UK Budget 2026: the IFS says Healey faces a £35bn choice of tax rises or cuts

The UK Budget 2026 cannot be a quiet one, the Institute for Fiscal Studies said on Monday. In its Green Budget, the IFS says the Chancellor, John Healey, will probably still meet his fiscal rules. The harder problem is spending: inflation is eating into departments’ cash budgets. Avoiding cuts to public services and paying for more defence could need tax rises or benefit cuts of around £35bn, the IFS said.

Healey delivers his first Budget on 28 October, alongside a new forecast from the Office for Budget Responsibility, the Treasury confirmed in July.

Where the £35bn comes from

Because of the war in the Middle East, inflation in the coming years will be higher than expected in the spring. Departments’ budgets are fixed in cash, so higher prices mean they buy less. Keeping health spending on its planned path and avoiding real-terms cuts to other departments could need a top-up of around £25bn in 2030–31, the IFS estimates. Raising defence spending to 3% of GDP by 2030 would cost another £11bn in that year.

Together, those could require tax rises or benefit cuts of about £35bn. Leaving the spending totals as they are would be a choice too, the IFS says: a choice to let some public services shrink or get worse.

The UK Budget sums, £bn. Source: Institute for Fiscal Studies, Green Budget 2026. Headroom is against the binding fiscal rule in 2029–30; the spending figures are for 2030–31.

Headroom, OBR forecast in March	24
Headroom now, IFS plausible case	20
Top-up to avoid real cuts	25
Defence at 3% of GDP	11

Source: Institute for Fiscal Studies, Green Budget 2026. Headroom is against the binding fiscal rule in 2029–30; the spending figures are for 2030–31.The Macro Notebook

“A ‘steady-as-she-goes’ Budget is not an option available to the Chancellor,” said Helen Miller, the director of the IFS. If Healey writes in spending cuts he does not intend to make, she said, it “would make the Budget a work of fiction”.

Headroom matters less than it seems

Most attention before a UK Budget goes to “headroom”, the margin by which the government meets its fiscal rules. Here the IFS has better news than many expected. Higher interest rates on government debt will add roughly £10bn to borrowing in 2029–30. But higher inflation also lifts tax revenues, and probably by more than it raises spending on benefits.

In a plausible case, headroom against the binding rule would be around £20bn in 2029–30, down from £24bn in the March forecast. The figure is very uncertain: a different OBR view of earnings alone could move it by about £10bn either way. Frozen income tax thresholds add to the revenue, as rising pay pulls more people into higher tax bands.

The IFS argues against paying for more day-to-day spending with more borrowing. Debt interest has more than doubled as a share of GDP since 2019, and now takes £1 of every £13 the government spends.

What the bond market wants from the Budget

Borrowing costs are the backdrop. The yield on 10-year gilts rose from 4.4% on the eve of the Spring Forecast in March to 5.4% on 2 October, and the 30-year yield from around 5.2% to 5.9%, a chapter of the Green Budget by Barclays economists shows. Those rises have pushed UK mortgage rates up too: we reported on 6 October that five-year fixes had reached 6%.

But the UK is not an outlier this time. Since the last Budget, 10-year gilt yields have risen by about 0.9 percentage points, against 1.0 to 1.4 points in other large bond markets. Market pricing points to UK inflation rising from just over 3% to 4.5% in early 2027, and to rate rises of at least 0.75 to 1 point over the next year in the UK, the US and the euro area.

The market can still turn. On 20 July, after Prime Minister Andy Burnham spoke of “fiscal flexibility”, the 30-year gilt yield jumped 10bp to 5.75%, while other long-dated yields rose by 1 to 3bp. The chapter’s advice is a “boring” Budget that reaffirms the fiscal rules. “One of the Chancellor’s key priorities should be to keep them there,” said Jack Meaning, Barclays’ chief UK economist, of markets whose eyes are now on the US and France.

What to watch before the UK Budget on 28 October

Three things will shape the Budget. The first is the OBR’s earnings forecast, which drives tax revenue and so the headroom. The second is whether Healey sets a spending envelope now, as the IFS urges, or leaves it to next year’s Spending Review. The third is the Bank of England, which, the Barclays chapter says, now seems likely to raise rates at its November meeting.