What are the consequences of the increase to defence spending?

1st March 2025

João Sousa of Fraser of Allender Institute looks at possible affects of increased defence spending.

On Tuesday, the Prime Minister announced before the House of Commons that the Government would be increasing spending on national defence from its current level of 2.3% of GDP to 2.5% in 2027, with "an ambition to reach 3% in the next parliament."

How much does the UK currently spend on defence?
All members of the NATO are expected to spend at least 2% of national income on defence, and the UK has been meeting this throughout its membership of the Alliance. Nonetheless, spending on defence has decreased dramatically from the heights reached during the Cold War, when it peaked at 7% of GDP in the mid 1950s. Spending has hovered around 2.3% for a number of years now.

What did the Prime Minister actually announce?
While the 3% ambition was stated, the timeline for this was quite vague - the next parliament will run from 2029 to 2034, and so whether this is reached at the beginning or the end of that term makes a lot of difference.

The Prime Minister stated that the increase in spending to 2.5% of GDP would mean an additional £13.4 billion a year in defence spending, although this was a slight of hand. To reach those figures, it would imply spending remaining at today's levels in cash terms.

But of course, we were already committed to 2.3% of GDP in any case, and so the base scenario included a rise in the amount of spending that was already baked in.

As such, the real figure is £6.2 billion more than originally planned. This is a significant amount of money - just as a way of illustrating this, it would be the equivalent amount of money raised by increase employee and self-employed National Insurance Contributions by one percentage point.

But reaching 3% of GDP is much more challenging - it would require £22 billion a year altogether relative to current plans, and there are still £16 billion a year to find even after the 2.5% target has been achieved. £16 billion is more than the 1.2 percentage point increase in employer NICs will raise from next year.

How is this being funded?
The increase to 2.5% of GDP has been funded by cutting that amount from the official development assistance (ODA) budget, or foreign aid as it's usually called. Spending on ODA was first cut from 0.7% of gross national income (GNI) to 0.5% by then-Chancellor Rishi Sunak in the 2020 Spending Review, with a promise to restore the original target when some conditions were met.

Since then, it has hovered around 0.5% of GNI, although in October the UK Government claimed it was committed to restoring ODA spending to 0.7% of GNI "as soon as the fiscal circumstances allow" – while noting that this would not be the case during this parliament.

The cut to 0.3% of GNI will reduce the ODA budget to around £10 billion, from the current projections of around £16 billion from 2027 onwards. This is enough to pay for the 2.5% of GDP defence target, although it's far from plugging the gap to reaching 3%. In fact, even if the UK spent nothing on foreign aid – which the Government has said it’s not its policy – there would still be a £6 billion gap a year to plug to be able to afford PM Starmer’s ambition.

So what are the options?
To get to 3% of GDP on defence would require a significant shift in domestic fiscal policy, although the effects are different depending on what path (or combination of paths) is chosen.

The UK Government could try to simply borrow the additional funds, but this is a commitment in perpetuity, and as such it would add 0.5% of GDP to the structural deficit, which is already looking relatively high come the end of the Parliament. This would break Chancellor Rachel Reeves’ fiscal rules as they currently stand.

The Government could decide to cut more of the ODA budget, although as discussed above it wouldn’t be enough to pay for the whole increase. So if the Government wanted to avoid having to increase spending as a whole, some of it would fall on public services.

The UK Government could also look at increasing taxes to pay for this additional spending. Realistically, it would require raising one of the big taxes (income tax, NICs, VAT or corporation tax) – which the Government pledged not to increase – or introducing some sort of new defence contribution, which would probably be just another form of income tax.

How would these affect the Scottish Government’s spending power?
The funding of 2.5% of GDP on defence through reducing ODA is a movement within reserved areas, and so it has no effect on the Scottish Government’s block grant.

The consequences for the Scottish Government’s funding would depend on what path was chosen by the UK Government. Borrowing for reserved areas – as defence is – or shifting it between ODA (also reserved) and defence attracts no Barnett consequentials. But cutting budgets of public services for which the equivalents are devolved would reduce the Scottish Government’s funding. £16 billion worth of cuts would cost the Scottish Government something like £1.3 billion.

The effects of tax rises on Scottish Government funds would depend on which taxes were raised. If the tax is not devolved, then it has no direct consequences. But if income tax were chosen, then it would increase the block grant adjustment, which is used to estimate how much would have been raised in the absence of Scottish Government policy. £16 billion raised that way would reduce Scottish Government funding by around £1.1 billion.

Of course, the likelihood is that the UK Government would want to do some combination of these options, but there are at least several plausible scenarios in which decisions of how to fund this additional spending on defence that would lead to reduce spending on public services or additional taxes – and in either case, the effects could be felt by the Scottish Government.

Author
João Sousa
João is Deputy Director and Senior Knowledge Exchange Fellow at the Fraser of Allander Institute. Previously, he was a Senior Fiscal Analyst at the Office for Budget Responsibility, where he led on analysis of long-term sustainability of the UK's public finances and on the effect of economic developments and fiscal policy on the UK's medium-term outlook.

Source
https://fraserofallander.org/weekly-update-what-are-the-consequences-of-the-increase-to-defence-spending/