The government is in crisis after watering down benefit reforms further – an eleventh-hour attempt to salvage the welfare bill as rebels attempted to block it at a Commons vote on Tuesday.
New eligibility rules for personal independence payments (PIP) – a disability benefit – have now been shelved.
Disability minister Stephen Timms is conducting a review into the future of PIP, and is due to publish it in the autumn of 2026. No changes will be made until after the report is published – raising questions about whether the cuts could be abandoned completely.
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The bill passed by 335 votes to 260, with 49 Labour MPs voting against it and 18 others abstaining – an embarrassing outcome for Keir Starmer which raises questions about the future of his government.
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Tuesday’s climbdown is the second U-turn the government has made on the policy over the past week – and came at the last minute. Labour MP Mary Kelly Foy told fellow MPs that she popped out for a banana during the debate and when she returned, “things had changed again”.
Work and pensions secretary Liz Kendall had already outlined a major concession the day before, telling Parliament the cuts would now only apply to future claimants, leaving existing claimants unaffected.
Labour had originally been intending to narrow the eligibility criteria for PIP so that all claimants – existing and future – had to score a minimum of four points on at least one daily living activity to be eligible for the payment.
The government had also planned to freeze the health element of Universal Credit at £97 per week until 2029/30, rather than increasing it in line with inflation.
Starmer was hoping to save £5 billion a year by 2030 through the original policy. Monday’s concessions reduced this saving to £2.5 billion, and Tuesday’s U-turn is expected to reduce it further to zero.
“Without reform to Personal Independence Payments, the watered down bill is not expected to deliver any savings over the next four years,” said Helen Miller, deputy director of the Institute for Fiscal Studies (IFS).
“This is because, over this period, the forecast savings from reducing the Universal Credit health element for new claimants (£1.7 billion in 2029-30) will be roughly offset by the cost of increasing the Universal Credit standard allowance.”
The government has committed to increasing the standard allowance above inflation for the next four years.
Rachel Reeves’s fiscal headroom will be halved
Watered down spending cuts mean chancellor Rachel Reeves will have a challenging job heading into the Autumn Budget.
Given PIP cuts have been shelved subject to a review, the fiscal watchdog is unlikely to include them in its report when summarising the state of the UK’s finances.
The Office for Budget Responsibility (OBR) previously calculated that Reeves had around £9.9 billion in “fiscal headroom”, otherwise known as the amount of leeway the government has to increase spending or cut taxes.
Given welfare savings have been slashed from £5 billion to zero, this headroom could effectively be halved by this one measure alone. It is worth pointing out that the government’s U-turn on winter fuel payments is also costing £1.25 billion.
Weak economic growth and high borrowing costs will do little to help.
“Putting together our estimates on changing market conditioning assumptions, the trade war, and a slight downgrade to the OBR's productivity growth estimates, we estimate that the hit to the chancellor’s primary fiscal rule (i.e. the stability rule) could be as large as £31.6 billion,” said Sanjay Raja, chief UK economist at Deutsche Bank.
This is a top-end estimate, and a range of factors mean the fiscal hole is likely to end up being considerably smaller. Deutsche Bank has factored rumoured plans to scrap the two-child benefit cap into its analysis, for example, but accepts this could ultimately be delayed. The government may also look to recoup some welfare costs elsewhere.
The bank thinks a more likely range is “somewhere between -£8.5 billion and -£21.7 billion”.
“If our estimates are in the right ballpark, sticking to the current fiscal headroom of £9.9 billion would therefore require fiscal consolidation and/or growth initiatives to total somewhere between £18 and £32 billion,” Raja said.
Will taxes rise in the Autumn Budget?
Senior Labour minister Pat McFadden told the BBC this morning that the government “will keep to the tax promises that we made in our manifesto when we fought the election last year”. That means no hikes to income tax, employees’ National Insurance contributions, or VAT.
The problem is that these are some of the biggest revenue-raisers for the government.
In the 2024/25 tax year, income tax accounted for 35% of the total tax take, VAT accounted for around 20% and employees’ National Insurance contributions accounted for around 6%.
Last year’s Autumn Budget focused on areas like inheritance tax and capital gains tax. The problem is that these represent a far smaller proportion of total tax revenues – 1% and 1.5% respectively last year – making them less lucrative.
Many now believe Reeves will extend a freeze on income tax thresholds beyond 2028 – something she ruled out last Autumn. This is effectively a stealth tax, as inflation drags more people into paying a higher rate.
Government estimates published at the end of June show over 8.3 million people are now higher or additional-rate taxpayers, up over 45% since the start of the threshold freeze in 2021, when former chancellor Rishi Sunak introduced the policy.
However, lower earners and pensioners are also impacted by the freeze, if their income exceeds the £12,570 tax-free personal allowance.
“The taxman is set to rake in an extra £20 billion this year, with the total income tax haul set to rise to £323 billion,” said Laura Suter, director of personal finance at AJ Bell.
“In contrast, in the first year of the income tax threshold freeze, the government collected £245 billion in tax. The staggering £78 billion climb in the nation’s annual income tax bill illustrates the huge impact the tax freeze has had on our finances.”
