Fixing the Foundations? Reeves seeks to deliver change with first Budget 

Context

The first fiscal event of a Labour Government for 14 years—and the first by a female chancellor—might have been seen as an event to look forward to following the General Election, a chance to enact all that the party had fought for. With a leaderless opposition, an unassailable majority, and potentially five years before the next election, it was the opportunity to reshape taxation and spending and to define Labour’s economic approach for this Parliament.

Rachel Reeves, however, entered this Budget under a surprising degree of pressure for the chancellor of a victorious party. The transition from election winning machine to Government has been far from smooth. There have been rumblings of discontent over the apparent lack of a plan for the first 100 days and the mishandling of the winter fuel payment decision. Cabinet colleagues resisted their 2025-26 spending review settlements and appealed over the head of Reeves directly to the prime minister.

Although Starmer backed his chancellor in these disputes, this has only increased the pressure on Reeves to deliver. She took time to plan her policies rather than rushing into an emergency budget immediately after the election, but this has also allowed expectations to accelerate and stifled the Government grid’s ability to churn out many retail-friendly announcements so far. Today, she has now had to simultaneously address the fiscal black hole, end austerity, encourage investment, stimulate growth, and provide stability and fiscal certainty. Starmer’s comments that this Budget will do the hard work to free up future budgets further raised the bar.

Coming into this Budget, Reeves appeared boxed in by the tax red lines she committed to at the election and the rule that current spending must be met by tax revenue. Secondly, the commitment not to increase taxes on “working people” meant that business taxes were always going to bear the brunt. Yet, Reeves and Starmer have also sought to embrace wealth creators and business as key to delivering their growth mission. Balancing these two ambitions are crucial considerations in this Budget.

The theme of this Budget, she had said previously, would be “invest, invest, invest.” The preannounced change to the fiscal rule for borrowing helps Reeves roll the pitch for additional  GBP 20 billion in capital spending. Undoubtedly, this first Budget is a key step in defining Labour’s approach and reshaping the nature of the economy. It will, however, only be the beginning of that process. The full multiyear spending review and the publication of the Industrial Strategy in the spring will also be important in guiding the decade of renewal Labour intends. 

What has been announced?

Economic and fiscal stability has been a defining mantra for Reeves—and the foundation for today’s Budget. While the Budget sees an eye-watering GBP 40 billion in tax increases (including GBP 25 billion from increased Employer National Insurance Contributions) and increased borrowing of around GBP 32 billion per year, Reeves is nonetheless aiming to achieve a current budget surplus of GBP 10.9 billion in 2027-8, two years early in relation to her self-imposed fiscal rule. This will require a considerable degree of fiscal discipline, including spending cuts in unprotected areas.

This imperative to balance the books does, however, cut across Reeves’ other stated missions, namely repairing public services and generating growth. The chancellor said that the only way to deliver growth is to “invest, invest, invest,” but the Office for Budget Responsibility’s (OBR) growth forecasts are mediocre and part of the reason is that it expects falling private consumption and business investment as a result of the policy changes announced today. The chancellor will be hoping that, as has happened before, growth will exceed OBR forecasts, including by raising the economy’s growth potential thanks to structural reforms in areas like welfare and skills.

Central to the Budget today was Reeves’ determination to demonstrate Labour’s commitment to public services. Referring repeatedly to “choices,” Reeves outlined billions in additional spending for both the NHS and education. The Budget commits to “growing day-to-day departmental spending at an average of 2.0% per year in real terms between 2023-24 and 2029-30 to support public services, including to deliver 40,000 extra elective appointments a week and reduce NHS waiting lists.”

The chancellor also announced an extra GBP 22.6 billion for day-to-day spending on the NHS in England, and a GBP 3.1 billion increase in the capital budget, which will include GBP 1 billion to address the backlog of repairs and GBP 1.5 billion for new beds and testing capacity.
On education, Reeves hit a personal note as she reflected on the reasons she and her sister Ellie, also a Labour MP, joined the Labour Party, saying it was because of the condition of their school in the 1980s and 90s under Conservative Governments. This experience was reflected in her announcements today as she committed to a range of big-ticket education measures, including a 19% real-terms increase to the Department for Education’s budget, with GBP 1.4 billion to rebuild schools in the greatest need. The schools budget will increase by GBP 2.3 billion to support the hiring of teachers in key subjects as well as a tripling of investment in breakfast clubs, a GBP 1 billion uplift in funding for children with special educational needs and an additional GBP 300 million for further education in England. She reiterated Labour’s policy to introduce VAT on private school fees in January 2025.

