Economy under pressure: will it stabilise, or fall flat on its face?

The Chancellor has set the Budget date for November 26th, the latest it could possibly be. That risks a repeat of last year, with prolonged speculation over potential tax rises undermining confidence and allowing damaging uncertainty to linger.

It now looks increasingly likely that the Chancellor will miss her self-imposed fiscal rules – by around £20 billion to £25 billion – although at least one forecast suggests the gap may be as high as £50 billion. The actual number will depend on several moving parts: the outlook for growth, interest rates, bond yields and the underlying trajectory of the public finances.

The gap is significant. Yet instead of confronting the substance – controlling public spending and aiming for fiscal solvency – the policy debate remains fixated on a narrow concept of fiscal headroom, which is the notional buffer by which the government expects to meet its rules. 

That headroom was already small: as just £9.9 billion, or 0.3% of GDP, for the main rule which is to borrow only to invest. And by last week, two-thirds of the headroom would have already evaporated were bond yields to remain at their high levels. In practice, the Chancellor is now operating with little to no room for error and looks set to breach her rules.

The options to bring the numbers back into shape boil down to: growth, reform, austerity, taxation, or borrowing. The growth outlook is too modest to close the gap. Reform of public services to deliver better value for money is a long-term effort that will not materially affect the near-term position. Curbing public spending growth appears politically untenable, at least in the current context, as we saw earlier in the summer. Borrowing is already exceptionally high, with over £300 billion in gilt issuance planned this year alone. While recent gilt auctions have been heavily oversubscribed, the market’s capacity to absorb further supply at acceptable rates is not unlimited.

That leaves taxes. And here, the reality is unavoidable: the only taxes capable of delivering the scale of revenue required are the main ones — income tax, VAT, national insurance, and corporation tax. Yet, Labour’s election manifesto last year explicitly ruled out increases in these areas. Of course, stealth rises are already evident with national insurance increased last year, and income tax thresholds frozen so they do not rise in line with inflation, thus dragging millions into higher bands. One could argue the manifesto commitments are already being bent.

The current trajectory suggests a push to raise more from property and capital. That would be a mistake. It would lead to a messy Budget filled with piecemeal changes unlikely to deliver the revenue anticipated, and highly likely to prompt behavioural shifts that damage investment and growth. It would also compound the complexity of a tax system already too fragmented to function effectively. In all likelihood it would result in a repeat next year of what we have seen this year and last, with scrambling to find extra tax revenue.

Speculation will now swirl around possible changes to capital gains tax, pensions, property bands, and wealth taxes. But this route risks sending the wrong signals to investors, employers, savers and workers and could do more damage than good.

Sensibly, the UK already has a highly progressive tax system. Around 28% of all income tax is paid by the top 1% of earners, and two-thirds by the top 10% of earners. Meanwhile, the average income taxpayer now contributes a smaller proportion of their income in tax than at any time since the mid-1970s. This is often overlooked in public debate.

The priority for tax policy should not be redistribution for its own sake, but to support economic growth, productivity, and sound public finances. Incentives matter. Over the last year, there have been growing signs of a brain drain and wealth outflow. The UK saves too little, invests too little, and productivity remains weak. Repeated tinkering with capital, property and a host of other smaller taxes will only worsen the picture.

To her credit, the Chancellor’s first Budget focused on incentivising business investment – although those benefits will take time to materialise. But all the good that did was more than offset by the damaging rise in national insurance, and higher minimum wages, which are now leading to large-scale job-shedding. Add in the impact of AI (starting to make inroads in more menial tasks and roles) and the jobs market is turning. The idea that a scattergun set of tax rises can close the fiscal gap while supporting growth is misguided.

If taxes must rise because of an inability to control spending then they should do so in a simple, transparent, and credible way. For example: increasing the basic rate of income tax by 2p would raise £16.4 billion; increasing the top rate by 5p would raise £10.3 billion. Together, those two measures would raise £26.7 billion. 

Other credible options include: increasing VAT by 1p: £9.6 billion; broadening the VAT base: potentially billions more (and offsetting the impact to those in families, say, with targeted child benefit); raising Class 1 National Insurance by 1%: £5.4 billion; maintaining frozen allowances: £3.6 billion per year.

These figures are based on the fiscal year 2028–29, which is the target year for the fiscal rules. 

Additional smaller changes such as a £5 increase in air passenger duty (£650 million) or modest rises in vehicle excise duty (£1 on bikes and £5 other vehicles raise £215 million) might raise a few hundred million more. But they are no substitute for structural reform of the main revenue streams.

The markets will be watching closely. If the Chancellor attempts to fill the gap with marginal, opaque, or politically expedient tax changes, credibility will be lost. Investors may simply assume that next year’s Budget will bring more of the same with delayed decisions, reactive policy, and weak delivery and more uncertainty.

The most economically efficient – and politically defensible course is to be honest with the public. If the government needs to raise £20–25 billion to meet its own fiscal rules, that will require returning to the main tax levers. Doing so transparently – with a clear explanation of purpose and trade-offs – could even help ease market conditions, with this scale of fiscal tightening reducing bond yields and policy rates.

Unfortunately, current signs point in a different direction.

The obsession with headroom persists. The government continues to rely on uncertain growth and productivity forecasts from the OBR (Office for Budget Responsibility), which now look optimistic. If those forecasts are downgraded, particularly on productivity, the fiscal gap will widen further. Yet the Chancellor has chosen not to adjust the fiscal framework, despite being given the opportunity earlier this year following the third external review of the OBR. The moment was missed.

Rules cannot be credibly changed now from a position of weakness. By deferring reform, the Chancellor has boxed herself in. Now she must not only meet the rules, but generate additional headroom – and she can only do so by breaking her own party’s manifesto commitments.

Could anything turn up by late November? The slowdown in the US economy could allow the US Federal Reserve to cut rates and US bond yields to fall, and in turn ease the market pressure here in the UK, too, with gilt yields declining. 

Also, even though inflation may peak at 4% this autumn it looks set to fall next year, allowing scope for gradual easing from the Bank of England. And the economy is stumbling, not stagnating, with real incomes rising, the savings ratio high and some firms in good shape – so the right policy calls could help it to stabilise, the wrong ones may see it fall flat on its face. 

This commentary is for informational purposes only and does not constitute investment, tax, or legal advice. The views expressed are those of the author. 

Please note, the value of your investments can go down as well as up.