Salami-slicing capital budgets for defence is bad fiscal policy making

Shortly after the strategic defence review was published last June, Keir Starmer committed to increasing defence spending to 3.5% of GDP by 2035. However, worsening geopolitical instability since has further increased the pressure to find the extra cash.

Starmer has said that the long-awaited Defence Investment Plan (DIP) will be published before the NATO summit in early July. Defence chiefs have, rightly, pushed for the DIP to be funded. Its credibility depends on it, given the long history of inadequate funding to meet over-ambitious plans for military capabilities. So it is welcome that, finally, Starmer is grappling with what that means for the overall fiscal position.

But cutting capital budgets across the board to pay for defence – as has been widely reported – is a choice to backtrack on one of this government’s headline achievements to date: beginning to reverse historic underinvestment in economic and (especially) public service infrastructure. The result of these cuts, in the long run, is likely to be weaker growth and worsened public service performance.

The cobbling together of capital cuts to fund defence would be a failure of fiscal policy making

Deciding how to pay for higher defence spending is not easy. The unpalatable options on the table are cuts to other budgets, tax rises or higher borrowing. But this is what spending reviews and fiscal events are for. These processes allow government to make comprehensive trade-offs across the breadth of fiscal policy about what will best deliver its objectives. Yet governments do need to retain flexibility to respond to unexpected and urgent fiscal pressures outside of fiscal events. This pressure is indeed urgent, but it is far from unexpected.

The broad defence spending pressures were known before the 2025 spending review last June, and the commitment to increase spending to 3.5% of GDP on defence came months before the 2025 autumn budget last November. Yet the government chose not to deal with those pressures at the time, postponing the inevitable difficult choices to a later date.

That later date has now come, and Starmer finds himself trying to make big fiscal decisions on how to fund the DIP outside the processes specifically designed to do this.

Capital cuts would undermine a core plank of Labour’s economic and fiscal strategy

The UK economy and public services have suffered from under-investment and short-termist budgeting over the past 15 years, that the Labour Party were only too keen to remind voters of in 2024. The chancellor should be commended for taking concrete steps towards reversing this since entering office: changing the fiscal rules to enable more investment, setting five-year capital budgets and publishing a 10-year infrastructure strategy. Stable capital investment has stood out as a key strength of this government’s fiscal policy.

Backtracking on this approach would undermine that. Asking all departments to find 1% cuts to capital budgets would create uncertainty and instability – which is particularly damaging for investment. It could mean stopping programmes that have begun, or delaying projects to reprofile spending to beyond 2029/30.

History tells us delays mean projects become more expensive. The stop-start nature of capital investment in the UK is one reason why infrastructure tends to be more expensive to build in the UK than elsewhere, ⁴ HM Treasury, UK Infrastructure: a 10 year strategy, 2025, https://assets.publishing.service.gov.uk/media/6853c5db99b009dcdcb73649/UK_Infrastructure_A_10_Year_Strategy_Web_Accessible.pdf  and is another reason this government has prioritised stability and certainty. It also means waiting longer for the benefits to economic growth and public sector productivity, making it harder for today’s politicians to take the credit for their decisions.

Maintenance spending is often the first place to bear the brunt when capital budgets get cut. But this is often a false economy, holding back productivity and increasing costs later on. These cuts being requested at a time of higher-than-expected inflation and construction costs will only add further pressure.

Any cuts should be done strategically

It is welcome that Starmer looks close to taking a decision on the DIP. The prime minister has been clear on the imperative for increased defence spending – but the decision to cut capital in this way has a cost, and the impact may be more damaging than the other options available.

None of the options is easy. Day-to-day budgets are under pressure too. This government has already been burnt by rushed and ill-thought-through welfare cuts – finding savings there will require more time. The UK has little room to borrow more given its high borrowing costs and the worsening economic outlook, despite the extra buffer Reeves built against her fiscal rules last autumn. And the government continues to feel constrained by its own manifesto commitments on tax.

If the government is committed to holding overall capital spending fixed, then the optimum approach would be to strategically stop or delay a small number of specific capital projects that are lowest value, whichever department they sit in. Selecting these projects would have been difficult – particularly outside of a spending review process – but would be less damaging than across the board cuts.

Balancing these various options against defence spending pressures would have been easier at a fiscal event. But having delayed a decision, then reportedly now decided to cut investment to pay for defence, Starmer, or indeed any future prime minister, should not ignore the fact this will make it harder to boost growth and improve public service performance in the years ahead. That means making capital choices that deliberately minimise those impacts.