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Who will pay for our defence commitment?

Date: 27 June 2025

4 minute read

This week’s blog is written by portfolio manager, Ian Jensen-Humphreys.

Man taking notes at a laptop

This Wednesday (25 June) the UK, and other NATO members, committed to spend an amount equal to 5% of their respective GDPs on defence each year by 2035, but is this a credible and realistic commitment that the UK government can make? Or is it empty posturing to appease the US administration’s demands?

To start with, it’s not really 5% on defence. It is 3.5% on ‘core’ defence spending and 1.5% on ‘resilience and security’ spending. As the UK already spends 2.4% on ‘core’ defence, that part of the pledge is an increase of 1.1%. With regards to the ‘resilience and security’ commitment, the IFS response to the announcement suggests that they believe the government had already included it in their budget estimates for 2027-28. Therefore, that part of the pledge is not a ‘new’ additional promise, but rather it seems some existing spending plans have been reclassified as ‘security’ to make the headline number look as large as possible.

So, the real increase is an extra 1.1% of notional income on ‘core’ defence, or an extra £30bn per year in today’s money, but how large is this in the context of broader government spending? As a comparison, the controversial Winter Fuel Payment changes announced by the government last summer were expected to save c.£1.5bn per year, so we are talking about a lot of money.

How will this be paid for?

There are clearly three ways to pay for this additional expenditure: raise more through taxation, cut spending elsewhere, or run larger deficits and borrow the difference.

Tax rises will be unpopular. Public sector current receipts for 2023-24 were 40.5% of GDP, the highest overall rate of taxation since 1982-83, and IFS forecasts from October of last year saw this increasing to 42.5% by 2027-28. To put this in context, the Labour governments led by Tony Blair and Gordon Brown from 1996 to 2010 never collected tax at a rate higher than 37.4% of GDP. Will the population tolerate a further 1.1% increase? It is roughly the equivalent of raising the rate of VAT from 20% to 23.5% or increasing corporate tax by nearly a third. Certainly, these can be achieved but they are hardly likely to encourage the growth that the government so desperately needs.

Will we see spending cuts?

So, could the government take the £30bn from other departments? That would definitely be a struggle and also highly controversial. The areas that spend that largest amount are social protection – mainly pension payments and unemployment benefits (13.3% of GDP in 2023-24), health (8.1%), interest on gilts (4.6%), and education (4.1%). None of these could cope with a reduction of 1.1% in spending. To make matters worse, the interest payable to gilt investors is likely to increase in coming years as lower coupon gilts issued in previous years mature, and new issuances at market rates will bear higher coupons.

That leaves us with having to run larger deficits and borrow more money. The UK is certainly not alone in this – the US has been running ever larger deficits with no sign of reining in spending. UK government net borrowing in 2023-24 was £149bn, so an extra £30bn is a material increase. To give more context, the then-government’s growth plan from September 2022 (that helped generate a short-term gilt crisis) called for an increase in spending by £72bn. So, not quite a ‘Liz Truss moment’, but a large increase, nonetheless.

What’s the likely outcome?

We suspect that this, and any future government, will not want to cut spending elsewhere and will try to avoid raising taxes. So, they will most likely borrow more money and push the problem further into the future. As a result, we will be keenly watching the gilt market over the coming days as market participants digest the news and adjust their positions accordingly.

Portfolio manager blog - this week written by

Ian Jensen-Humphreys

Portfolio Manager

Ian is a portfolio manager of the Quilter Investors Cirilium and Creation Portfolios. Ian joined Quilter Investors in March 2020 from Seven Investment Management (7IM), where he was deputy chief investment officer. Ian also spent 15 years at Goldman Sachs in risk management and portfolio hedging strategies.

Ian is a CFA charterholder and has a degree in Physics from the University of Oxford.

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