Britain’s Finance Minister John Healey faces a difficult choice between raising taxes, cutting welfare spending or accepting a deterioration in public services as he prepares to deliver his
first budget on October 28. The Institute for Fiscal Studies (IFS) estimates the government may need to find up to £36 billion to compensate for rising costs and meet its defence commitments.
The independent think tank warned that the government cannot simply maintain its existing fiscal plans without risking deeper pressure on public services and undermining investor confidence. Inflation driven by the war involving Iran has increased the cost of delivering government services and added to the financial burden facing the Treasury.
Helen Miller, director of the IFS, said a budget that makes no significant adjustments would effectively mean accepting substantial reductions in the volume or quality of public services.
Prime Minister Andy Burnham and Healey have pledged to ease the cost-of-living pressures facing households. However, their room for manoeuvre is limited by the condition of the public finances and tax increases totalling more than £60 billion introduced in the two previous budgets under former finance minister Rachel Reeves.
The government is also facing growing pressure to explain how and when it intends to increase defence spending to 3% of gross domestic product. Delivering on that commitment while absorbing higher inflation-related costs will add to the demands on an already stretched budget.
The scale of the potential shortfall highlights the difficulty of finding additional revenue without breaking Labour’s existing tax pledges. Raising £36 billion entirely through income tax would be equivalent to increasing the main rate by approximately three percentage points.
Healey and Burnham have committed to preserving the previous government’s promise not to increase the main rates of taxation. Nevertheless, the Treasury is expected to consider alternative measures to generate additional revenue, alongside possible changes to public spending and welfare provision.
Welfare costs are another area of concern, particularly as government borrowing expenses have risen sharply since the conflict in the Gulf began. Higher debt-servicing costs and inflation-linked benefit payments threaten to place further pressure on the government’s financial plans.
There may, however, be some relief from stronger-than-expected earnings growth. If inflation leads to higher wages, income tax receipts could increase, helping offset some of the additional expenditure. According to the IFS, this could limit the deterioration in the government’s fiscal headroom — the amount available to meet its borrowing rules — to a relatively modest level.
Under that scenario, the Treasury’s margin for meeting its fiscal targets in the 2029/30 financial year could fall to around £20 billion, compared with the £24 billion estimated in March. Although that would remain relatively high by historical standards, it would exceed the roughly £12 billion headroom anticipated by some analysts.
The IFS assessment assumes average inflation of 3.1% in 2026 and 3.0% in 2027. Both figures are above the official forecasts published in March, which projected rates of 2.3% and 2.0%, respectively.
The economic outlook is also expected to change. Growth in 2026 could be revised upwards to 1.4%, compared with the earlier projection of 1.1%. However, the forecast for 2027 could be reduced to 1.2%, down from the previous estimate of 1.6%.
One option for Healey would be to postpone major changes to the government’s fiscal strategy until the next Spending Review in 2027. By then, the conflict involving Iran might have ended and borrowing costs could have eased, potentially giving the government more flexibility.
The IFS cautioned, however, that such an approach would depend on uncertain future developments. Rising government bond yields across international markets indicate that investors are increasingly sensitive to fiscal risks and the credibility of public spending and revenue plans.
Miller warned that the government could not base its financial strategy on the expectation that conditions would eventually improve, arguing that a credible budget requires concrete decisions rather than reliance on future economic relief.
