2025 Budget Analysis: The breathing space Budget?

The breathing space Budget?

The backdrop to today’s Budget makes it one of the most significant in recent years. Described as “make or break”, the primary political objective was to improve the government’s precarious position with its own MPs and delay any challenge to Keir Starmer’s leadership. Its economic objective was to allow the Chancellor to address the fiscal black hole, fund new spending commitments and reduce the extent to which the UK is in hock to the bond markets. All whilst trying to avoid measures that choke off economic growth. The result is a Budget that significantly increases the overall tax burden to fund measures that will be popular on the left but unlikely to be widely celebrated.

It is striking that the government is only 18 months old and has felt compelled to deliver a budget directed primarily at its base. The government has too often pursued policies that require large amounts of political capital but deliver limited financial returns, such as the winter fuel payment cuts early in the government’s tenure and the inheritance tax changes for small farms and family businesses.

The Chancellor went into this Budget with little room for manoeuvre. The government’s manifesto commitment to not raise income tax, National Insurance or VAT continues to put the Chancellor in a strait jacket. A government in a healthier political position may have taken the risk and gone ahead with the increases to income tax that Reeves hinted at on breakfast television a fortnight ago. No.10 concluded that such a high profile break with the manifesto was a risk too far, but some will wonder if the government should have been bolder last year when it had more authority and was five years away from the next election. Raising income tax is, in relative terms, a predictable and efficient way of raising revenue and may have helped the government shake off the sense that it is lurching from budget to budget, stuck in a defensive position against bond markets and shifting OBR forecasts.

The government’s alternative, and its main revenue raising measure, is to extend the freeze of income tax thresholds. This was the stealth tax of choice for recent Conservative chancellors. The problem for Reeves is that it no longer feels very stealthy. Her predecessors were able to get away with it in a way that it doesn’t seem she can. The Chancellor had told the country last year, after raising taxes by £40bn, that she would not be returning with another tax-raising Budget, but today’s measures amount to £26bn in additional tax. The government’s messengers will need to work hard to avoid this being the main takeaway for voters.

Many in the Parliamentary Labour Party and wider membership will say it’s worth it. The two child benefit cap was, according to the Resolution Foundation, a major driver of child poverty. It had become a totemic issue for the left. Scrapping it will be hugely popular on the Labour benches and will improve the government’s standing with the membership.

However, positioned as a Budget of fairness to which “everyone will make a contribution”, a key question is on who the tax burden will fall, when, and where it leaves disposable income. We are awaiting the Institute for Fiscal Studies’ authoritative distributional analysis, but through measures like the revaluation of council tax on high value properties and tax increases on dividends and property income, the government is pushing the narrative that this is a Budget that primarily places the burden on higher earners. However, freezing income tax thresholds will mean 780,000 people will end up paying income tax for the first time. For a government that prides itself on its progressive values, this feels regressive. Couple that with the OBR’s grim household disposable income forecasts, and the government risks economic and political pain in the latter half of this Parliament.

For now, though, the government has bought itself some respite. Fiscal headroom has been restored to £22bn and the main plea of Labour MPs and child poverty campaigners has been heard. No.10 will now be looking at the next six months as a vital opportunity to get back on track before an extremely challenging set of local elections in May 2026.

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