Reeves’ ‘ambitious’ £14bn savings plan leaves Healey with a Budget headache
Cost saving measures pencilled in by the last government have dramatically reduced Chancellor John Healey’s ability to look for spending cuts and efficiency gains at his first Budget, economists have warned, raising the prospect of fresh tax hikes.
Healey is under pressure to rebuild his £23.6bn fiscal buffer, which is predicted to shrink due to higher debt interest costs and possible revisions to growth forecasts. The buffer indicates that the current budget, or the balance between day-to-day spending and tax receipts, will be in surplus by 2030, the third year of the Office for Budget Responsibility (OBR)’s forecast window.
Analysis by the Resolution Foundation, a left-leaning think tank, suggests that the current level of headroom available to the Chancellor is now a mere £5bn due to higher borrowing costs and public sector pay pressures.
But leading economists have warned that proposed savings across government departments by his predecessor Rachel Reeves have boxed the Chancellor in, making tax hikes more likely.
The fresh set of warnings could test both Healey and Burnham as each has pushed to ease concerns about a new wave of tax hikes, having written to Cabinet ministers to find savings within departments in a bid to ease cost of living pressures for Britons.
Welfare reforms are not expected to be delivered before the Budget, which could ease concerns over rising government spending. The completion of both the Alan Milburn review on youth unemployment and the Stephen Timms review on disability are expected only after 28 October, putting further pressure on government departments to slash costs.
Spending cuts to limit Healey’s options
Previous chancellors including Jeremy Hunt and Rachel Reeves have looked to pencil in spending cuts in the final year of the forecast window in order to meet key fiscal targets on lowering borrowing.
Last year, Reeves announced that government departments would have to deliver £14bn in efficiency gains by the financial year between 2028 and 2029. The Defence Investment Plan published in June separately committed to a total of £10.7bn in efficiency savings over the four years between 2026 and 2030.
The pledge to cut costs through using AI and “root[ing] out waste” is part of a target to deliver two per cent productivity growth across health, which is the largest area of government spending, according to the Treasury.
At last year’s Budget, Reeves went further as she slashed the real terms growth rate in spending, which accounts for inflation, from one per cent in to zero per cent 2029-30.
The new plan helped the Chancellor meet her fiscal headroom after the rise in real terms spending was upgraded between 2025 and 2027 relative to a forecast in March 2025, but it leaves her successor facing stark choices.
Economists at the Institute for Fiscal Studies said the current plan to slow spending around the time of the next General Election would require the government to exercise “near heroic restraint”.
Speaking to City AM about the predicament facing Healey at this year’s Budget, IFS economist Bee Boileau said existing plans were based on “really quite ambitious productivity improvements”.
“I think there are several reasons right now to be quite skeptical that you could make substantial cuts to already-tight spending envelopes without meaningful consequences for public services,” she said.
She explained that pressure to raise defence spending from 2.6 per cent of GDP to three per cent of GDP by 2030, which would cost nearly £11bn more a year, and Burnham’s plans for social care reforms would add to demands on day-to-day expenditure. Boileau added that while departmental spending cuts were “always an option”, ministers would need to be “realistic about what that actually means”.
Under the current plans, day-to-day spending is set to rise by 1.3 per cent in 2028-29 and 0.3 per cent in 2029-30 in real terms, which is equivalent to a rise of about £10bn altogether.
Each 0.1 percentage point reduction in 2029-30 could save Healey about £600m against the fiscal rules although the Chancellor may wish to avoid writing in real terms spending cuts to plans given a Labour pledge for “no return to austerity” and Burnham’s criticism of cuts.
Inflation to erode Labour plan
The National Institute of Economic and Social Research has warned that higher inflation as a result of the Iran war could also erode government spending plans, with its previous forecast saying the value of expenditure would be cut by up to £24bn. The think tank’s senior economist Peter Dixon told City AM that options available to the government on spending were limited.
“I think the government will probably remain to the view that it’s going to have to sail very close to the wind with regard to its headroom,” Dixon said.
ITEM Club economist Matt Swannell added that any plans for spending reductions outside of welfare would have to be clearly spelled out in order to “look plausible” with markets.
“For some government departments, a reduction in day-to-day spending would put more pressure on already-difficult settlements,” he said.
“You have to tread very carefully because you have to make sure that they stack up and look plausible for credibility to be maintained.”
City analysts at RSM UK and Investec have suggested tax hikes look “inevitable” due to spending pressures facing the government.
A Treasury spokesperson said: “The Chancellor is fully focused on his priorities to boost business, help with the cost of living and support people in every postcode, underpinned by fiscal discipline and a commitment to meeting the fiscal rules with a buffer against uncertainty.
“The OBR will publish its updated forecast alongside the Budget in October and we will not comment on rumour, speculation or proposals about its contents ahead of then.”