Rachel Reeves will need to raise taxes to close a government spending gap that is on course to reach more than £40bn after a slowdown in economic growth and higher-than-expected inflation, according to a leading thinktank.
In a blow to Labour’s hopes of balancing the books without breaking manifesto commitments ruling out personal tax rises, the National Institute of Economic and Social Research (NIESR) said a number of factors would knock off course the chancellor’s plans to stay within Whitehall spending limits.
These factors included headwinds from Donald Trump’s tariff war, higher debt interest payments and U-turns on welfare spending cuts.
NIESR said “moderate but sustained” tax rises would be needed in the autumn budget for Reeves to overcome a deficit of £41.2bn and then restore a near £10bn buffer in the current budget, forcing the Treasury to raise more than £51bn from taxes, secure extra borrowing or use severe cost-cutting measures to find extra savings.
With extra borrowing likely to spook financial markets and ministers already struggling to stay within departmental spending limits, the thinktank said tax rises would be the most likely option.
A rise of 5p in the pound on the basic and higher rate of income tax would fill the budget gap, NIESR said, though it recommended a broader review of tax rates and an overhaul of Reeves’s budget rules as a way to balance the books and bring greater stability to the public finances.
Stephen Millard, a senior economist at NIESR, said: “We think the current budget deficit will be around £40bn, or £41.2bn to be precise. It means if the chancellor wants to maintain a buffer of £9.9bn then she will have to find £51.1bn, either in extra taxes or lower spending or both, annually, by 2029-30.”
He said NIESR recommended a bigger buffer. “To do that requires a moderate but sustained increase in taxes.”
Last month the chancellor warned ministers that taxes would have to rise after the government scrapped restrictions on welfare payments, without indicating which taxes would be affected.
There is already a long queue of claims by public sector workers for higher wage rises, adding to already rising pressures on the public purse that includes higher spending on immigration and the courts system to defence and education.
Backbench Labour MPs, emboldened after successful campaigns against cuts to winter fuel allowance and disability support payments, are expected to challenge the Labour leadership if manifesto spending pledges are scrapped in the budget to reduce the deficit.
NIESR said its updated analysis from the spring meant it expected the Bank of England to reduce the cost of borrowing from 4.25% to 3.75% by the end of the year, but the cuts will arrive too late to boost growth.
Speculation has mounted over which taxes Reeves will raise, with current favourites an extension to the freeze on income tax bands and a cut to the current cash Isa limit.
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NIESR said a freeze on tax thresholds, bringing more households into higher tax bands, would raise about £8bn while a rise in income tax to 25p for the basic rate and 45p for the standard rate would close the gap entirely.
David Aikman, the NIESR director, said: “It will be crucial for the chancellor to restore market confidence by demonstrating fiscal discipline. This will require a determined attempt to rebuild the fiscal buffer and that will inevitably involve gradual but sustained tax increases or spending cuts.”
A projection by the Office for Budget Responsibility (OBR), the government independent forecaster, to coincide with the chancellor’s spring statement in March showed the deficit falling in the 2025-26 financial year.
However, official figures have shown public finances already beginning to veer off track since April. Across the first three months of fiscal year 2025-2026, the budget deficit was £44.5bn, £5bn higher than the OBR’s forecast.
A Conservative spokesperson, Mel Stride, blamed the government for mismanaging the economy and “always reaching for the tax rise lever because they don’t understand the economy”.
He said: “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.”