Soaring borrowing costs and weak economic growth will force Rachel Reeves to break her pledge not to raise taxes, according to a think tank.
The National Institute of Economic and Social Research (NIESR) said the chancellor will need to cut spending or raise taxes to bridge a £40 billion hole in the government books.
In its latest UK economic outlook, NIESR said: “This shortfall significantly increases the pressure on the chancellor to introduce substantial tax rises in the upcoming autumn budget if she hopes to remain compliant with her fiscal rules.”
The first rule stipulates that day-to-day spending should be covered by tax receipts. Borrowing can only be for investment.
The second rule is that debt must be falling as a share of national income by the end of a five-year period. Ms Reeves has repeatedly said these rules are “non-negotiable”.
However, the u-turn over winter fuel payments has added to soaring expenditure, while weaker-than-expected output is failing to bring in sufficient revenue.
She may now have to break her manifesto promise not to increase income tax, VAT or employee national insurance. She also gave assurances after last year’s Budget that there would be no repeat of her tax increases.
The NIESR urged the government to build a larger fiscal buffer through moderate but sustained tax rises.
“This will help allay bond market fears about fiscal sustainability, which may in turn reduce borrowing costs,” it said.
“It will also help to reduce policy uncertainty, which can hit both business and consumer confidence.”
There are now expectations that the autumn budget will see income rate thresholds frozen for another year, pulling more people into the higher 40% rate of tax, so-called “fiscal drag”.
Stephen Millard, of NIESR, said the Chancellor had to choose between breaking her fiscal rules or hitting the government’s spending targets.
“Can she fill that gap without breaking the manifesto commitment to raising taxes on working people? I think the quick answer to that is no,” he said. “Fiddling at the edges won’t do the job.”
The NIESR’s estimate for the fiscal shortfall is higher than estimates from City analysts who expect Reeves to face a lower shortfall of between £20 billion and £25 billion.
Some economists believe after last year’s assault on business, the Chancellor is likely to turn her focus on households.
The NIESR said that money could be raised by reforms to council tax bands or, in a more radical approach, by replacing the whole council tax system with a land value tax.
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