The next Budget has become even more challenging - 3rd July 2025

Why the next Budget has become even more challenging. The Chancellor had two pieces of bad news to start July. Together they could mean that the Spring Statement’s £9.9bn fiscal headroom has disappeared.

Cast your mind back to 18 December last year. On that day the Treasury issued a press release confirming that “the Spring forecast will take place on Wednesday 26 March.” It went on to say, “The Chancellor remains committed to one major fiscal event a year to give families and businesses stability and certainty on upcoming tax and spending changes.”

By the time 26 March arrived, the Spring forecast had morphed into a Spring Statement amid speculation that tax rises might be announced. In the event, the Department for Work and Pensions was forced to make last minute changes to its planned disability reforms so that revised projections from the Office for Budget Responsibility (OBR) could show fiscal headroom unchanged at £9.93bn. Curiously, that headroom figure was exactly the same (to two decimal places) as it had been following the Autumn Budget 2024.

In early June, the Chancellor effectively abandoned her precise headroom match by announcing a climb down on Winter Fuel Payments, costing the Exchequer £1.25bn a year. As the first half of the year ended, her neighbour at 10 Downing Street then took his own slice out of the headroom by limiting the proposed tougher Personal Independence Payment regime to new claimants, at a cost of about £2.5bn. 

If June was bad for the Chancellor, 1 July was worse:

• What remained of the savings from the planned disability reforms were, depending upon your viewpoint, either kicked into the long grass or abandoned. On the Institute for Fiscal Studies’ reckoning, the result is an extra £5.5bn on welfare costs in 2029/30 compared with the March 2025 OBR projection.

• By coincidence, the OBR issued its latest Forecast Evaluation Report, examining the differences between its past projections and actual outturns. The OBR’s conclusion covering the period from its launch in 2010 was that:

  “On average, our forecasts have underestimated annual real GDP growth at the one-year horizon by 0.4 percentage points but overestimated it by an average of 0.7 percentage points at the five-year horizon. Our short-term forecasts for government borrowing have overestimated one-year ahead borrowing by on average 0.2 per cent of GDP but underestimated five-year ahead borrowing by 3.1 per cent of GDP.”

  The report explains that the OBR is now undertaking its “usual annual supply stocktake over the summer months”, involving research into “the potential output forecast and its components to review the validity of the assumptions used in this forecast’s construction”. 

  The wording of the OBR report has prompted suggestions that it may be a pitch-rolling exercise ahead of autumn cuts to GDP and productivity growth assumptions. Any such move could have a much more significant financial impact than the Winter Fuel and disability benefit U-turns. Just shaving 0.1% from future annual GDP growth will reduce tax revenue by about £10bn a year. The latest Treasury consensus of independent forecasts points to GDP growth of 1.0% in 2026, whereas the OBR’s March 2025 Economic and Fiscal Outlook assumed 1.9%. Back in March, the consensus figure was 1.3%.

Extending the freeze on income tax allowances and bands by another two years to April 2030 – worth about £10bn a year by 2029/30 – now looks a distinct possibility, despite Rachel Reeves confirming indexation would resume from 2028 in her Autumn 2024 Budget speech. Beyond that – and there will probably be a need for more – could 2025 be the year when a Chancellor finally grabs the pension tax relief lever.

Comment

There is some media speculation that Rachel Reeves will not be Chancellor by the time autumn arrives. If that is the case, her successor may feel less constrained in what tax-raising strategies to use. 

Source: Techlink Professional