Public finances: the state of play heading into the Budget

Introduction

The CBI shared its Autumn Budget submission with the Chancellor and her Ministerial team on 14 October, setting out what our members want to see delivered on 26 November. Difficult decisions lie ahead, with persistent inflation, high borrowing costs, and ongoing uncertainty all weighing heavily on the UK's public finances. This article sets out the fiscal challenges faced and explains why much of the commentary leading into the Budget has focused on how the Chancellor can best maintain stability and avoid breaching her fiscal rules.

The state of play

So where does the government find itself heading into the Budget?

In the 2024/25 fiscal year, public sector net borrowing was the third highest since records began in 1993 - recorded at £146.3 billion. This was significantly higher than the £87.2 billion the OBR forecasted in March 2024 (based on the previous government's spending plans), and well above the £127.5 billion forecast in October 2024. The upward movement in borrowing reflected not only the ongoing impact of higher inflation and interest payments on government debt, but also because of increased departmental spending and sluggish tax receipts.

Figure one shows how borrowing grew in 2024/25 on a monthly basis, how it's been accumulating in 2025/26, and what the differences are between the realised figures and the OBR forecasts. We can see that in the current fiscal year borrowing has been consistently above both the 2024/25 numbers and the OBR's expectations. We expect the OBR to revise up its borrowing forecast in November.

The September data on debt looks similarly discouraging. Public Sector Net Debt (PSND) has reached 95.3%, while Public Sector Net Financial Liabilities (PSNFL), on which the fiscal rule is based (debt should fall as a share of the economy in 2029/30), has increased to 83.8%. Both measures have been steadily increasing in absolute terms, reaching £2,916.1 billion and £2,564.8 billion respectively.

The burdensome outlook suggests that we can expect another fiscally challenging Autumn Budget. The Chancellor is going to need to either raise revenue, cut public spending, or a combination of both, ensuring decisions made also help to boost productivity and growth outcomes.

What's driving the numbers?

The evolution of the UK's public finances in 2025/26 is shaped by a complex interplay of spending pressures, debt servicing costs, investment decisions, and only modest changes in tax receipts. Here's a detailed look at the main drivers:

1. Spending pressures

a) Departmental spending

• Departmental spending has continued to rise, reflecting both policy commitments and inflationary pressures. The 2025 Spending Review set out plans for total departmental spending to grow at 1.5% a year in real terms, with the NHS receiving increases of 3% between 2026/27 and 2028/29. Other departments have seen real terms cuts - including the Home Office and DEFRA.

• In their analysis, the IFS notes that, despite the apparent scale of increases, the public sector will still face significant hardship, and there is scepticism about whether spending can be slowed in the second half of the parliament. There is also a risk of capital underspends, with unspent budgets pushed into later years.

b) Investment spending

• Capital spending is a key focus, rising by 1.8% a year between 2025/26 and 2029/30. Investment as a share of GDP is set to average 2.6% over this parliament, maintaining the high levels reached in recent years rather than increasing further. This is intended to support long-term growth, but the effectiveness depends on how well the investment is targeted and delivered.

c) Welfare and social security

• Welfare spending has been higher than forecast, driven by benefit uprating (linked to inflation), cost-of-living payments, increased demand for certain benefits, and the U-turn on reforms planned post Spring Statement. The OBR's forecast evaluation report highlights that classification changes and underestimated local authority spending have also contributed to higher outlays.

2. Debt interest costs

• Elevated interest rates have sharply increased the cost of servicing government debt. Debt interest payments are now a significant and volatile component of public spending, limiting fiscal headroom for other priorities. The OBR and IFS both stress that high debt interest is a structural challenge, not just a temporary spike.

• The composition of debt (with a large share linked to inflation via index-linked gilts) means that inflation shocks feed directly into higher interest costs, compounding the fiscal challenge. Recent global bond market volatility has been driven by rising yields across major economies, reflecting concerns over fiscal sustainability, increased debt issuance, and reduced demand from traditional buyers like pension funds and central banks. The UK stands out with the highest borrowing costs among G7 nations due to its elevated inflation, weak growth, and ongoing investor concerns resulting from previous fiscal decisions such as the employer NICs hike. While fears of a crisis are overstated, sustained high yields are straining public finances and dampening economic activity.

3. Tax receipts

• Central government receipts in the first six months of the fiscal year were £32 billion higher compared to the same period in the previous year - as expected due to the various tax increases - with HMRC cash receipts being £438 billion, in line with the OBR's expectations (£437 billion). However, this is not the primary driver of the fiscal position.

• The OBR and IFS both highlight that recent policy changes (such as tax threshold freezes, the rise in corporation tax and NICs, and anti-avoidance measures) have boosted receipts, but these are offset by higher spending and interest costs.

• The ONS recently corrected an error in VAT receipts data, which reduced borrowing by £2 billion for the year to date, but this does not fundamentally alter the overall fiscal picture.

4. Policy changes and fiscal rules

• The government's fiscal rules have shifted, with a new focus on net financial liabilities (PSNFL) and a supplementary target to keep borrowing below 3% of GDP. The rules now allow more headroom for investment, but this flexibility is constrained by the realities of high debt and interest costs.

• Recent budgets have included significant tax and spending measures: increases in employer NICs, anti-avoidance measures, changes to capital taxes, and targeted investment incentives. However, the overall impact is that spending growth and debt interest costs are outpacing any gains from tax receipts.

What do we expect moving forwards?

