The 2025 Spending Review Big Picture: A Difficult Macroeconomic Balancing Act
Published: 16 June 2025
In this blog Prof. Sir Anton Muscatelli provides an overview of the UK Government’s 2025 Spending Review, highlighting macroeconomic and political challenges. He explains that while the plans do not represent a return to austerity, they are constrained by slow growth and global uncertainties. The review front-loads spending increases in health, defence, and housing, but raises difficult questions about long-term sustainability, tax policy, and political feasibility.
Blog by Professor Sir Anton Muscatelli, Principal and Vice Chancellor of the University of Glasgow.
Last week’s Spending Review was a crucial moment for the UK Government. It set out the government’s spending plans for the rest of this parliamentary term, focusing mainly on Phase 2 spending plans from 2026-27 to 2028-29. Phase 1 spending had been announced last year.
In terms of the overall macroeconomic picture, there are two key points to make. First, despite some comments suggesting it, this is not a plan for ‘austerity’: quite the opposite. Compared to the Coalition Government (2009-10 to 2014-15), when average annual real spending in government spending fell by 1.7%, taking Phase 1 and 2 of the current spending review, spending is rising in real terms by 2.3% per year. Sometimes commentators unfairly compare the current Labour government’s plans to those of the Blair-Brown years, when public spending was rising at faster rates. But in the years between 1997-2007, the UK economy was growing at a much faster rate. This gave the last Labour administration much more fiscal space.
This takes me to my second point. I feel considerable sympathy for the current Chancellor, Rachel Reeves. Unlike her Labour predecessors she has inherited a much more difficult macroeconomic environment: an economy where trend growth has been slower since the 2007-08 Great Financial Crisis, and the supply-side has struggled to recover from Covid and Brexit.
The current government has come to power pledging to re-boot trend productivity growth, but that is not solved by throwing a switch. If the additional measures to boost UK productivity growth (e.g. planning, housing, transport, and the industrial strategy) work, they will only begin to boost growth towards the latter end of the current parliamentary term.
The difficult choices announced to date have led to very acrimonious political debates around welfare payments and benefits, and on whether taxes should have been raised to create more fiscal room for the large boost in spending in Phase 1 of the spending review. These are ultimately political choices and judgements on which economics is (mostly) silent. It could be argued that the government was over-cautious in ruling out changes in most major taxes prior to the election. However, critics of this stance should also note that if it’s politically hard to change a universal welfare benefit, tax changes to fund more generous spending might have been similarly unpalatable. The ‘cost of living crisis’ post-Ukraine War, which is often blamed for the current polarisation in UK politics, would not have been made easier by higher taxes on the majority of the electorate. And let’s be clear, a loosening of the fiscal purse on the scale of the 2001-2010 Labour years would have required higher taxes for most, not just for a few. Would that have worked politically?
In a recent UofG Spotlight podcast I was asked what underlies the UK reluctance to deal with difficult fiscal choices by avoiding raising taxes. As I said, ultimately, I do think it comes down to electoral competition – and the process that economists call ‘political economy’. In the UK it has led not only to a reluctance to increase major taxes, but also the scope and coverage of taxes like VAT.
It should also be recognised that the Phase 1 of the current Spending Review (2023-24 to 2025-26) involves an annual real growth in department spending which is higher compared to Phase 2. The current spending review is front-loaded in this Parliamentary term. In Phase 1, annual real spending is growing at 3.4%, a rate close to the spending achieved by the last Labour government (3.6%) between 2005-06 and 2009-10. As has already been discussed at length, the additional spending is very focused: the major winners are defence, where the plan is to take spending to 2.6% of GDP by 2027; health, which accounts for more than half the increase in spending, which is increasing by 3% in real terms; and housing with a major £39bn boost in affordable housing.
This also makes the Scottish Government’s prospective fiscal choices interesting and challenging. The UK government decisions mean that the Scottish Government’s fiscal space from Barnett consequentials will increase by less in 2026-27 and in subsequent years than it did in Phase 1 of the spending review. Taken together with the Scottish Fiscal Commission’s latest economic and fiscal forecasts from May 2025, which highlighted a weaker tax position in Scotland and a growing gap on social security spending, this will limit the total envelope which the Scottish Government has to increase spending post-2026. If it chooses to privilege NHS spending as the UK government has done, there will be little room for other public services.
Finally, what makes the job even more difficult for Rachel Reeves compared to other Chancellors in recent history is that the external macroeconomic environment continues to be hugely uncertain. The UK is an open economy whose growth depends on world economic conditions. Global economic prospects were already damaged by the US tariff wars. The Israel-Iran crisis, if it persists, could worsen the picture further.
The government has no control over these variables: a prolonged Middle East War which significantly disrupts oil supplies from the Gulf would be another unwelcome adverse supply-side jolt for the world economy as the Ukraine War was in 2021-22. This would further damage prospects for UK growth and worsen the cost-of-living pressures.
First published: 16 June 2025
