Tinkering around the edges at the next Budget risks another year of economic pain, a leading think tank has warned, urging the chancellor to take “bold action” in November.
The Institute for Fiscal Studies (IFS) said it expects Rachel Reeves will need to find at least £22bn next month, thanks to rising borrowing costs, weaker growth forecasts and spending commitments made since spring.
But the IFS said there was a “strong case” for the chancellor to go further, arguing that a £10bn buffer – the amount of headroom Ms Reeves previously left herself against her self-imposed debt rules – was not enough to ensure stability and would leave her “limping from one forecast to the next”. This funding, the think tank said, is likely to have to come from tax rises.
While the think tank didn’t rule out spending cuts entirely, they said they would “pose challenges” due to a lack of parliamentary support for welfare cuts and the fact that departmental budgets were only agreed in June.
Speaking about the narrow headroom the chancellor left at the last budget, IFS economist Ben Zaranko said: “The reason why this causes so many problems is when you have a pass-fail rule, and you leave such a narrow margin against it, even fairly standard, typical forecast movements can be enough to push you onto the wrong side of the line.
“That means policy has to respond overly frequently… and that volatility itself creates damage.”
The £22bn figure also does not include the cost of widely expected announcements on abolishing the two-child benefit cap and maintaining the freeze on fuel duty.
IFS director Helen Miller said the current situation, where the chancellor is likely to be forced into making large spending cuts or tax rises, is “to a large extent” her own making, after choosing to “operate her fiscal rules with such teeny tiny headroom” that left her exposed to “run-of-the-mill forecast changes”.
“For Rachel Reeves, the Budget will feel like groundhog day,” Ms Miller added.
The IFS said implementing a larger fiscal consolidation in November would be “the most straightforward route” to avoiding similar challenges in future years.
But tax increases are also far from simple, with Labour’s manifesto ruling out increases to income tax, national insurance or VAT.
Ms Miller suggested it would be possible to raise the required sums from changes to property taxes and levies such as capital gains tax or inheritance tax, but added these were “badly designed” and could harm growth.
The IFS also warned against seeking “large sums from a small number of taxpayers”, instead saying the chancellor “should be bold” and reform the tax system to be “more rational” and impinge less on economic growth.
The IFS warning came after leading tax expert Dan Neidle, the founder of Tax Policy Associates, said the chancellor would have no choice but to raise major taxes and reform others in the upcoming Budget if she is to turn Britain’s “desperate” economic situation around, warning she cannot afford to tinker at the margins “by picking from a Scrabble bag” of smaller tax increases.
He said the “wise” way for Ms Reeves to increase taxes would be “raising one of the main taxes, possibly by expanding the base of VAT, which may or may not break a manifesto pledge”.
Asked on Wednesday whether the government could still rule out increases to VAT, income tax or national insurance contributions, the prime minister’s official spokesperson pointed to Sir Keir Starmer’s previous insistence that “the manifesto stands”. But he would not explicitly rule out increases to those taxes.
On the same day, Ms Reeves admitted she is looking at tax rises and spending cuts to fill the financial black hole, pinning the blame on Brexit, which she said has had a “severe and long-lasting” impact on the economy.
But shadow chancellor Sir Mel Stride claimed Labour “came to office with no plan”, adding: “The IFS has laid bare the consequences of the chancellor’s decisions.”
“Rachel Reeves has delivered higher taxes, more borrowing, and no credible path to growth – with more tax rises on the way.
“Britain faces serious economic challenges, but instead of confronting them, Rachel Reeves and Keir Starmer are hemmed in by their own MPs and too weak to take the tough decisions the country needs,” he said.
The IFS’s latest warnings come alongside the publication of its annual “green budget”, setting out the challenges facing the chancellor ahead of the Budget each year.
The green budget also includes analysis from Barclays, which suggests that unemployment could rise to 5 per cent in 2026 amid slowing growth and above-target inflation.
Jack Meaning, chief UK economist at Barclays, said: “With the right policy decisions, this near-term challenge can be navigated toward a more favourable medium-term outlook.
“If the chancellor can avoid delivering an inflationary Budget, headline price growth should ease significantly in the coming months, allowing the Bank of England to cut interest rates further and support households and businesses in driving more balanced economic growth.”
