The Spending Review 2025: Plugging the gaps and hoping for growth (and private sector money…)

Rachel Reeves has been dealt a tough hand – but, as an economist, has played it reasonably well in choosing which areas to prioritise for extra spending. How her plans land politically, given the relative tight settlements for most public services, is less certain. And unless there is a sustained upturn in the economy, even tougher decisions lie ahead.

Former Treasury spending team leader John Hall identifies the key things that happened (and didn’t happen) when Rachel Reeves addressed the House of Commons on 11 June. What do the choices she made mean for public services, economic growth and future tax bills?

It’s a tough time to be an Iron Chancellor. Since the 2008 financial crash, the UK has seen the slowest growth in productivity and household incomes in generations. So whilst the state has grown in size, fuelled by the highest tax and borrowing levels seen since the 1950s, the performance of key public services has deteriorated. Forecasts of anaemic economic growth, interest payments on the national debt now approaching 4% GDP and simultaneous pressures to both raise defence spending and reduce NHS waiting lists didn’t leave Rachel Reeves much room for manoeuvre.

Most incoming Governments exercise a modicum of restraint before turning the spending taps on as a reckoning with the electorate approaches. But in her autumn 2024 budget, Rachel Reeves did the opposite. Short term largesse was scattered widely across public services, with average rises in overall Departmental Budgets of 3.4% over the first two years of the Parliament, but with a more modest annual 1.5% rise for the next 3 years. The June 11th announcements were how that 1.5% average would be divided up between Government departments.

This “catch up” then “keep up” approach to public spending meant even the perennial Cinderellas of the public service world, such as local government, saw an influx of cash last year and this. The Chancellor’s hope will be that is sufficient to plug the holes in public services which, outside of health and education, are less well-funded than 15 years ago. For the next 3 years, around 90% of the increase in day-to-day spending will go to the NHS, with scope for improvements elsewhere – or for public sector salaries to keep up with rises in the private sector – largely dependent on productivity improvements.

Increased public capital (in some places …)

Where the Chancellor deserves considerable credit is her focus on long term investment spending. Lack of both public and private investment has plagued the UK economy for decades, and if these plans are delivered, public sector investment will be sustained at the highest share of GDP in decades. This is a big if. Large infrastructure projects are notorious for delays and cost over-runs, and it has traditionally proved hard for Governments to increase capital spending quickly, whatever the supply of supposedly shovel-ready projects. But if delivered, these plans will undoubtedly stimulate economic growth in the long run. It may be the right economic choice but it is a bold political choice - the public are unlikely to see much of the benefit from the improved transport links, housing and energy supplies – or any significant impact on economic growth - this side of the next election.

The clear beneficiaries of the increased capital spending are Defence (which gets 90% of the extra capital shared across public services on June 11th) and the Department for Energy Security and Net Zero (which plans to triple investment over the Parliament). These investments in defence technology and the green transition will hopefully generate wider economic spillovers. But there are far more modest increases in Britain’s economic infrastructure such as transport, despite the blizzard of announcements for new trains and trams on June 11th.

Public services will be stabilised – but not transformed

The extra cash this year and last should be enough to stabilise most public services – and this is clearly not another period of austerity - but it won’t be enough to transform services in line with public expectations.

Whilst 3% annual increases in day-today NHS spending across the parliament looks generous compared to the last 15 years – and other public services, it is less than the historical average rise of 3.6%. The NHS has missed every single waiting time standard every single year since 2015 – with performance at best flat-lining in recent years. It is likely that a considerably larger sustained rise in spending – in the region of the 5% to 6% average of the 2000s – would be needed to meet the Government’s waiting times targets before the next election.

Securing higher productivity will be key to service improvement. Public sector productivity languishes 5% below pre-pandemic levels (10% below for the NHS) so there is clearly an opportunity. The publication of Departmental Productivity plans is welcome – but many look fairly thin – and identical targets to reduce administrative spend across Whitehall suggests the operation of Treasury dictat rather than any systematic attempt to identify opportunities.

The other big risk to the Government’s spending plans may well arise from the other big winner – Defence. The UK is on course to hit its target of spending 2.5% of GDP on defence by 2027. But no funding is ear-marked to progress towards the Government’s 3% aspiration (last seen under John Major), the NATO general secretary’s 3.5% target (last achieved under Margaret Thatcher) or Donald Trump’s 5% challenge (which would take us back to the first Wilson government).

Increases in public capital, whilst large, are unlikely to be sufficient to resolve long periods of under-investment. Apart from a brief period in the last 2000s, the UK has spent considerably less than similar countries on health system investment for example. Depending which countries we compare with, this investment short-fall is between £27bn to £37bn over the last fifteen years, leaving the NHS with a backlog of around £12bn just to bring its estate up-to date.

A need for private capital …

With no further increases in NHS capital budgets after this year, the NHS is likely to continue to explore options to secure private investment in infrastructure and equipment. Wacky schemes designed purely to get around the fiscal rules are unlikely to pass muster, either with the Treasury (who will, quite rightly, want to ensure they offer VFM for tax-payers) or the ONS (who will need to be assured that control of the assets and risks do not remain in the public sector if they are to be classified as off-balance sheet).

Delivering this spending review will therefore require Government to be more agile in partnering with the private sector. There are massive opportunities for investment in energy and transport infrastructure. In addition to the increase in public sector capital, details of how the Government intends to use its new flexibilities to invest in illiquid financial assets, such as debt and equity are only slowly emerging. Some estimates suggested a long run opportunity of around £200bn created by the redefinition of the fiscal rule last autumn. Published Government plans, to use around £8bn of this flexibility each year (mostly for energy and housing projects) may just be the start.

… and future tax rises

So are tax rises going to be announced this autumn? The short answer is yes. The plans published on June 11th depend on councils and Police Authorities increasing Council Tax bills by 5% per year. More generally, Rachel Reeves has boxed herself in with “iron clad” fiscal rules – which in reality are so loose that it is hard to see how they could credibly be relaxed – but which the OBR said last autumn had just over a 50% chance of being met. The OBR economic forecast on which that judgement was based was more optimistic than most independent forecasts at the time – and these have become more pessimistic since. Rising gilt yields (which impact on debt repayments) and risks to the world economy created by President Trump and geo-political developments, not to mention the unfunded commitment to restore the Winter Fuel allowance to most pensioners may eat up most of the £10bn margin on the fiscal rules by the autumn Budget. So – unless there is a sustained improvement in the economy - keeping within the fiscal rules will force the Chancellor to look at tax increases or reopening the 11 June spending plans.