Also announced were a series of investments in housing and transport, as the chancellor made pledges on affordable homes, HS2, and regional transport connectivity. She reiterated the Government’s promise to limit single bus fares at GBP 3 until the end of 2025. On local government, Reeves announced GBP 1.3 billion of additional grant funding, including at least GBP 600 million for social care. The chancellor also committed to giving carers greater flexibility to work by raising the Carer’s Allowance Weekly Earnings Limit to the equivalent of 16 hours at the National Living Wage.

It is no surprise that a Labour Chancellor would seek to place spending on public services—health and education, in particular—so central to the new Government’s first Budget, though the scale of ambition is perhaps more substantial than many were expecting. It also speaks to the politics on which Labour won in July, with a promise to fix the country’s damaged public services. When looking to the next General Election, the party knows they need to demonstrate real change and improvement in the day-to-day lives of voters in order to convince them to return a Labour Government once again. Today’s Budget was the start of that journey.

Analysis

The Budget pre-briefing prepared the ground for difficult tax increases. And taxes have indeed been increased on a huge scale—this Budget has introduced the largest increase in tax revenue in cash terms since 1991. The magnitude of these changes has taken some by surprise compared to the more limited figures included in the party’s manifesto. Reeves has largely focused on one major increase, Employers National Insurance Contributions, to close most of the GBP 22 billion black hole the Government points to, and to create a fiscal buffer. Some of the other less prominent tax changes—on carried interest and capital gains, for example—may, however, become equally important if real negative business consequences become apparent.

That the OBR has in some ways supported that the “blackhole” in the public finances does exist was welcome to the Chancellor. Once this inherited fiscal gap has been addressed, the Treasury has suggested that its intention is that no further tax increases on this scale will be required for the rest of this Parliament. If major tax increases are limited to this Budget, then politically the blame can, to some extent, be pinned on the need to address the Conservatives’ fiscal legacy. If, however, further tax hikes are again required in future budgets, the full responsibility will fall squarely—and fairly—on Reeves and Starmer.

Introducing the biggest tax increase for a generation, however, is more than just about fixing the fiscal blackhole. This Budget’s purpose is to provide money at the scale required to renew public services. Jeremy Hunt had bequeathed very tight spending plans involving cuts for some departments and minimal increases for others. Instead, protected departments will now see meaningful increases. Health spending, the Government’s intended headline measure from this Budget, will increase by GBP 22.6 billion over the next two years. Painful settlement decisions were announced for unprotected departments, like Defra and the Home Office, both of which faced cuts in their day-to-day spending. The real-world impact of these decisions on individual policies, or the removal of particular grants or schemes, however, may only become clear and politically consequential in the days and weeks ahead.

With today’s spending announcements, Reeves is seeking to use her political capital early in the Parliament to make bold decisions for the long term. It is also an attempt by the Government to change the nature of the political and economic conversation in the country and provide hope to her party and the country that this Government can deliver improved public services. Rather than having to talk about how to address the fiscal deficit, the Government wants to refocus upon how to address the “deficit” in public services, how this Government will get teachers into schools, doctors into the NHS, and improve the lives of working people.

To continue to spend on public services, and to prevent the need for future tax increases, the Government is banking on economic growth. Their means to do this is investment. Labour has been clear that it believes that it is under-investment that has restricted growth and the only way of fixing the UK’s long-term fiscal position is by correcting this. Reeves has kept to her word to “invest, invest, invest,” committing to an additional GBP 100 billion over the next five years funded by borrowing. As was trailed in advance, the move to the PSNFL measure of debt has enabled this.

