Rachel Reeves planning to raise taxes and cut spending in October budget

Rachel Reeves is planning to raise taxes, cut spending and get tough on benefits in October’s budget amid Treasury alarm that the pickup in the economy has failed to improve the poor state of the public finances.

The chancellor is insisting she will still have a substantial black hole to fill despite stronger than expected growth in the first half of 2024.

Strong spending on public services and welfare pushed government borrowing to £3.1bn last month , more than double its level in the same month a year earlier and worse than experts had expected, according to figures released on Wednesday from the Office for National Statistics.

The deficit was the highest for a July in three years and £3bn higher than expected by the government’s spending watchdog, the Office for Budget Responsibility.

She announced last month that she was scrapping winter fuel payments for most pensioners, shelving plans for social care reform and axing road, rail and hospital investment as the first stage of a plan to reduce borrowing.

Now the Treasury has made it clear that further hard choices would need to be made when Reeves delivers the first Labour budget since 2010 on 30 October.

A source said: “We don’t accept the positive economic inheritance line, given the decade that went before – but regardless, nothing in the recent data can offset the scale of the black hole in the public finances we’re looking at.”

New chancellors traditionally seek to get bad news out of the way in the first budget after an election – a time when they can seek to blame their predecessors for any unpopular decisions they make.

Reeves will receive the OBR’s initial assessment of the state of the economy early next month, but she believes there is nothing to suggest the government’s underlying financial position is getting any better.

The International Monetary Fund has said the UK would need a one percentage point boost to its growth rate to relieve the pressures on the public finances caused by an ageing population and the transition to a zero-carbon economy.

Among the changes Reeves is believed to be considering are:

• Raising more money from inheritance tax and capital gains tax.

• Sticking to plans for a 1% increase in public spending even though it would involve cuts for some Whitehall departments.

• Rejecting pressure to scrap the two-child benefit cap.

• Changing the way debt is measured to exclude the Bank of England.

Reeves said before the election that she would inherit the worst public finances of any chancellor since the second world war and, after arriving at the Treasury, said the position was even worse than she had thought.

She accused the Conservatives of covering up the true state of the public finances as she announced an initial £5.5bn in savings to tackle a forecast £22bn overspend by Whitehall departments.

The subsequent figures showing the UK economy grew by 0.6% between April and June led to speculation that there might be a knock-on effect on the public finances that might allow Reeves to limit the pain in her October budget. The OBR is expected to revise up its 0.8% growth forecast for the year as a whole in its assessment for the October budget.

But the Treasury pointed out that a stronger than expected recovery in the first half of 2024, when the UK was the fastest growing economy in the G7, had merely made up for the soft patch in the second half of 2023, when the economy contracted for two quarters and was technically in recession.

Figures from the Office for National Statistics last month showed that borrowing in the first three months of the 2024-25 financial year stood at £49.8bn, which is £3.2bn more than the OBR had anticipated.

Government spending between April and June was £297.3bn – £4.6bn more than in the same period a year earlier – partly as a result of the impact of inflation on benefits and departmental spending.

The borrowing figures are often revised down as fresh data comes in, but the Treasury says borrowing is on course to exceed the OBR’s £87bn forecast for 2024-25 as a whole. The OBR said in March that the UK would barely meet the rule that the state’s debt should be falling as a share of national income within five years.

Labour has sought to stress the poor state of the public finances, while the Conservatives have tried equally hard to disparage Reeves’ assessment of the economy, arguing that the new government is trying to find political cover for tax rises already planned for the budget.

After last week’s stronger-than-expected growth figures, Jeremy Hunt, the shadow chancellor, said they were “further proof that Labour have inherited a growing and resilient economy”.

He added: “The chancellor’s attempt to blame her economic inheritance on her decision to raise taxes – tax rises she had always planned – will not wash with the public.”

James Cleverly, one of the contenders to replace Rishi Sunak as Conservative leader, said Labour’s economic inheritance was very different from how ministers billed it. “The economy is growing, unemployment is down, inflation under control,” he said.