Fiscal repair and cost-of-living relief: How Reeves fared on the Budget’s twin challenges

This article was originally published on LSE Inequalities.

After months of speculation and expectations (mis)management, we at last know the contents of Rachel Reeves’ second Budget. The backdrop to this event was a deteriorating economic outlook and sticky inflation, as well as stretched public finances, with political pressures from all sides. To make matters worse, there was a pressing need to “de-risk” the parlous state of the public finances at the same time as easing the squeeze on families struggling with the cost of living. And to do all of this without sabotaging growth or inspiring mutiny on her own back benches. So how did she do?

The fiscal repair job

High and volatile borrowing costs in recent months meant that restoring trust in the public finances was top of the Chancellor’s “to do” list. And here the repair job was easier than feared.

It was widely expected that “trend” productivity growth – effectively our economic speed limit – would be downgraded by the Office for Budget Responsibility (OBR). Lower growth means lower revenues and, without further action, higher borrowing. But while the widely-anticipated downgrade materialised, it was offset by other forecast changes, including a chunky increase in the assumed path of wage growth. As a result, the economic forecast had very little impact on the borrowing challenge faced by the Chancellor.

As an aside, it’s tempting to view the OBR’s gloom on growth as a dismissive verdict on the government’s growth policy. But the official forecaster was clear that this was the result of longer-term trends, rather than anything the government has done since the election. In fact, it’s curious that the OBR chose this moment for the downgrade as productivity growth has actually been pretty strong in recent quarters.

Embarrassing policy U-turns on the Winter Fuel Payment and disability benefit reforms did add to pressure on the public finances. This, plus higher borrowing costs, meant the Chancellor needed to put up taxes to meet her rules. In response, the Chancellor wisely decided to go even further, giving herself a projected £22 billion of headroom in 2029-30, although this is still below the £29 billion average headroom held by previous Chancellors since 2010.

This is a market-friendly move, receiving a thumbs up from traders in the form of a modest fall in the cost of government borrowing. But this firmer fiscal footing has been achieved by pencilling in savings to be delivered in 2028 and beyond – an easy choice now, but one which may become trickier with the passage of time.

Figure 1: Despite a fiscal tightening, the Government only has plans to run a modest surplus in the future

Easing the cost-of-living squeeze

With millions of Britons still struggling with high prices and inflation remaining above target, the Chancellor sensibly made cutting the cost of living a priority.

Here the Chancellor’s decision was to ease energy bills – the epicentre of the cost of living crisis – with a £130 discount from next year. Half of the energy bill package comes from the Exchequer picking up some of the social and energy policy costs, currently added to bills , but this funding will only last for three years, meaning £55 is set to be added back onto electricity bills in 2029-30 – so also in the most likely year of an election.

Rachel Reeves also announced a freeze in rail fares and a continuation of the (notionally temporary) freeze in duties on petrol. As well as helping families with unavoidable costs, these measures are forecast to shave 0.5 percentage points off inflation in Spring 2026. This reduction should help the Bank of England bring down interest rates, giving space for one or more interest rate cuts to be brought forward, providing some cheers for mortgagors.

What definitely is not right is asking children in poverty to pick up the tab for the old and ill… the Government deserves credit for moving away from that

More urgently, the Chancellor announced the long-overdue abolition of the impoverishing two-child limit on welfare payment that should result in 450,000 fewer children living in poverty by 2029-30. This is the right priority within an overall welfare bill which is still set to be roughly flat as a share of GDP. Yes, there have been post-pandemic rises in some areas, notably pensions and working-age health and disability benefits. And yes, paying for an ageing and ailing society is a serious challenge. What definitely is not right, however, is asking children in poverty to pick up the tab for the old and ill. The Government deserves credit for moving away from that.

Taxing smartly  

This welcome help to families – on top of the challenging fiscal and economic conditions – nevertheless made revenue raising measures (read: taxes) inevitable. But not all taxes are created equal. The name of the game for Rachel Reeves, then, is to “tax smarter”: by improving how the £1 trillion tax system works, she can minimise the damage from rising taxes.

In the end, most of the revenue raising was done by extending the freeze of personal tax thresholds for another three years (until 2030-31). After nine years of rises to the personal allowance in the 2010s, the eventual nine year freeze will still leave it over £1,300 higher in real terms than in 2010-11. Still, this is undoubtedly a measure that asks working people to pay more: a typical employee will face a £220 higher tax bill in 2030-31 as a result of the freeze extension. It is also a somewhat less progressive way to raise personal taxes than a manifesto-breaking rise in Income Tax rates, which would have cost less for anyone earning under £35,000 a year.

Beyond that, there were welcome gestures towards the principles of smarter taxation. The 2 percentage point rise in taxes on landlords, shareholders and savers is an important step towards treating different forms of income equally. But National Insurance means that the basic distortion against employment and in favour of self-employment – a key friction in our complex system – will remain close to record highs.

The new “mansion tax” reasonably extracts a modest extra contribution from an important form of wealth that has swelled in value for decades. And yet it arrives as an appendage to a discredited Council Tax which remains an untidied mess.

These tax changes are very backloaded, with more than three-quarters coming in around or after the most likely date for the next election. This raises questions over how they are likely to be delivered. And fans of tax reform were left wondering what the Government’s plan for future tax changes might be.

Rachel Reeves lives to fight another day

Overall, then, the Budget has provided welcome relief for struggling families, balanced the books for now at least, and went some way to reducing distortions in the tax system. In terms of the distributional impact, we estimate that decisions at this Budget, along with those from this government so far, have been progressive. Incomes of the poorer half have risen roughly £90 on average (as shown in the average level of the white diamonds for vigintiles 1-10 in Figure 2 below), compared with losses of £1,000 for the top half (vigintiles 11-20).

Figure 2: Permanent tax and benefit changes since Autumn Budget 2024 have been progressive

But while the pressure is off for now, tough choices loom. Unemployment has been rising and the stagnation of living standards looks set to continue. Crucially, real household disposable income is forecast to grow more slowly over this Parliament than during any other on record bar the previous one. Reversing this trend remains the holy grail for this – or indeed any – Government and can only come from a sustained return to consistent growth. Delivering that with taxes rises in the offing means more challenges ahead for the Chancellor to negotiate.