Of fiscal gaps and geese

A year ago Britain’s chancellor, Rachel Reeves, said that the £40bn of tax rises announced in her October budget, the largest in 30 years, were needed “to wipe the slate clean and put our public finances on a firm footing”. The following month, Ms Reeves told the CBI that she would not be “coming back with more borrowing or taxes”.

Things have not turned out as the chancellor had hoped.

Government borrowing is running well ahead of Ms Reeves’s plan. In the first five months of 2025-26 the government borrowed £83.8bn, £16.2bn more than in the same period last year and £11.4bn more than planned. Without higher taxes or cuts to public spending the chancellor is likely to miss her own rule for reducing debt which she has repeatedly described as being “non-negotiable”.

The true scale of the problem is greater than these numbers imply. Higher government borrowing costs, government U-turns on cuts to winter fuel payments and sickness and disability benefits, and an expected downgrade to the Office for Budget Responsibility’s estimate for UK productivity growth have created a hole in the public finances. Estimates of the size of the ‘fiscal gap’ vary, but a figure of around £30bn seems plausible. To this it would be prudent to add a margin of error of at least £10bn to avoid being blown off target by future shocks and surprises. That would leave the chancellor needing to find around £40bn in her budget on 26 November, an amount similar to the scale of last October’s tax rises.

The obvious solution would be to change the fiscal rules to allow more borrowing. That would be risky. High inflation and government borrowing, and a falling away of demand for gilts from a shrinking pool of UK defined benefit schemes, mean that the UK government already faces interest rates that are higher than its European or North American peers. To overturn what the chancellor has described as ‘ironclad’ fiscal rules – in what would be the 11th change to the rules in 18 years – to fill a hole in the UK public finances could test the patience of the gilt market.

That leaves the chancellor facing a choice between reducing public expenditure and raising taxes.

The government’s inability to win the support of its backbenchers for relatively modest welfare cuts earlier this year suggests that significant reductions in public spending are not on the cards. In any case, the existing plans for departmental spending for the next four years, which were unveiled in July, already look tight and public satisfaction with services is low. The government could kick the can down the road, pencilling in an even tougher spending settlement towards the end of the forecast period, but given the slippage on spending in recent years such a commitment might not be credible.

This leaves taxes. The Party’s manifesto stated: “Labour will not increase taxes on working people, which is why we will not increase National Insurance, the basic, higher, or additional rates of Income Tax, or VAT.” The chancellor said last month that the manifesto pledge stands but other comments seemed designed to create more room for manoeuvre on tax. Before her speech to the Labour Party conference Ms Reeves said that the “world had changed” since last year’s budget due to a combination of conflicts, US tariffs and higher borrowing costs. The chancellor’s comments have been widely construed in the media as meaning that she no longer stands by last year’s pledge not to raise taxes.

Chancellors occasionally raise significant revenues through a single tax change – as with George Osborne’s increase in VAT to 20% in 2010, Rishi Sunak’s introduction of the Health and Social Care levy in 2021 and Ms Reeves’s increase in employers’ NICs last year. These are the exception. Chancellors tend to favour a mix of smaller tax-raising measures, sometimes stealthy, such as through freezing income tax allowances.

The media has speculated about the possibility of a wide range of tax-raising measures in recent weeks. Some of the larger revenue-raising measures that have attracted discussion include extending the freeze in income tax allowances, reducing pension reliefs, increasing council tax and extending the VAT base. What is clear is that the chancellor could raise £40bn or even more through a series of smaller tax measures and without increasing rates of income tax, VAT or national insurance.

Implementing a host of tax-raising measures may seem like the least risky course of action. But, as the Institute for Government (IfG) has observed, “small isolated [tax] changes can create a concentrated group of losers and attract outsized bad press”. More fundamentally, the IfG also cautions that “an eclectic grab bag of tax raisers that complicate an already inefficient tax system would hamper, not promote” the government’s key aim of supporting growth.

Louis XIV’s finance minister, Jean-Baptiste Colbert, famously declared that “the art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.” £40bn of tax rises would occasion a good deal of hissing. With the tax burden already at the highest level in more than 70 years perhaps the more pertinent question is what £40bn of additional tax increases might do to the health of the goose.

PS: Last week’s Briefing examined the so far limited impact of AI on the US and UK jobs markets. A report from the Yale Budget Lab and the Brookings Institution think tank-released later in the week came to a similar conclusion, noting that since the introduction of ChatGPT in November 2022, the US labour market has not "experienced a discernible disruption" from AI. Moreover, fears of the destructive force of AI in relation to jobs seem, at least so far, wide of the mark. The report found that the occupational mix of the US job market is not changing at a markedly different pace today than during the personal computer revolution of 1980s and the rollout of the internet in the 1990s.