Prime Minister Rachel Reeves said this could rise further as economists warn that she could be forced to fill a £40bn loophole in public finance in the budget this fall.
After the warning was issued, the Prime Minister acknowledged that the government’s recent turnaround on welfare reform would have “costs”, adding that the impact would be “reflected in the budget.” However, Reeves insists that she would not violate the fiscal rules that restrict borrowing, but instead directed the tax rate to the leverage that is most likely to remain.
This marks the potential reversal of her previous commitment no longer hikes taxes after last year’s record budget, which imposed £2.5 billion in national insurance on employers and was blamed for stagnating economic growth.
The Institute for Finance (IFS) said Reeves could be forced to announce taxes up to £40bn to cover a combination of reduced economic forecasts and spending commitments, warning the government now faces a “perfect storm.”
“If the growth forecast is lowered again and welfare spending continues to rise, you can comfortably look at the £2-40 billion budget,” said Ben Zaranko, senior economist at IFS. “That’s not what the government wants, but it’s certainly within the range of possibilities.”
The Office of Budget Responsibility (OBR) cut it in half in March. Just a downgrade of just 0.2 percentage points will leave only a £18 billion gap in public finance.
A series of welfare turnovers worsened the strain. The decision to cut individual independent payments (PIPs) last week was as much as £600 million, while the rise in winter fuel allowances is expected to add £1.5 billion to public bills. Workforce seats have also urged the abolition of the dual-child welfare cap – a move that will increase pressure.
Reeves and Prime Minister Sir Kyle Starmer have so far refused to detail how to fund these commitments, but the Prime Minister’s latest comments suggest that higher taxes could be restored to the table.
Conservatives seized on uncertainty and accused the labor economy of poor management. Former Prime Minister Sir Mel Stride said: “The welfare chaos of Labor has left the country facing the time bomb in the face of taxation. Businesses and hard-working families should be prepared for further pain in tax hikes.”
IFS Director Paul Johnson said Reeves will face enormous political pressure on any path she chooses. “She is trapped in a rock and a tough place. Raise taxes, you make the market or voters bother you, or break your fiscal rules,” he said.
The rebound has begun in parliament, with several Labor MPs demanding a wealth tax or an increase in taxes for those with higher incomes. But analysts warn that this could undermine confidence and growth in the business, just as the economy is becoming more and more important.
