Increasing defence spending will mean government breaking promises elsewhere

Donald Trump is demanding that European allies spend more on defence, and the prime minister is nodding along.

At a summit in Paris, Sir Keir Starmer will urge his counterparts to take the new president seriously and to make concrete spending commitments before the NATO summit in June.

Starmer is taking a leading role at the summit, but some might (rightfully) point out that Britain has itself dithered when it comes to parting with actual cash.

Labour has already pledged to increase defence spending from 2.3% to 2.5% of GDP but, as of yet, there is no date for when the target will be met - unsurprisingly the Treasury wants to push it back as far as possible.

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The challenge is clear: An increase in defence spending means sacrifices will have to be made elsewhere, and promises might have to be broken.

Ministers must weigh geopolitical and diplomatic risks against their domestic agenda.

This government has promised to adequately fund public services, but it is also committed to keeping a lid on borrowing, imposing a fiscal rule that requires tax receipts to cover day-to-day spending.

It is managing for now. Business taxes have been hiked up to support public services - at a considerable political cost to the chancellor.

Little room for manoeuvre

However, she will need to find even more money if she wants to avoid real-term cuts to courts, prisons and local authorities after this year.

Rachel Reeves has promised she won't go after businesses again, but the government has also promised that it won't raise VAT, income tax or national insurance, meaning she has little room for manoeuvre.

She could eat into the headroom against her fiscal target - £9.9bn - but that is already set to shrink considerably when the Office for Budget Responsibility (OBR) publishes updated economic forecasts alongside the budget next month.

The watchdog is likely to downgrade the country's growth prospects, which means forecasts for tax receipts will also shrink.

The Treasury is already eyeing departmental budget cuts to meet the target, an unpopular decision that runs against the government's political ambitions. So, how does all of that square with plans to increase defence spending from 2.3% to 2.5% of GDP?

The move would amount to an extra £5bn-£6bn in cash terms, taking total defence spending to around £66bn a year. It may not seem like a huge sum, but it is significant in the context of the tight public finances and could easily eat up most of the chancellor's headroom.

It might not even be enough

Even 2.5% won't silence the critics.

Military chiefs have warned that the extra sums won't be sufficient to meet current targets and would require the military to rein in its ambitions. Going to 3% of GDP would mean spending £20bn more on defence.

If the country were to placate the US president and go all the way to 5% of GDP, that would mean spending around £80bn more.

That's twice as large as the historically large tax rises in the autumn budget, which amounted to around £40bn. Within the current framework, that seems implausible.

So, could the framework change?

Britain is in the same fiscal bind as much of Europe, but the bloc has agreed to temporarily ease its fiscal rules to allow countries to spend more on defence.

EU fiscal rules require countries to maintain debt-to-GDP ratios below 60% and annual deficits at 3% or below. However, Ursula von der Leyen announced the change at the Munich Security Conference on Friday

"This will allow member states to substantially increase their defence expenditure," she said.

A tough decision

That's not a decision Britain could take lightly.

Changing the fiscal rules less than a year after setting them could damage credibility within the financial markets.

The government is already ramping up borrowing to fund investment, which it has marked out as a spending exception necessary to spur economic growth. If it starts creating more exceptions, that could create jitters among investors.

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Ben Zaranko Associate Director at the Institute for Fiscal Studies, said: "If defence spending does need to rise significantly, it's difficult to overstate the seriousness of the fiscal challenge this would pose to the government.

"Meeting the pressures of an ageing population on the NHS while simultaneously ramping up defence expenditure, in an era of stagnant growth and elevated interest rates, would be an epochal challenge - and certainly not one that could be met while sticking to the letter of Labour's manifesto promises."