There are some signs of caution on fiscal rules in today’s statement. Reeves has committed to ensuring debt is falling by the third year of the five-year Parliament instead of on a continuously rolling timeframe. The GBP 20 billion per year of capital spending will be undertaken with four strict “guardrails” such as the oversight of the OBR and NAO.

So far, the ten-year yield on gilts has been rising but only slightly and ultimately within the range of international comparisons and the norms of recent years (see Market Reactions section). This is in stark contrast to the 2022 “Mini Budget.” How the bond market reacts to this borrowing and any pressure for future spending, will, however, be an ongoing monitoring process for the Treasury.

Reeves has argued that stable public finances are a precondition for economic growth and that, ultimately, what the Government can spend depends upon levels of growth. If growth remains stagnant, as was predicted in the OBR’s lower forecasts, spending choices will continue to be difficult. Whether today’s business tax changes do discourage highly mobile capital and entrepreneurs or whether visibility on the Government’s future plans, for example via the Tax Roadmap, provide enough clarity and stability, remains to be seen.

Combined with the increased costs to business from the employment rights package and minimum wage increase, the Government will need to keep the business impact of this Budget under review. The ultimate test of this Budget will be whether growth, the Government’s top priority, materializes. Business confidence, however, can be unpredictable and international events, beyond the UK Government’s control, may also come into play.

After this hugely ambitious Budget, the state will emerge far larger and the UK’s overall tax burden will be closer to our European neighbours. The Government feels it was elected on a mandate to repair public services. This budget suggest that they will deliver that, at least in part by a permanently larger role for the state in the economy, through both higher current and capital spending. This will be funded in the immediate term by a mix of new taxes and new borrowing, but in the future the Government hopes it will be from the proceeds of growth. 

What happens next?

The Chancellor’s speech is the first part of a choreographed legislative process to approve the Government’s forthcoming economic agenda. Stripping away the politics, Reeves’ Financial Statement—to give it its proper name—consisted of two main elements: an update on the state of the economy and public finances, and an outline of the Government’s taxation plans.

Following the Statement, the Budget Report or “Red Book” is laid before Parliament for scrutiny, accompanied by supporting documentation such as policy costings, an economic and fiscal forecast from the OBR, data sources, and press releases from Government departments about specific budgetary measures. It is the details contained within this supplementary documentation that will be pored over by analysts, politicians, and journalists. Only following that scrutiny can a Budget be crowned a success—or unravel spectacularly. There are many pitfalls, both political and economic, and it will be vital that the figures add up. Chancellors’ reputations are made or broken on the back of a Budget.

Between today and November 6, the House of Commons will debate the contents of the Budget itself. First up will be the Leader of the Opposition. Given that the contents of this Budget are largely a response to an economic situation that developed when Rishi Sunak himself was chancellor and prime minister, we saw a fiery defense of his own record and an attack on the Government’s plans. More widely, the next few days of debate are an opportunity for MPs to stand up and laud—or condemn—the contents of the Budget.

The four days of debate will culminate in a series of votes: each individual tax or duty must be approved in the form of a Ways and Means Resolution, a specific type of motion which then must be approved by the Commons before the Government can levy a tax on the population. This is a key moment for the Parliamentary Labour Party—the UK system is designed in a way that ensures the whole elected House is responsible for the Budget. This means that Labour MPs will have to answer questions from their constituents on why they supported measures.

The wording of these resolutions will form the basis of the next milestone in the process: a piece of legislation called the Finance Bill, which, once passed, provides the legislative authority to the Government to both levy taxes and carry out expenditure for its program of governance. The bill usually comes before the Commons a few weeks after the Budget.

As the next few days unfold, it’s important to remember that this year’s Budget is different from many others. Upon taking power, the Government launched a multi-year Spending Review. A Spending Review occurs every few years and is an exercise where the Government re-establishes the spending limits of each of its departments. The current review is due to conclude by late Spring 2025 and today’s Budget, with its tax-and-spend implications, may prove to be a harbinger for a Spending Review which contains more difficult choices. 

How did the Opposition respond?  

Conservatives

During his Dispatch Box swansong, Rishi Sunak adopted a bullish approach as he sought to defend his legacy and deliver a damning verdict on Labour’s first Budget in 14 years.

