Two years in, Labour’s promise of a strong government delivering growth, pro-business policies, stability and no income tax rises remains a far cry from the reality.
GDP growth is anaemic, and while the US war with Iran carries some of the blame here, the UK’s hard-hitting tax burden is fully the government’s design. Chancellor Rachel Reeves has extracted around £80bn of additional revenue from taxpayers so far, and businesses are vocal about the damage this is causing. As for stability, 95 Labour MPs have called on Keir Starmer to step aside, with the starting gun on a leadership challenge awaiting the result of today’s Makerfield by-election.
But a new Labour leader will face the same thorny problems as the current one, including how to fund increased defence spending. In the 2025 strategic defence review, the Prime Minister argued that a step-change in the threats Britain faces required a step-change to meet them.
This isn’t just an abstract discussion on how to prepare for future conflict that might be visited on Europe. Aerospace and defence are key sectors of the economy. Investing in them and funding research and development would boost economic growth, while watered-down spending risks destroying jobs and expertise. Capital Economics notes that the UK could also benefit by exporting more to countries raising their defence spending, enabling it to gain some ground on the world’s two largest defence exporters, the US and France.
The promised step-change has proved a faux pas, however. For the sake of a tiny fraction of the UK’s £334bn welfare budget, a government minister has been lost, and an opportunity for growth and national security has been risked.
That the government has struggled with its own stated commitment to spend 3.5 per cent of GDP on defence by 2035 is evident both in the year-long wait for its defence investment plan to see the light of day, and in the disappointing spending allocation which it is suggested to contain. The Ministry of Defence had argued that it needed £28bn over four years. It has reportedly been allocated £13bn, of which only £10bn is ‘new’ money.
The government continues to discuss ways to close the funding gap. Its great difficulty is that in an era of constrained public finances, its cloth cannot stretch to covering its preferred spending priorities of welfare and the energy transition and other causes less to the party’s liking.
We didn’t need to read the work and pension minister’s grumbles that “every meeting is about who can we tax to pay more benefits” or watch the removal of the two-child benefit cap to understand the importance to the party of protecting the welfare budget.
It was already clear in the strength of backbench and cabinet resistance to proposed reforms. Ominously for taxpayers, welfare spending, which includes the state pension, now exceeds the amount raised in income tax (estimated by the Office for Budget Responsibility to be £329bn in 2025-26), and the bill rose by £2.7bn in April. The Resolution Foundation says the cost of the triple lock alone could be £14bn higher by 2029-30. The government’s cost of living tsar, Lord Richard Walker, argues that the lock is unsustainable and unaffordable, and has also called for reform to prevent benefits from being used as a “lifestyle” choice.
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How could the defence funding gap be filled? A rise in taxation is certainly one option, but funding the entire rise from the current level to 3.5 per cent of GDP would require increases in the order of 4p on income tax or 4p on standard VAT, according to the Institute for Fiscal Studies (IFS). Starmer’s rival Andy Burnham has indicated that he favours a wealth tax, and he is supported in this by the leader of the Unite union, who has declared that “if the government needs to raise funds [for defence] it should introduce a wealth tax rather than attack the most vulnerable in society yet again”.
Increased borrowing, even if presented as an exceptional cause or enabled by a loosening of the fiscal rules, would still add to the growing national debt (borrowing rose by more than £24bn in April) and, says Capital Economics, would be likely to provoke a backlash in the bond market.
That leaves spending cuts. The government has inherited a poor post-pandemic economic situation, but every administration has to cut its cloth accordingly. Welfare is the most obvious area for spending reductions, but the most problematic for Labour. Yet cuts elsewhere – such as in education or infrastructure – would ultimately be detrimental to growth and self-defeating.
It may be time for a hard reckoning. After all, it was the decline in defence spending in recent decades that allowed spending to increase in other areas, notes the IFS. In 1987-88, the institute says, defence spending stood at 3.5 per cent of GDP, while health accounted for 4 per cent. As defence spending fell in subsequent years, taking it to 2.3 per cent, health spending rose and now stands at 9.2 per cent.