherent vision for how the tax system can support her objectives. It is too late to undertake sweeping tax reforms this Autumn – such measures should be carefully developed and explained first – but she can use this budget to implement some less complicated reforms as well as providing more certainty by signalling a new tax strategy. 

Reeves should use the budget to develop a more robust fiscal strategy

Reeves finds herself once again facing a difficult autumn, after enacting substantial tax rises last year. Even though the forecast is only likely to deteriorate slightly, it will almost certainly require corrective action.

But the government still has three or four more budgets – and more than half a dozen forecasts – before the next election, and Reeves can use her upcoming budget to ensure she is in a stronger position at subsequent fiscal events. That means ensuring she has sufficient headroom against her fiscal rules so that she does not feel compelled to respond to every forecast adjustment, and articulating a fiscal and tax strategy so that the public, markets and her own backbenchers understand how the measures she is enacting are designed to achieve her objectives, including the government’s overarching growth mission.