Starmer’s options in funding a further defence spending rise would be limited

Keir Starmer has few options if he wants to increase annual defence spending by up to £14bn before the end of this parliament.In last summer’s spending review, the government set out plans to increase defence spending from 2.3% of national income, or gross domestic product (GDP), in 2024-25 – about £66bn, to 2.6% in 2028-29.But now there are hints that the embattled prime minister wants to go much faster. At the Munich Security Conference at the weekend, Starmer argued for higher and more sustained defence spending to meet the threat from Russia. “We must build our hard power because that is the currency of our age,” he said. “We must spend more, deliver more and coordinate more.”The BBC said No 10 was considering an increase to 3% of GDP by the end of this parliament in 2029 to meet Starmer’s ambition, although it is unclear if this will turn into a concrete plan given the many obstacles.Labour backbenchers have other ideas as many seek to remedy more prosaic – though no less costly – headaches, such as NHS waiting lists and social care.Graph showing percentages of GDP spent by UK government on health and defence from 1955 onwardsAnd then there are the Treasury borrowing limits. These have been put in place to bring down a spending deficit that has remained stuck at 5% of GDP for several years.To achieve lower borrowing, Rachel Reeves was accused of sleight of hand in her November budget. The chancellor has pencilled in tight spending limits between 2027 and the summer of 2029, when the next general election must be called by.Reeves hopes that strong economic growth will bail her out. A calmer global economy, with Donald Trump distracted by more domestic concerns, could mean most western governments also enjoy lower inflation than expected and reduced borrowing costs.A recent assessment by Bloomberg of gilt yields – the interest rate paid by the Treasury on government debt – shows they have fallen since last November, saving about £1.5bn a year. That may help explain the curious timing of Starmer’s sudden enthusiasm for higher defence spending, with Reeves due to give her spring statement on 3 March.However, the Office for Budget Responsibility (OBR) has taken a tough stance. The Treasury’s independent economic forecaster has insisted on calculating Whitehall spending without recourse to optimistic predictions for tax receipts and government borrowing costs.Bee Boileau, a research economist at the Institute for Fiscal Studies (IFS) thinktank, said Labour, in order to stay aligned with OBR projections, had pencilled in only small increases in government spending in the years after 2027, limiting the scope for Starmer to take from rival Whitehall departments to feed the Ministry of Defence.“You can’t find this kind of money from salami-slicing other departments,” she said. “The extra funds needed equal the total spending [by the justice department] on courts and prisons. So it will be very challenging to find what is needed from within existing spending limits.”The OBR said in March last year that increasing defence spending to 3% of GDP would cost an additional £17.3bn a year by 2029-30.Ruth Gregory, deputy chief UK economist at the consultancy Capital Economics, said the OBR was over-pessimistic: “If defence spending were to rise to 3% of GDP in 2029-30, that would probably cost about £14bn.The IFS said it estimated that increasing defence spending to 3% of GDP would cost between £13bn and £14bn.Gregory said Starmer and Reeves might be persuaded to borrow to fund the extra spending, but that would be a mistake. “Debt-financed defence spending is not a big growth- or productivity-enhancing investment. And there is a question of whether investors would tolerate much more debt-financed spending.”She added: “That may mean the bulk of any adjustment would need to be financed through either higher taxes or lower spending elsewhere.”Starmer could turn to higher taxes: it would take about 1.5p on income tax to raise the funds. This would be applied as extra to the freeze on income tax thresholds, which is already due to raise tens of billions of pounds by 2029.Borrowing the funds to build more warships, buy extra fighter jets, and reverse the long-term decline in numbers of military personnel could spook the financial markets, which are on the lookout for reckless government spending.Britain’s lenders are already nervous. Reeves must accommodate a £6bn overspend in 2029 on special needs education. Louise Casey’s report on adult social care is unlikely to be cost-free, adding a further budget line to the government’s accounts when the final recommendations are made in a couple of years’ time.These extra costs are expected, even if the final numbers are not known. In addition, there could be many unforeseen events before the end of the decade, with large bills attached that would compete with a new enthusiasm for military spending.Boileau said: “It will be crucial what the OBR says about the public finances on 3 March to coincide with the chancellor’s spring statement. The OBR could offer more fiscal space for the chancellor, though it would be a mistake to justify higher spending over many years from a one-off forecast.”