UK Labour Year Two: Reeves, the Fiscal Lock, and the 2026 Spending Choice

The fiscal inheritance and the October 2024 reset #

Labour took office in July 2024 with a 22 billion pound in-year spending pressure, a tax-to-GDP ratio on track for a postwar high of 37.7 percent by 2029, and public sector net debt close to 98 percent of GDP. The OBR's March 2024 forecast had relied on a real-terms departmental spending squeeze the Reeves Treasury judged undeliverable. The October 2024 Budget legitimised a higher level of current spending, reset the capital envelope upward, and raised roughly 40 billion pounds of revenue to make the medium-term path consistent with new fiscal rules.

The revenue package leaned hardest on employers. The main rate of secondary Class 1 National Insurance rose by 1.2 percentage points to 15 percent from April 2025, and the secondary threshold fell from 9,100 pounds to 5,000 pounds, raising about 25 billion pounds a year by 2029 to 2030 according to the OBR. Capital gains rates rose for non-residential assets, the non-domiciled regime was abolished from April 2025, and inheritance tax relief on agricultural and business property was capped above one million pounds. Departmental Expenditure Limits were uplifted by around 70 billion pounds a year on average over the parliament, with the NHS in England the largest single allocation, and the capital envelope was raised by 100 billion pounds over five years to fund transmission, school estate, prisons, Sizewell C, and the Lower Thames Crossing.

The fiscal lock and the move to PSNFL #

The defining technical choice was the move from public sector net debt excluding the Bank of England to public sector net financial liabilities as the new anchor for the fiscal lock. PSNFL is a wider balance sheet aggregate that nets illiquid financial assets, including student loan book valuations, equity stakes, and the funded element of public sector pensions, against gross liabilities. The Treasury argued that PSNFL better reflects the economic substance of capital-intensive investment, because productive assets that generate financial returns offset the borrowing that financed them.

PSNFL was around 84 percent of GDP at the time of the Budget, against PSND ex BoE near 98 percent. The new investment rule, that PSNFL falls as a share of GDP between the fourth and fifth years of the forecast, produced roughly 16 billion pounds of additional borrowing capacity in the fifth year compared with the previous rule on the same forecast assumptions. The current budget rule, that the public sector current budget moves into balance by the third year, was retained. Fitch affirmed AA minus with a stable outlook in November 2024, S and P retained AA with stable in March 2025, and the IMF Article IV mission in May 2025 endorsed the framework while pressing for a clearer medium-term DEL path. The Institute for Fiscal Studies cautioned that PSNFL headroom is not a free fiscal lunch, because gilt issuance still has to clear the market against the same primary balance arithmetic.

NHS productivity and the Darzi response #

Lord Darzi's independent investigation into NHS England, published in September 2024, set the diagnostic frame. It documented productivity falling by roughly 11 percent between 2019 and 2023, capital starvation in mental health estate and diagnostic equipment, and a workforce that had grown faster than activity. The Treasury responded with a 22.6 billion pound increase in resource DEL for NHS England by 2025 to 2026, supplemented by a 3.1 billion pound capital uplift, the largest cash injection outside the pandemic.

Conditionality matters as much as the headline. The 2 percent productivity ask, embedded in NHS planning guidance for 2025 to 2026 and re-stated for 2026 to 2027, requires elective activity per consultant to rise, length of stay to fall, and the agency staff bill to compress. The ten-year health plan published in summer 2025 organised the agenda around three shifts, hospital to community, analogue to digital, and treatment to prevention. Elective waiting lists peaked at 7.77 million pathways in September 2023 and fell to 6.24 million by February 2026, still above the 4.4 million pre-pandemic level. The Resolution Foundation concluded in early 2026 that the resource envelope is consistent with flat to modestly rising real-terms activity per pound only if the digital and community shifts are delivered to plan.

Planning reform, housing supply, and the NPPF #

The revised National Planning Policy Framework, published on 12 December 2024, is the supply side counterpart to the capital envelope. The standard method for assessing local housing need was rebased to a 0.8 percent baseline of existing stock, modified by an affordability uplift, producing a national target of around 370,000 homes a year. Local plan coverage and five-year land supply requirements were strengthened, the grey belt concept was introduced to release lower quality green belt land for housing and infrastructure, and the presumption in favour of sustainable development was reinforced where local plans are out of date.