Sunak began by describing the chancellor’s characterization of the economic inheritance left by the Conservative Government as “nonsense” and “nothing but a cynical political device.” Instead, he sought to remind her that the Conservatives left behind an economy which was the fastest growing of any in the advanced world.

Turning his aim to Labour’s taxation measures, Sunak was clear about how he sought to warn the public time and time again that the party now in government would tax, borrow, and spend far beyond what they were telling the country. Arguing that today’s Budget vindicates those warnings, Sunak stated that despite claiming to want to restore trust in politics, Labour’s actions had achieved the opposite with “broken promise after broken promise.”

In perhaps his most damning attack, Sunak gleefully announced that “despite these record-breaking tax rises, despite fiddling the figures, despite letting borrowing soar,” according to the OBR, economic growth will be lower under Labour than it was forecast to be under the Conservatives.

The elephant in the room throughout Sunak’s response is the fact he will be replaced as Leader of the Opposition this weekend and whoever takes over will have their own views on how best to oppose Labour. In a warning shot across the bows of both Kemi Badenoch and Robert Jenrick, one current Conservative MP told EGA, “Sunak is simply in a league above both Badenoch and Jenrick.”

Nonetheless, Sunak will be pleased with his performance. When the story of how the next General Election was won or lost, his short time as Leader of the Opposition may well be credited as the reason why Labour was unable to successfully pin the difficult decisions it takes over the course of this Parliament on its inheritance from the Conservatives. Only time will tell.

Liberal Democrats

Ed Davey began by acknowledging the enormous challenge that the chancellor faced, but quickly moved on to argue that he fears that the Budget will not live up to that challenge. In doing so, he urged the chancellor to be bolder on delivering on adult social care, a key theme of the Liberal Democrats’ election campaign. Given their electoral base in wealthy rural and semi-rural seats, the party has also been quick to warn about the changes to Agricultural Property Relief which will see farming estates valued at over GBP 1 million coming into scope for Inheritance Tax.

Today’s response is further proof of the electoral tightrope the Liberal Democrats will have to tread between now and the General Election. On the one hand, they need to present themselves as opposing the Government of the day, but on the other, their real battle is with the Conservatives in many seats across the country. 

Business and market reaction

Learning from the mistakes of political rivals is an art. Two years have passed since the notorious “mini-budget” that caused the pound to plummet to a 37-year low against the dollar and drove borrowing costs up due to a series of unfunded tax cuts—a series of events that quickly led to the collapse of the Truss administration and damaged the UK’s fiscal standing globally.

By this measure, Rachel Reeves has passed her first test from an investor’s viewpoint, with no sign of any immediate market concerns at the time of writing. Such an outcome is in part thanks to the Government’s proactive political handling. Driven by fears of a repeat of two years ago, the vast majority of announcements had either been pre-briefed or leaked, while the simultaneous publication of a “Business Tax Roadmap” is evidently aimed at providing clarity on corporate tax policies, with the goal of encouraging investment and giving businesses the confidence to grow.

In short, markets breathed a sigh of relief in response to this Budget, which was expected to be much more punitive for investors than what was ultimately announced. During the Chancellor’s speech, the FTSE 100, 250, and AIM markets rose, contrasting with the falls seen prior to the event. Emma Mogford, Fund Manager at Premier Miton, said the Budget “sets the UK on a path to higher investment and growth” and argued this should be positive for investors in UK companies.

However, concerns have been expressed about the weak growth outlook. Julian Howard at GAM Investments said the forecast “brutally articulated” the challenge inherent in Labour’s plan to grow the economy. Included among the much-feared tax changes was a plan to subject pensions to Inheritance Tax. Steve Hitchiner, Chair of the Society of Pension Professionals Tax Group, had a relatively mild reaction, arguing this is a “more attractive solution for raising revenue than many of the speculated alternatives, such as reforming pensions tax relief or imposing NICs on employer pension contributions.” Investors are now focused on the first Mansion House speech Rachel Reeves will deliver on November 14 and, in particular, any additional reforms to boost pension investments into UK assets. 

Materials presented by Edelman Global Advisory UK. For additional information, reach out to Mohammed.Hussein@EdelmanEGA.com