New tax year gives mechanical boost to Chancellor’s ‘headroom’: he should resist the urge to spend it

On 6 April, we entered a new tax year and the government’s forecast horizon rolled forward by a year. The government’s fiscal mandate, which requires debt to be falling as a share of national income between the fourth and fifth years of the forecast, now applies a year further into the future.

While difficult to predict with precision, we estimate that this mechanical rolling forward of the forecast could, all else equal, add something like £12 billion to Chancellor Jeremy Hunt’s ‘headroom’ against his fiscal mandate – a target that Rachel Reeves has promised to retain if Labour forms the next government. The precise figure is very uncertain, but the direction of the impact is not.

This mechanical boost to the Chancellor’s ‘headroom’ is a quirk of a poorly designed fiscal rule. On the face of it, it could allow for a third 2p cut to National Insurance in a pre-election fiscal event. But this quirk should not be the basis for immediate and permanent tax cuts, especially when the government’s adherence to its fiscal mandate is predicated on large, unspecified spending cuts in the next parliament.

Indeed, even with a slight easing of the government’s self-imposed fiscal constraint, whoever is Chancellor come the autumn will face a whole raft of difficult choices. To illustrate the key trade-offs and show the scale of the fiscal challenge ahead, IFS researchers have, in partnership with Nesta as part of UK 2040 Options, developed an interactive online tool that allows you to ‘Be the Chancellor’.

We estimate that the next Chancellor will inherit a forecast with a budget deficit of around £40 billion in 2029–30, which would be low enough to have government debt falling as a share of national income in that year (as is required by the government’s fiscal mandate). But this is predicated on the next government overseeing significant tax rises, allowing fuel duties to rise in line with inflation, cutting investment spending and delivering a return to austerity for many public services.

• All personal tax thresholds are due to remain frozen in cash terms until March 2028: a substantial planned tax rise. Unfreezing thresholds would reduce revenues by £11 billion in 2029–30.
• A ‘temporary’ 5p cut to fuel duties is due to expire in March 2025, and fuel duties are due to rise in line with RPI inflation in each year of the next parliament – something that has not happened since 2011. Keeping fuel duties frozen would cost £6 billion in 2029–30.
• Current policy plans imply real-terms cuts to public investment of 2.6% per year over the next parliament. Avoiding those would require increasing spending by £18 billion in 2029–30.
• Spending on public services is set to grow by 1% per year in real terms over the next parliament, under current government policy. But ‘protecting’ the NHS, schools, childcare and defence budgets will mean that most departments will face real-terms cuts averaging 3% per year. To avoid those would require around £20 billion of extra spending in 2029–30.

Deviating from current policy on any one of the above would be enough to mean that debt is no longer meaningfully falling as a share of national income in 2029–30 but is merely stable. Doing even a subset of them could put debt on an ever-rising path and so breach the fiscal rules Jeremy Hunt and Rachel Reeves have both committed to.

This underlines the scale of the challenges ahead. But, as our tool shows, the next government also has many options. We illustrate the impact of some of the options the political parties are openly discussing – as well as many they are not.

Helen Miller, Deputy Director at IFS, said:

‘Just by virtue of moving into a new tax year, Jeremy Hunt’s debt target has become easier to meet. The rolling forward of the forecast, coupled with a one-year extension of the planned post-election spending squeeze, could add something like £12 billion to his so-called ‘headroom’. This is a quirk of a poorly designed fiscal rule. It is not a sensible basis for more pre-election tax cuts. And it should not distract from the serious fiscal challenges facing the UK and the smorgasbord of difficult tax and spending choices awaiting the post-election Chancellor. The next government’s choices will determine the size and role of the state; the distribution of resources between different households, generations and regions; and the long-term sustainability of the public finances – these are the issues that deserve attention and debate.’

Ravi Gurumurthy, CEO of Nesta, said: 

‘The debate on the size of the state is prone to “cakeism”. Those who argue for tax cuts are often in denial that this requires more austerity. Advocates of higher spending are sometimes reluctant to say which taxes will need to increase. We ought to have a transparent debate on how we deal with an ageing society, the net zero transition and national security threats. This tool allows us to see the choices we face, and the difference they make. It ought to be the basis for comparing the plans of the major parties at the next election and coming up with our own.’

See the 'Be the Chancellor' tool here.