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The Institute for Fiscal Studies has warned Rachel Reeves that any more bad economic news will “almost certainly” spark fresh tax rises.
Council tax will already have to rise at its fastest rate in a generation, the IFS said, as it added to concerns the chancellor has left herself with little room for manoeuvre a day after she unveiled her spending plans for the rest of the parliament.
The warning came as the government was hit with the news that the economy had shrunk by 0.3 per cent, sparking fears of a potential recession.
Ms Reeves came into office with a pledge to grow the economy, but it has been sluggish at best in her first year.
Paul Johnson, director of the IFS, said council tax is set to rise at its fastest rate for 20 years as local government tries to close its funding gaps with annual increases of up to 5 per cent. More councils could also reach a “tipping point” unless demands on their resources fall, he warned.
Mr Johnson also raised the spectre of many more people being forced to pay higher rates of income tax, under so-called “fiscal drag”, where the threshold at which workers begin to pay more stays frozen even as wages rise with inflation.
Mr Johnson described this as “the most politically straightforward thing to do” and said it would bring in about £10bn a year by 2029.
In response, government sources did not deny they could extend a freeze on thresholds, saying only that future tax and spend decisions are taken at the Budget.
In a scathing assessment, he suggested that the Treasury was at times “making up the numbers” and described Ms Reeves’ speech to the Commons on Wednesday as “baffling”.
But he said that the chancellor’s priorities were “reasonable” and conceded that she was dealing with difficult economic circumstances.
Mr Johnson also noted that the spending review did not represent austerity as some of Ms Reeves’s critics in the Labour Party have claimed.
There were also concerns that the cost of Labour’s flagship free childcare promises will cost a whopping £1bn more than originally planned by 2029, because of higher than expected take up.
In his conclusions, Mr Johnson said: “If you were baffled by the chancellor’s speech yesterday, so were we. It did not appear to be a serious effort to provide any useful information to anybody.”
He said the “real test” would be in how well the money is spent, especially funding in investment.
And he warned: “Ms Reeves is now going to have all her fingers and all her toes crossed, hoping that the OBR will not be downgrading their forecasts in the autumn. With spending plans set, and ‘ironclad’ fiscal rules being met by gnat’s whisker, any move in the wrong direction will almost certainly spark more tax rises.”
Asked if the UK’s finances were doomed because of high spending on health and pensions, he said “no”, although he added he was worried about the longer-term trend of not having children.
The IFS also cast doubt on Labour’s much-vaunted defence spending aims, saying they would have expected higher increases going forward if Sir Keir Starmer’s 3 per cent “ambition” was “concrete”.
And it said there was “uncertainty about how asylum costs will fall in reality” after Ms Reeves announced huge savings by ending the use of hotels, an aim that has defeated successive governments.