Both the CBI and the OBR expect borrowing to fall over the coming years. Our June 2025 forecast projects net borrowing to drop from 5.1% of GDP in 2024/25 to 2.8% by 2026/27. The reason for this is the combination of higher GDP growth, which increases the denominator in the borrowing-to-GDP ratio, and lower net borrowing. Borrowing is expected to fall due to reduced emergency spending as pandemic and energy crisis support measures unwind; improved tax receipts; and tighter control on departmental spending. The OBR is slightly more pessimistic, expecting borrowing to drop less, to 3.1% in 2026/27. PSNFL is expected to peak in 2026/27 at 83.1% according to our forecast, and 83.5% according to the OBR, and then gradually decline. However, early-year figures are often revised as more data on tax receipts and departmental spending becomes available.

A note on forecasting

The OBR has recently been questioned on its optimistic economic outlook. For instance, while our forecast assumed a 1.1% GDP growth in 2026/27, aligning with other independent forecasts, the OBR currently estimates growth of 1.9%.

In July, the OBR published its forecast evaluation report where they concluded that their short-term assessment on growth has been somewhat pessimistic since 2010, while in the medium term they tend to be overly optimistic. On average, their forecasts have underestimated annual real GDP growth over a one-year horizon by 0.4 percentage points but overestimated it by an average of 0.7 percentage points over the five-year horizon.

Table One illustrates how forecasts change over time and provides a good comparison on forecasts. It shows clearly how the OBR's current 2026 GDP growth forecast is out of line with other independent forecasters.

There are a few things to conclude form these differences:

• Forecasts can be somewhat volatile. While the forecasts of the Bank of England and the IMF have not changed much (although the BoE forecasts are only three months apart from each other), we revised down our 2026 GDP projection by 0.5 percentage points, which is a third of the total growth we expected in December 2024. The OECD has done the same, although they only accounted for a drop of 0.3 percentage points, mostly because they were less optimistic in their earlier forecast. Unexpected events and shocks in the market such as gilt rises and tariff announcements can have significant impacts on future growth.
• Forecasting is not an exact science, and the variations reflect the subjective nature of building appropriate assumptions into economic modelling. Whilst one economist may be very optimistic about how AI will transform the productivity of the workforce in the medium term, another may be more cautious on the medium-term benefits noting, for example, the absence of economy wide technology adoption support. These differences of opinion translate to differing takes on the UK's productivity potential and can be seen in other macroeconomic decision making (e.g. when members of the Monetary Policy Committee decide whether to cut, raise or maintain interest rates on a monthly basis).
• Despite the volatility and varied assumptions, the OBR need to provide forecasts twice a year - providing an independent check on the government's fiscal plans. Even if forecasts evolve, having two formal assessments per year ensures that fiscal decisions are based on the most up-to-date and transparent economic outlook. Removing the bi-annual forecasts runs the risk of fiscal plans being based on outdated assumptions on economic performance, undermining the government's credibility with markets.

Table One: GDP growth forecast for 2026

If you're interested in more detail on forecast comparisons, HM Treasury publishes a monthly publication comparing forecasts (that we contribute to). You can find the latest (September) version here.

The Chancellor's choices

The Chancellor faces a stark fiscal reality: public sector net borrowing remains elevated, and debt interest payments are at record highs. The government's main fiscal mandate is to reduce underlying debt as a share of GDP by 2029/30, with a supplementary target to keep borrowing below 3% of GDP. However, with NIESR projecting a fiscal shortfall of over £40 billion, the risk of breaching these rules is real and growing. The government's fiscal headroom is wafer-thin, and even small economic shocks could push the government out of compliance.

Spending commitments set out in the Spending Review are effectively locked in, making deep cuts politically and practically difficult. The Chancellor cannot rely on borrowing more, as debt servicing costs are already crowding out other priorities and risking market confidence. With growth subdued and investment plans slow to materialise, the government's options are severely constrained.

The challenge of raising taxes is compounded by manifesto commitments not to increase taxes on working people, which includes income tax, National Insurance and VAT. These taxes account for two-thirds of total tax receipts, meaning two-thirds of the tax base is off-limits for significant increases. Small adjustments across multiple taxes risk adding complexity and damaging growth. The Chancellor may be forced to consider "stealth" measures, such as freezing thresholds or broadening the scope of existing taxes, but these alone are unlikely to raise the sums needed.

Last year's Budget leaned heavily on business, with employer National Insurance increases and other measures raising the business tax burden to historic highs. Over half of the additional tax revenue raised in the last budget is due to come from employers. Businesses are signalling that further tax hikes would undermine investment, competitiveness, and long-term growth. The Chancellor cannot look to business again without further weakening the UK's growth prospects.

Persistent inflation complicates the fiscal outlook. Tax rises that feed directly into prices, such as VAT increases, would exacerbate inflation and erode real incomes, especially for lower-income households. NIESR and IFS modelling suggest that income tax rises, while politically sensitive, are less inflationary than VAT or corporation tax increases.

Put simply, there are no easy choices for the Chancellor with revenue needing be raised in a non-inflationary manner and bond markets looking for signs that the government can take the difficult decisions (e.g. spending cuts) to maintain fiscal stability. Failing to take credible actions could exacerbate the fiscal challenges faced.

What we will be doing leading into the Budget?

The CBI will be continuing to engage HM Treasury in the lead up to the Budget, ensuring the decisions the Chancellor makes are pro-business and focused on delivering the growth needed to strengthen the UK's public finances. We will be launching our submission in early November, making clear how the government can work with business to fast-track infrastructure, maximise workforce potential, scale technology, and boost competitiveness.

Read the CBI's 2025 Autumn Budget Submission: here’s what we and our members are pushing on and why.

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