The Labour government would need to raise £25 billion from extra taxes in the Budget later this month if it aims to wipe out the current ‘black hole’ in the UK public finances and ensure all government department budgets rise in line with national income.
That is one of the headline findings from a new analysis published by the Institute of Fiscal Studies, with help from economists at Citigroup.
However, just to honour another election manifesto commitment to avoid real-term cuts to public services, the thinktank said Chancellor Rachel Reeves will need to raise another £16 billion in taxes on top of the £14 billion to pay for the public sector pay deals and other commitments already made.
“Given the pledges she has made not to raise the main rates of income tax and corporation tax, or to increase national insurance or VAT at all, she might struggle to implement a tax rise on that scale,” the IFS said.
Reeves’s recently mooted plans to loosen fiscal rules in order to meet the goal of actually increasing public investment could give her £50 billion of headroom for investment, the report said.
However, to avoid spooking the bond market like former prime minister Liz Truss, “this does not mean that the government should increase borrowing by anything like that amount”, the report cautioned.
Citi’s chief economist Benjamin Nabarro said there was a risk of bond buyers “effectively going ‘on strike’ until they are happy with the level of yields” unless Reeves was reassuring enough in the Budget that any increase in investment spending would be gradual.
Nervousness in money markets has seen UK 10-year gilt yields already rising in the past few weeks, in part due to the situation in the Middle East and mixed signals on the US economy, leading some mortgage providers to pivot to raising rates in recent days after weeks of cuts.