Delivery is lagging the ambition. Net additional dwellings in England were 221,000 in 2023 to 2024 and the Home Builders Federation estimated 200,000 to 210,000 for 2024 to 2025, against the 370,000 target. The OBR's March 2026 forecast embedded a planning reform supply response worth roughly 0.2 percent of GDP by the end of the decade, smaller than the Treasury's internal estimate, on the judgement that build-out rates and skilled labour rather than permissions are now the binding constraints. The NIESR view is broadly consistent, with an additional caution that mortgage affordability at current Bank Rate continues to suppress private demand at the lower end.

Employment Rights, North Sea, and Crown Estate #

The Employment Rights Bill, introduced in October 2024, removed the two-year qualifying period for unfair dismissal protection, restricted zero hours contracts, strengthened collective bargaining rights, and imposed new duties on flexible working. The Regulatory Policy Committee scored a steady state cost to business of around 5 billion pounds a year, concentrated in retail, hospitality, and social care. The Federation of Small Businesses and the British Retail Consortium have argued that the cumulative effect, combined with the employer NI rise and the National Living Wage uplift to 12.21 pounds in April 2025, is a meaningful drag on hours and entry level hiring.

On energy, the Energy Profits Levy was extended to 31 March 2030 and raised to a 38 percent headline rate, taking the marginal tax rate on North Sea oil and gas profits to 78 percent under the existing ring fence corporation tax and supplementary charge. The investment allowance was narrowed and the 80 percent decarbonisation allowance retained. The Crown Estate's Round 5 floating wind leasing in the Celtic Sea awarded 4.5 gigawatts in 2024, and a Round 6 fixed bottom seabed lease is scheduled for the second half of 2026. Allocation Round 7 of the Contracts for Difference scheme returned offshore wind to auction with a higher administrative strike price. The Crown Estate Act 2025 broadened borrowing and investment powers, releasing balance sheet capacity for the leasing programme, consistent with the 50 gigawatt offshore wind ambition for 2030.

Bank of England, gilts context, and the 2026 path #

The Bank of England under Andrew Bailey moved Bank Rate down from 5.25 percent in mid-2024 to 4.00 percent by the April 2026 meeting in cautious 25 basis point steps, with the Monetary Policy Committee describing the trajectory as gradual and data-dependent. CPI inflation printed at 2.6 percent in March 2026, against a target of 2 percent, with services inflation still close to 4 percent and wage growth cooling more slowly than the headline. Quantitative tightening continued at a slower pace through 2025 to 2026 to manage the active sales channel against a higher gilt issuance remit.

The fiscal arithmetic for the November 2026 Budget is dominated by debt interest, demographic costs, and DEL settlements. The Treasury's working assumption is that headroom against the current budget rule, around 9.9 billion pounds in March 2026, has been substantially eroded by sticky services inflation and weaker than expected nominal GDP. The Resolution Foundation has identified a 10 to 20 billion pound consolidation requirement at the autumn forecast, depending on the OBR's productivity assumption. Reeves has ruled out a return to the major personal tax rates and to VAT on essentials. That leaves frozen thresholds, capital allowances, and selective rate increases as the main usable revenue instruments.

Politics, devolution, and the EU reset #

Reform UK polling has run between 22 and 28 percent through the first quarter of 2026, ahead of Labour on a four-party split in several published series, although seat projections under first past the post still favour Labour by a wide margin. The political pressure on the Treasury is therefore not parliamentary but reputational, concentrated on cost of living, illegal migration, and the perceived fairness of the employer NI package. The Conservative Party under Kemi Badenoch has anchored its line against the rule change and the non-dom abolition.

Devolution arithmetic is tightening. The Welsh Government, under the Barnett floor that uplifts Welsh block grant by 105 percent of comparable English changes, argues the floor is now eroded by relative population dynamics and the composition of the spending uplift, and is pressing for a review of the Holtham framework. The Scottish Government, with the highest income tax rates in the United Kingdom and a fiscal framework that locks in per capita comparison, has flagged a structural shortfall against its published spending plans. The EU UK reset agreed at the May 2025 summit established a sanitary and phytosanitary alignment agreement, a security and defence partnership, and a capped youth mobility framework. NIESR estimated in early 2026 that SPS alignment could raise UK goods exports to the European Union by 1 to 2 percent in the medium term, not large enough to change the fiscal arithmetic but shaping the policy bandwidth available for the November 2026 Budget.

Sources #

• HM Treasury Autumn Budget 2024
• Office for Budget Responsibility Economic and Fiscal Outlook
• Office for National Statistics public sector finances
• Bank of England Monetary Policy Report
• IMF Article IV consultation United Kingdom
• Institute for Fiscal Studies Green Budget
• Resolution Foundation Macroeconomic Policy Outlook
• NIESR UK Economic Outlook
• S and P Global Ratings United Kingdom
• Financial Times UK fiscal coverage