How the new UK government will handle public finances

Britain wakes up to a Labour government for the first time in 14 years, and that government will have a large majority in the House of Commons. But the honeymoon period for new Prime Minister Keir Starmer will be short-lived.

Labour will already have its eyes on another election in 2029, although that now seems a long way off. Britain’s First Past the Post electoral system tonight showed how it can cause huge swings in an environment where the two main parties are receiving an increasingly small share of the vote. Labour won with just 34% of the vote, up just two percentage points from 2019, when it won half the seats.

The party will take nothing for granted, and the pressure to get going will be intense. But when it comes to public finances, new Chancellor Rachel Reeves faces an unenviable decline. Britain is struggling with a deficit of 4.4% and a national debt that is fast approaching 100% of GDP.

We suspect that Labour’s first priority will be to find a way to end the previous government’s planned cuts to public spending. Labour has promised there will be no “return to austerity”.

Left unchanged, the Treasury’s existing plans would have seen real-terms cuts of at least 3% a year across government departments outside “protected areas” such as health or defence. These plans were always going to look tough, especially given that several government departments have already seen real-terms cuts of more than 20% over the past decade.

The price of ending these cuts is likely to be around £20bn a year for the rest of the Parliament. Labour’s manifesto, based on its own costs, is well below that figure. The revenue increases amount to less than half a per cent of GDP.

At first glance, the choices seem limited. Labour has ruled out raising taxes, which make up 80% of public revenues that it can actively control – see the chart below. The party has pledged to keep key fiscal rules unchanged, and in their current form, these rules will be met by only a narrow margin.

Still, we think finding the money to reverse these planned spending cuts won’t be as hard as it seems. Here are four options that Labour will be seriously considering in the run-up to its first Budget.