Rachel Reeves 'will need to raise income tax by at least 2p' to plug Budget hole

Rachel Reeves will need to plug a £50 billion deficit in the nation's public finances, with at least a 2p hike to the basic rate of income tax likely to be needed, a major economic think tank has warned.

The National Institute of Economic and Social Research (Niesr) has further raised concerns about potential tax hikes in the upcoming November 26 Budget, stating it believes the Chancellor is set to fall short of one of her fiscal rules by £38.2 billion in 2029-30. This is before considering the nearly £10billion needed to restore the fiscal buffer that has been wiped out, according to the group. In its latest economic outlook, Niesr predicts that the UK's independent fiscal watchdog, the Office for Budget Responsibility (OBR), will forecast a smaller deficit of around £20billion when its latest predictions are published alongside the Budget.

However, Niesr is urging the Chancellor to aim for a buffer of at least £30billion on top of this to safeguard the finances against future shocks, which would still leave her needing to find £50billion.

The think tank suggests that the Chancellor will likely have to break her manifesto pledge and raise income tax, rather than "messing around" with changes to marginal taxes, which it argues would be more damaging to the economy in the long run.

Niesr estimates that a 2p rise on the 20% basic rate of income tax would be the minimum required to mend Britain's bruised public finances, generating around an additional £20billion.

A 5p increase on the 40% higher rate could add an additional £10billion, with around £500million from a similar rise to the upper band, it was noted.

This could affect economic growth - reducing approximately one percentage point on its forecast for next year to 1.1% in 2026, and leading to a 0.3 percentage point decrease in the third year.

However, it warned that the alternatives could be much worse, with a VAT increase causing inflation to rise as costs are passed onto consumers, while corporation tax increases "discourage investment leading to permanently lower GDP".

And if trust in the public finances is not restored, borrowing costs are likely to remain high while debt will reach "unsustainable" levels, Niesr said.

Stephen Millard, deputy director for Macroeconomics, said Ms Reeves would need to make "brave choices".

He said: "She will likely need to break her manifesto pledge by raising income tax - rather than attempting to fill the gap by messing around with lots of changes to marginal taxes - as this would be the least bad option for the economy.

"A mixture of tax rises and spending cuts is needed to put the UK economy and public finances 'back on track', which would in turn help the Government to focus on its mission to deliver higher economic growth and better living standards across the country."

Ms Reeves had promised not to increase taxes for working individuals in Labour's general election manifesto - a pledge widely understood to cover income tax, VAT, employee national insurance contributions, and corporation tax.

Instead, she raised employers' national insurance contributions (NICs) in last autumn's budget and vowed at the time that she would not repeat such a tax-increasing budget "ever again".

However, she has already laid the groundwork to backtrack on Labour's manifesto promise, refusing to dismiss potential tax increases in her pre-Budget speech on Tuesday and cautioning that "each of us must do our bit".

David Aikman, a director at Niesr, said: "The economics are clear; what is required now is political will - the readiness to take difficult decisions on tax and spending in this Budget in the long-term interests of the UK economy."

In its forecast, Niesr upgraded its growth outlook for 2025 to 1.5% from 1.3% in August, but maintained its prediction for next year at 1.2%.

It anticipates that the Bank will keep interest rates at 4% this week, but will reduce them again in February as inflation is expected to drop from the current 3.8% to 2.7% in the second quarter of next year.