Chancellor John Healey faces a significant fiscal challenge as rising inflation threatens to undermine government spending plans, requiring up to £35 billion in additional funding by the end of the decade to maintain public services and meet defence targets, according to the Institute for Fiscal Studies (IFS).

The IFS warned that preserving current expenditure levels without cuts may be impossible unless the government either raises taxes substantially or reduces public spending elsewhere. While higher tax revenues have provided some fiscal leeway, the think tank emphasized that merely maintaining existing departmental budgets in real terms would necessitate extra funds. Inflation erodes the value of government allocations, meaning that fixed nominal spending amounts effectively result in cuts to services.

The think tank’s projections suggest that avoiding reductions in public service budgets will require an additional £25 billion annually by 2030-31. This figure could climb to approximately £35 billion if the government aims to increase defence spending to 3% of gross domestic product (GDP), a target referenced in Labour’s manifesto and ongoing defence policy discussions.

Defence Secretary Wes Streeting confirmed that the upcoming budget, scheduled for October 28, would include an allocation of £4.7 billion for defence spending. However, Streeting stopped short of committing to the 3% of GDP defence spending goal by 2030, indicating uncertainty about the full scale of future increases.

The IFS flagged that raising £35 billion through taxation would involve significant tax hikes, such as increasing all income tax rates by three percentage points or raising the main rate of value-added tax (VAT) by a similar margin. Such measures would contravene Labour’s previous manifesto pledges to avoid tax rises on low and middle earners.

Helen Miller, director of the IFS, underscored the gravity of the fiscal dilemma, stating that a “steady-as-she-goes” approach—sticking to the current tax and spending framework—would lead to substantial reductions in public service quality or quantity as inflation diminishes real spending power. She cautioned that accepting this scenario would mean tolerating considerable service cuts that could affect many sectors.

The economic analysis presents Chancellor Healey with a stark choice: pursue tax increases, reconfigure public spending priorities, or accept diminished service delivery standards amid inflationary pressures. The outcomes of the budget announcement later this month will be closely scrutinized as policymakers seek to balance fiscal responsibility with the demands of public services and defence commitments.