Reeves must slash spending as it balloons to 45% of GDP, says IEA
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Chancellor Rachel Reeves faces £30 billion 'fiscal black hole'
by 2029-30, requiring tax rises or spending cuts to meet fiscal
rules Taxing the rich cannot bridge the gap – each 1p rise in
the top income tax rate raises just £145 million in the
next year, and capital gains tax hikes would be economically
self-destructive Public spending has grown 2.5% per year in
real terms since 1997, far outstripping...Request free trial
A new briefing paper published by the Institute of Economic Affairs today reveals that Britain's long-term fiscal crisis is driven by spending growth that has consistently outstripped both demographic demand and economic expansion. The state has grown from approximately 35% of GDP in the late 1990s to 45% today, pushing the tax burden from 32% to 37.5% of GDP whilst still leaving persistent deficits. In this briefing, 2025 Budget Briefing: The Fiscal Context, Tom Clougherty examines the wider fiscal landscape surrounding the Autumn Budget 2025. It shows that Chancellor Rachel Reeves faces a significant 'fiscal black hole' of around £30 billion by 2029-30, driven largely by an expected downgrade in productivity growth forecasts from the Office for Budget Responsibility.
Public spending has grown by 2.5% per year in real terms since 1997, significantly exceeding the 1% annual increase required to keep pace with population growth after accounting for demographic shifts. Over the same period, real economic growth averaged just 1.8% per year. The result is a state that has consumed an ever-larger share of national income whilst delivering persistently unaffordable levels of borrowing.
The research finds that spending restraint is both plausible and necessary. Simply keeping overall spending increases in line with inflation until 2029-30 could improve the fiscal outlook by £40 billion relative to current plans. However, if cuts are focused on departmental spending whilst NHS funding continues to grow at recent rates of 4% per year in real terms, cuts of 14% to non-NHS departmental spending would be required by 2029-30.
The briefing challenges the notion that simply taxing the rich can bridge the fiscal gap. According to HMRC figures, each 1p increase in the additional rate of income tax only yields £145m in 2026–27, £265m in 2027–28, and £230m in 2028–29. Even dramatically increasing rates would not generate the tens of billions needed. The paper warns that significant hikes to capital gains tax would constitute economic self-harm, particularly given Britain's already uncompetitive position - nine OECD countries do not tax capital gains at all, and no other OECD country levies a rate as high as 45%.
The report emphasises the looming demographic challenge. The OBR's 2022 projections suggested that without policy change, public spending on the over-65s would increase by 11 percentage points of GDP over 50 years - equivalent to £260 billion in 2021-22 terms, more than all income tax and capital gains tax revenue combined that year.
Economic crises have played a key role in driving step changes in public spending that prove difficult to reverse. Both the financial crisis and the COVID-19 pandemic saw dramatic spending increases, but whilst the 2010s saw a decade-long effort to return spending to pre-crisis levels, spending post-pandemic has settled at a permanently elevated level. On current plans, Total Managed Expenditure will average 44.5% of GDP from the pandemic to the end of the decade.
Britain must fundamentally reduce public spending, or face a future of perpetually rising taxes. With demographic pressures set to intensify and the state already consuming 45% of GDP, the country faces a stark choice: meaningful reform of public services and the welfare state now, or an ever-growing tax burden that will strangle economic growth and leave future generations significantly poorer.
Tom Clougherty, author of “2025 Budget Briefing: The Fiscal Context”, said: “Ultimately, in both tax and spending, we ought to take a long-term view. For tax, that means a genuine effort to simplify and rationalise the system while making it more pro-growth. Our highly politicised budget process makes that kind of policymaking difficult. On the spending side, we need to recognise that our fiscal problems did not appear overnight and will not be solved at a single budget.
“Indeed, putting Britain on a sound fiscal footing – not just for 2029–30 but for the next generation – is a mission that could and probably should occupy a whole government across an entire Parliament. We can put off that day of reckoning, but we cannot avoid it forever.”
Read the full publication: 2025 Budget Briefing: The Fiscal Context |