Rachel Reeves faces Whitehall revolt over spending cuts

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Chancellor Rachel Reeves will next week face a Whitehall revolt over future spending cuts, putting her under new pressure to raise taxes by billions of pounds at her first Budget.

Reeves gave government departments until next Friday to draw up plans to live within the tight spending constraints she inherited from the Conservatives, but she will be warned that cuts have already gone too far.

One official briefed on the process said: “The message will be very clear that the cuts that the Treasury wants are just not possible.”

Another government official said that instead of accepting further cuts, vulnerable departments will instead ask for more money: “All of them will be asking for more.” 

The Institute for Fiscal Studies estimates that to protect areas such as local government, prisons, courts and further education from real terms cuts, Reeves would have to hike spending by £10bn-£20bn a year by 2028-9.

Reeves’s Budget on October 30, the first from a Labour government in almost 15 years, will set out detailed spending plans for the 2025-26 fiscal year. The chancellor will also need to lay the fiscal ground for a multiyear spending review that will follow in March.

Analysts said Reeves will want to take painful decisions to raise tax now, when it is politically easier to blame the Tory legacy, to pave the way for a stronger fiscal position that lasts for the rest of the parliament.

“It makes a lot of sense because it allows the chancellor to build in more leeway for future fiscal events,” said Ruth Gregory of Capital Economics.

Hikes in capital gains tax and inheritance tax are seen as increasingly likely by Labour officials, as Reeves seeks to fill a fiscal hole. More borrowing and targeted spending cuts are also expected to be part of the mix.

The Treasury said: “Following the spending audit, the chancellor has been clear that difficult decisions lie ahead on spending, welfare and tax to fix the foundations of our economy and address the £22bn hole in the public finances. Decisions on how to do that will be taken at the Budget in the round.”

Starmer is resisting big spending cuts: in June he said there would be “no return to austerity with a Labour government”.

Darren Jones, Treasury chief secretary, is in charge of detailed spending talks with ministers, with many Labour MPs already protesting over plans to cut winter fuel payments to 10mn pensioners.

The Labour government inherited a Tory “spending envelope” that envisaged real annual increases in day-to-day spending by Whitehall departments of 1 per cent until 2028-29.

But the IFS has estimated that because of likely higher settlements for defence, the NHS, schools and childcare, “unprotected” departments will face an average real-terms cut of 3.4 per cent a year for four years.

“This was always going to be challenging, if not impossible,” said Alex Thomas, programme director at the Institute for Government think-tank.

The Treasury is used to ministers and officials saying cuts are impossible, a routine known as “shroud waving” in 1 Horse Guards Road. But even Treasury veterans of previous spending rounds admit this time things are different.

“I think we are entering quite different territory,” said one. “I don’t think you can get the sums to add up without cuts in the quality of public services.” Another said: “This is very difficult stuff.”

Further fiscal pressures have arisen from the £22bn of overspending identified in Reeves’s July audit of the current fiscal year, some of which the government has mitigated through cuts to welfare and infrastructure.

Some of the fiscal strain may be offset by the fact that the Office for Budget Responsibility’s five-year fiscal forecast will roll forward an extra year, mechanically creating extra margin for manoeuvre in the fiscal rules. This could amount to £10bn, according to Citigroup estimates.

Reeves’s self-imposed fiscal rule specifies that public debt should be falling year-on-year in the fifth year of the Budget forecast. The Treasury has left open the option of tweaking the definition of public debt in the rule, which could create around £15bn of further budgetary headroom for investment.