Healey expected to deliver restrained Budget with modest tax rises

John Healey is set to present his first Budget on 28 October in a move that will test the Government’s ability to balance its political ambitions with the current state of public finances. Despite the UK economy remaining on course for growth this year, the fiscal position offers limited scope for immediate generosity. Analysts anticipate a broadly neutral package that maintains the gradual fiscal tightening inherited from the previous administration. This approach is expected to involve targeted spending financed by modest tax increases, with larger structural decisions deferred until 2027 to allow for a more stable economic foundation.

The decision to delay major reforms may provide the Chancellor with a stronger basis for future policy. A new Spending Review could assist ministers in aligning their priorities with available resources, while forthcoming welfare reports may offer political cover for necessary reforms and savings. Additionally, a potential easing of the Gulf conflict could relieve financial pressures. The shift in the fiscal target year next year is also projected to improve headroom by £6.7bn, based on the 2026 Spring Forecast. However, current headroom remains vulnerable. Forecasts from March indicated a buffer of £24bn against the current budget surplus rule and £27bn against the debt rule. Since then, higher gilt yields, interest rate expectations and inflation have potentially eroded up to £15bn of the Chancellor’s room for manoeuvre, limiting the capacity to accommodate new commitments.

Productivity improvements could eventually offer relief, although immediate improvements in forecasts are not expected. Revised official figures suggest that output per hour grew faster after the financial crisis than previously thought, which could strengthen the outlook for tax revenues. Nevertheless, with these revisions currently stopping at 2024 and changes to estimated hours worked complicating the picture, the Office for Budget Responsibility may prefer to await fuller evidence before adjusting its projections. Nearer-term forecasts are likely to send mixed signals, as growth has repeatedly exceeded expectations, making the OBR’s 1.1 per cent projection appear low. Conversely, inflation is set for an upgrade this year and next, with Investec forecasting 3.3 per cent for 2027. Higher earnings could bolster tax receipts, but uncertainty over wage responses to rising prices complicates the fiscal implications.

Household support is expected to focus on those most exposed to higher energy costs, with targeted assistance preferred over another expensive universal price cap. A reported increase in the warm homes discount from £150 to £250, costing £600m, is anticipated. Extensions to electricity VAT relief, the fuel duty freeze and the temporary 5p duty cut are also possible, highlighting the difficulty of withdrawing supposedly temporary concessions. Housing remains a priority through the “Your First Home” scheme, which would provide eligible first-time buyers of new-build properties with a government-backed equity loan of 20 per cent, initially interest-free, alongside a 2.5 per cent deposit requirement. Income and local property price caps would target this support, while additional funding for council housebuilding aims to address supply constraints.

The Budget should also clarify the delivery of existing political commitments, including Prime Minister Andy Burnham’s promise to prevent people relying solely on the state pension from becoming income taxpayers. The mechanism and cost for this remain unspecified. Resources may also be allocated to regional devolution, while a £1.2bn annual defence equipment funding gap needs addressing separately from longer-term defence ambitions. For businesses, measures to encourage recruitment of young people, potentially through National Insurance relief, could accompany business rates reductions for smaller high street retailers. Such support requires funding, and inherited plans already imply demanding spending restraint outside health and defence.

Tax rises appear likely, although manifesto promises sharply constrain the choices. Employee National Insurance, income tax rates, VAT rates and the main corporation tax rate are protected, together accounting for more than three quarters of central government tax revenues. Alternatives include widening tax bases by charging National Insurance on earnings above retirement age, increasing gambling duties or requiring online marketplaces to collect VAT. Banks and oil companies could also face additional taxes, while Capital Gains Tax changes remain possible through smaller rate increases or ending forgiveness at death. Full alignment with income tax appears to have been rejected, and entrepreneurs reinvesting in Britain might receive relief. Lowering the proposed mansion tax threshold also appears off the table, further narrowing the Chancellor’s revenue-raising options.