Rachel Reeves has been warned she faces an “impossible trilemma” ahead of the autumn budget and must raise taxes or tear up her flagship borrowing rules to fill a £41bn black hole left by Labour U-turns, higher borrowing and sluggish economic growth, top economists have warned.
The National Institute of Economic and Social Research (NIESR) – a leading economic think tank – said the chancellor could also look at spending cuts in the autumn Budget as a way to raise the money needed by 2029-30 to remedy a £41.2bn shortfall on her “stability rule”.
Its report said the chancellor has been left with an “impossible trilemma” of trying to meet her fiscal rules while fulfilling spending commitments and upholding a manifesto pledge not to raise taxes on working people.
But after a swathe of spending cuts squeezing departmental budgets at the last spending review, tax rises are the more likely option.
The chancellor is under increasing pressure to raise income tax or consider a wealth tax on the rich.
The think tank’s forecast warned that the poorest 10 per cent of people – amounting to 2.8 million households – have seen their living standards fall 1.3 per cent under Labour, some 10 per cent lower than pre-Covid levels.
Professor Stephen Millard, NIESR’s deputy director for macroeconomics, said a “credible, sustained increase in taxes” would be required due to the “worsening fiscal outlook”, not helped by Labour’s U-turns on welfare cuts.
He warned that a large part of this would need to happen in the first year to signal to the markets that the Treasury is committed to further increases down the line.
Speaking at a press conference on Tuesday, Prof Millard warned that the £9.9bn buffer the chancellor has set out for herself is “really way too thin”, and a “slight change in fiscal circumstances” would wipe it out entirely.
“With growth at only 1.3 per cent and inflation above target, things are not looking good for the chancellor who will need to either raise taxes or reduce spending or both in the October Budget if she is to meet her fiscal rules,” he added.
It comes despite the think tank nudging up its economic outlook for the UK, with growth of 1.3 per cent expected for 2025, up from 1.2 per cent forecast in May. But it cut its prediction for next year – to 1.2 per cent, down from 1.5 per cent.
Prof Millard also suggested the chancellor could rewrite her fiscal rules with a new framework that looks at the long-term direction of travel of debt, rather than judging debt based on a point five years in the future, as the current rules dictate.
He told The Independent the government should base its financial projections on current levels of taxation and spending, rather than planned increases or decreases.
The latest warnings come despite the chancellor’s promise not to come back for more major tax rises after she unveiled a £40bn package of increases in her first budget last year.
NIESR’s findings will pile pressure on her to come up with innovative solutions ahead of her budget in the autumn. In July, Ms Reeves is said to have told the Cabinet that plugging gaps would be a “big challenge” as there is no longer any “low-hanging fruit”.
Last month, the government’s embarrassing climbdown on planned welfare cuts saw Labour’s benefits reforms gutted almost entirely, with savings from the bill slashed from £5bn to nothing.
Meanwhile, fresh figures from the Office for National Statistics published in July showed that borrowing – the difference between public spending and income from taxes – rose to a higher-than-expected £20.7bn as debt interest payments soared.
Responding to the NIESR report, shadow chancellor Mel Stride said: “Experts are warning Labour’s economic mismanagement has blown a black hole in the nation’s finances which will have to be filled with more tax rises, despite Rachel Reeves saying she wouldn’t be back for more taxes.
“Labour will always reach for the tax rise lever because they don’t understand the economy. Businesses are closing, unemployment is up, inflation has doubled and the economy is shrinking. And Labour are refusing to rule out more damaging tax rises on investment.
“Only the Conservatives, under new leadership, believe in sound money and low tax.”
The chancellor has set herself two fiscal rules – the “stability rule”, which ensures that day-to-day spending is matched by tax revenues so the government only borrows to invest, and the “investment rule”, which requires the government to reduce net financial debt as a share of the economy.
Former Tory chancellor Nadhim Zahawi told The Independent: “The Chancellor’s iron clad fiscal rules may have to be melted down following a year of sluggish growth and turbulent global conditions.
“If the Chancellor wants to unlock substantial growth, tax revenues, and investment, she must revisit the non-dom tax regime and create a truly competitive scheme – foreign investors will invest and spend in the UK if given the right incentives.
“She would be right to slash the bloated waste of Government and the red tape that suffocates rapid growth. She cannot turn to tax rises, or she will crush British companies and hard-working people up and down the UK.”
An HM Treasury Spokesperson said: “The OBR will publish an updated medium-term forecast alongside the Autumn Budget – we will not speculate on their forecast.
“As set out in the Plan for Change, the best way to strengthen public finances is by growing the economy – which is our focus. Thanks to our planning reforms, the OBR has said that the economy is expected to grow by the end of the decade.”
