Rachel Reeves is under pressure to make significant tax hikes in the Budget that could breach her manifesto pledges as she faces a £30bn black hole amid gloomy economic forecasts.
Speculation is mounting that the Chancellor may face a shortfall of as much as £30bn when she sets out her plans for tax and spend on 26 November, with the majority of the funding gap expected to be due to a revision in productivity growth by the Office for Budget Responsibility.
It comes as Reeves was warned that inflation is likely to surge to the highest level among the G7 developed nations and tax hikes will slow down economic growth by the OECD, an international economic watchdog.
As such, Reeves is poised to blame looming tax rises on the 14 years of a Conservative-led government when she delivers her Budget later this autumn, The i Paper understands.
The Chancellor is awaiting the first official set of forecasts from the OBR, and the working assumption within the Treasury is that it will downgrade the UK’s outlook for productivity growth, adding billions to the Government’s fiscal blackhole.
It is understood that for every 0.1 per cent downgrade in growth, around £9bn to £10bn is added to the funding shortfall, and Treasury officials fear the OBR could revise down its forecasts by 0.2 per cent.
The move would mean the Chancellor would need to find around £20bn in tax rises and a further £10bn in spending cuts if she is to meet her own fiscal rules.
‘Stealth tax’ could be extended
It has led economists to predict that she will be forced to extend the freeze on income tax thresholds – so called ‘stealth taxes’ – just a year after she pledged to raise them in line with inflation by 2028.
While Reeves will seek to claim that such a move, which would raise around £7bn a year, does not break her manifesto pledge not to raise income tax, national insurance or VAT for working people, it will be widely regarded as a hefty tax burden on working households as thousands of people will be drawn into higher tax brackets as wages rise.
UK inflation is set to be the highest in the G7 the OECD forecastsa Provider: PA WireThe Chancellor is also under pressure to finally raise fuel duty, but any decision to raise the price of fuel is likely to be met with a severe backlash.
There are also calls for her to look at increasing capital gains tax, imposing a windfall tax on banks, while backbenchers on the left of her party are demanding she impose a full-blown wealth tax on the very richest people in the country.
Other options include cutting pensions tax relief. Currently people paying into a pension get relief at their marginal rate, so basic rate taxpayers get 20 per cent relief, higher rate taxpayers get 40 per cent relief, and additional rate taxpayers 45 per cent. This could be cut to as low as 20 per cent for everyone, if the Chancellor went ahead with reform.
The economic situation also raises questions over whether Reeves will be able to scrap the two-child benefit cap this year. The cap is hated by Labour MPs, and the government has indicated it would like to scrap it. But the £3.5bn cost may make it unaffordable in the short term.
It comes as the influential think tank the Organisation of Economic Co-operation and Development (OECD) warned that higher tax and spending cuts are set to drag on UK growth next year, adding to a hit from US President Donald Trump’s tariff hikes.
UK growth could be hit by tax rises the OECD forecastsProvider: PA WireThe UK is also expected to see one of the highest inflation rates among the G7 economies, according to its forecasts.
The OECD added that Britain’s “tighter fiscal stance”, meaning higher taxes and reduced government spending, is expected to weigh on the economy, with growth set to ease sharply from 1.4 per cent this year to 1 per cent in 2026.
“Normally when we think about tax rises it’s also in the context of spending increases. This time we’re really talking about deficit reduction, so there won’t be an offsetting increase in spending, which means the impact on growth could be worse than normal,” explains Thomas Pugh, economist at RSM UK.
Economists from the organisation also predicted that UK inflation will surge, with Britain experiencing the highest level among the G7 group of advanced economies this year.
Food prices pushing up cost of living
Inflation in the UK is expected to reach 3.5 per cent in 2025, 0.4 percentage points higher than its previous forecast, and still remaining far above the Bank of England’s target in 2026, at 2.7 per cent, with soaring food prices pushing up the cost of living.
This would see the UK suffering the second highest rate of inflation in the G7 next year, behind only the US, according to the report.
While the OECD nudged up its 2025 forecast for UK gross domestic product (GDP) from the 1.3 per cent it predicted in June, it kept the outlook unchanged for 2026 in what will mean a steep pull back in growth over the year ahead.
Reeves said the figures “confirm that the British economy is stronger than forecast – it has been the fastest growing of any G7 economy in the first half of the year”.
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She added: “But I know there is more to do to build an economy that works for working people – and rewards working people. That is what I’m determined we deliver through our plan for change.”
The UK economy grew by 0.7% over the first three months of the year and by 0.3% over the second quarter, official figures show.
Shadow chancellor Sir Mel Stride said the OECD’s data showed “Britain is in a high tax, high inflation, low growth doom loop,” adding that the UK was “now teetering on the edge of stagflation”.
The OECD’s chief economist Alvaro Pereira said it was “certainly not our working assumption” that the UK will experience stagflation – referring to a combination of stagnant economic growth and high inflation.
He added that growth was forecast to pick up this year while inflation was set to come down.
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