Labour Faces Fiscal Challenges Amid Calls for Tax Increases
Prime Minister Sir Keir Starmer has responded to concerns raised by economists about a potential £50 billion shortfall in public finances. He emphasized that he does not recognize some of the figures being circulated, particularly those suggesting that Chancellor Rachel Reeves might fail to meet one of her fiscal rules. However, he did not rule out further tax increases when the Budget is presented in the autumn.
Starmer highlighted that the focus of the upcoming fiscal package will be on improving living standards and ensuring that people feel better off. This comes after a leading think tank warned that Labour may need to raise taxes again soon. The National Institute of Economic and Social Research (NIESR) stated that Reeves would have to add 5p to income tax to maintain financial stability by the end of the decade and meet her fiscal rules.
According to NIESR, the small buffer of £9.9 billion that Reeves had left last year has been completely used up, resulting in a budget deficit of £41.2 billion. To fill this gap and maintain a buffer, the Chancellor would need to find £51 billion annually through higher taxes or reduced spending by 2029/30.
During a visit to Milton Keynes, Starmer declined to explicitly confirm whether Labour remains committed to not raising VAT, income tax, or corporation tax. He stated that the full forecast would be available in the autumn, with the focus on living standards. He noted that the economy has been stabilized, with interest rates cut four times, which has helped reduce mortgage payments. Additionally, wages have been increased in both the private sector and for the minimum wage, providing more money to people’s pockets.
Downing Street sources later clarified that Labour is still committed to its manifesto pledges, including not raising taxes on “working people,” such as income tax and VAT. When asked if he disagreed with economists warning of necessary tax rises, Starmer said he did not recognize some of the figures being presented.
Despite announcing tax rises worth £40 billion in last year’s Budget, Reeves has not ruled out another round this autumn. Critics have pointed out that Labour lacked an economic plan upon entering government. Tory shadow chancellor Sir Mel Stride accused Labour of economic mismanagement, stating that the party’s actions have created a black hole in the nation’s finances, which will require more tax rises despite promises not to increase taxes.
Professor Stephen Millard, deputy director of NIESR, expressed disappointment that Labour did not present a clear plan upon taking office. He suggested that many of the current challenges could have been avoided with a proper strategy. According to Millard, addressing the £50 billion shortfall would require significant tax increases, and small adjustments would not suffice.
Labour MPs and unions have urged Reeves to implement a wealth tax to balance the books. Freezing income tax bands for longer could also be considered. However, neither measure would generate £50 billion in revenue, and Reeves is constrained by Labour’s manifesto promise not to raise National Insurance, income tax, or VAT on “working people.”
Culture Secretary Lisa Nandy downplayed the idea of a wealth tax, stating that the Chancellor has already dismissed it. She emphasized that the goal is to lower taxes for working people and put more money back into their pockets.
Professor Millard highlighted that the current budget deficit in 2029/30 is expected to be around £41.2 billion, or 1.17% of GDP. Maintaining a £9.9 billion buffer would require an additional £51 billion annually through higher taxes or reduced spending. He recommended building a larger buffer, noting that the current amount is “wafer thin” and vulnerable to changes in fiscal circumstances.
He also mentioned that extending the freeze on income tax thresholds beyond 2028 could bring in around £8.2 billion. Filling the £50 billion gap would require substantial tax increases, such as a five percentage point rise in both basic and higher rate income tax.
Millard stressed the importance of protecting the most vulnerable and ensuring public investment is safeguarded. NIESR calculated that failing to pass planned welfare reforms would result in an additional £13.7 billion in spending, while continuing the winter fuel allowance would add £1.5 billion.
The think tank also noted that weaker growth in output and employment compared to the Office for Budget Responsibility (OBR) forecast accounted for a £22.2 billion difference in 2028/29. There was also a £14.3 billion difference between the OBR’s March forecast and NIESR’s analysis.
Reeves set two fiscal rules: the “stability rule,” ensuring day-to-day spending is matched by tax revenues, and the “investment rule,” requiring the reduction of net financial debt as a share of the economy. NIESR warned that meeting these rules, maintaining spending commitments, and avoiding tax increases presents an “impossible trilemma.”
In other parts of the report, NIESR improved its economic outlook for the UK, forecasting 1.3% growth for 2025, up from 1.2% in May. However, it lowered its prediction for next year to 1.2%, down from 1.5%. CPI inflation is expected to remain above the Bank of England’s target at around 3.5% this year and 3% in early 2026 due to high wage inflation and measures from last year’s Budget.
For mortgage holders, NIESR expects the Bank of England to cut interest rates twice more this year, reaching 3.5% by early 2026. The first 0.25% cut could happen tomorrow with the release of the latest monetary policy report.
A Treasury spokesperson emphasized that growing the economy is the best way to strengthen public finances, citing planning reforms that have led to positive economic forecasts.