Five big challenges John Healey is likely to kick down the road

Chancellor is deferring big decisions on defence and welfare

Good morning. I'm Delphine Strauss, FT economics correspondent, covering for Stephen today as we come into the final straight leading up to the Budget.

John Healey has been determined to avoid the constant drip-feed of leaks and speculation that had such a chilling effect on economic activity this time last year. But the broad outlines of his no-frills Budget are starting to take shape.

There will be a £20bn capital boost for the National Wealth Fund and British Business Bank -- carefully designed to stay within the fiscal rules the chancellor has inherited and avoid spooking bond investors. A chunk of existing tax revenues will be handed out to mayors, a low-cost but potentially consequential step in Andy Burnham's drive for devolution.

There will be new taxes -- most likely including a levy on banks -- to fund targeted help for households with energy bills and other spending announced since March, while limiting the damage the Iran war has done to fiscal headroom.

And Healey will no doubt have rabbits up his sleeve: some form of boost to youth jobs, perhaps, whether it takes the form of tax breaks, subsidies or restraint on minimum wage rates.

But I suspect we will hear next to nothing about some of the biggest fiscal issues the government must confront by the end of the parliament.

Here are five looming challenges Healey is likely to duck -- and why they matter.

Polite fiction

First, there is welfare. Alan Milburn is close to finalising recommendations on how to help jobless young people into work -- which are likely to involve cuts to cash benefits and substantial new spending on job support. The first comes with political difficulties, even with careful messaging. The second will be a big upfront expense with an uncertain, distant pay-off.

Healey is also deferring big decisions on defence, despite heckling from the wings as Wes Streeting calls for the UK to be "war ready" in 1,000 days and for households to start prepping. Some money may be channelled through the NWF and BBB into the defence industry -- meeting Nato's definition of defence spending. But Healey has said he will not set out a full timetable until next year to bring defence spending to 3 per cent of GDP, which he previously said should be hit by 2030.

Public sector pay is another potential flashpoint. The Institute for Fiscal Studies estimates it has already grown much faster than departments budgeted for at the last Spending Review, with an overshoot of some £7bn to £9bn possible by 2028-29. Ministers are guiding pay review bodies for the NHS and teachers to hold awards below inflation in the coming year, but with unions already pushing back, they may find it difficult to hold the line.

The government's current spending plans also depend on a step change in public service productivity, which is supposed to grow by some 1.2 per cent in each year of the parliament. Annual growth of 0.2 per cent has been the norm.

The Treasury claims departments are already "outperforming" in delivering efficiency gains -- citing worthy examples such as an AI lesson-planning tool to save teachers' time and the rollout of LED lighting across the NHS. There is room for scepticism about whether these changes will be really transformative.

All these issues contribute to the overarching challenge Healey must grapple with in next year's Spending Review, when he will allocate departmental budgets for 2028-29 to 2030-31.

At present, the spending totals pencilled in for these later years imply a sharp slowdown in overall spending growth. The IFS estimates the chancellor will eventually need to find an extra £35bn -- through spending cuts or new taxes -- if he wants to avoid cuts to some areas of public services, maintain growth in NHS spending and meet the government's goals for defence.

Helen Miller, IFS director, argues that if Healey leaves these spending plans unchanged this week, without explaining the trade-offs when he comes to fill in the details, then his Budget will be a "work of fiction".

Yet perhaps businesses and bond investors would prefer a polite fiction, for now, over complete candour. This year's lack of pre-Budget drama has helped the economy sustain a run of growth that is unusual by recent standards -- even in the face of rising inflation and borrowing costs.

Rob Wood, chief UK economist at Pantheon Macroeconomics, ascribes this partly to the absence of "palace intrigue" in contrast with last year's "months-long circus". He argues: "Delaying big spending and tax decisions is hardly a credible option, but for now it allows firms to get on with it."

Now try this

I found this thoughtful essay by the labour market economist Paul Gregg compelling on what has gone wrong with UK welfare.

And on a different note, I've just finished reading Halldór Laxness's Independent People, and recommend it to anyone who hasn't already come across this Icelandic classic. It flips from lyrical landscape to understated black satire in a heartbeat, it captures human failings in all their forms and it's full of humanity.

The FT's George Parker, Lucy Fisher, Sam Fleming, Katie Martin and Jen Williams will be answering your questions about the Budget on October 29 in a live webinar. To register, and send us your questions, go to ft.com/budget2026

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