The UK insisted unpopular tax rises were a one-off. Economists say hikes are now inevitable

When U.K. Chancellor Rachel Reeves announced her government budget last fall, unveiling a £70 billion ($95 billion) boost to public spending to be funded by higher borrowing and £40 billion in tax rises, which mostly hit British businesses, she insisted it was a one-off move, telling lawmakers that “we’re not going to be coming back with more tax increases, or indeed more borrowing.”

Times have changed, however, and as Reeves tries to balance the books and stick to her stated non-negotiable “fiscal rules” — while pursuing a spending splurge on public services amid an uncertain economic outlook — she may not have any choice but to enact more, unpopular tax rises.

In spring, the Treasury had around £9.9 billion of limited fiscal “headroom” to meet its main fiscal target of having day-to-day spending funded by tax receipts rather than by borrowing.

The economic and fiscal outlook has since become more challenging, however, with higher debt interest payments and weaker-than-expected tax receipts converging with lower economic growth forecasts.

The Office for Budget Responsibility (OBR) said in March that it expects the U.K. to record 1% growth in 2025 and 1.9% in 2026. The OBR is the U.K.’s independent economic and fiscal forecaster which assesses government budgets to see if they’re likely to meet or miss its fiscal targets.

That latter growth forecast now looks optimistic, economists say, and if the OBR revises its 2026 forecasts lower, it would leave a big dent — if not entirely wipe out — the government’s fiscal headroom.

That means the government with three options: cut spending, increase borrowing or raise taxes further.

Tax increases later this year are increasingly inevitable, economists say, with Reeves already committing to boosting public services and key departmental budgets in her Spending Review on Wednesday, and sticking to her mantra that day-to-day government spending won’t be funded by borrowing.

“We think the government’s ‘headroom’ will fully evaporate and that tax rises look increasingly inevitable later this year,” James Smith, ING’s developed markets economist, said in emailed comments.

ING forecast that if the OBR revised its 2026 growth forecast down to 1.5% for 2026, that would already halve the government’s fiscal headroom.

“Our scenario analysis shows that she could face a shortfall of £4 billion simply as a result of economic headwinds, and perhaps much more than that if the OBR’s forecast shifts are more substantial. That is before you consider the wider tax and spending pressures the Chancellor is facing,” he added.

When asked by Sky News about whether she may have to raise taxes further this year, Reeves appeared reluctant to answer the question, saying that “she was not going to write budgets for the future.”

“I’m not going to write another four years worth of budgets before we’ve even got through the first year of this government,” she told the broadcaster, although she conceded that “the world is very uncertain at the moment.”

Those comments came after a rude awakening for the chancellor a day after her spending review — preliminary monthly gross domestic product data out Thursday suggested the U.K. economy shrank 0.3% in April on a monthly basis, with output hit by trade tariffs and tax rises introduced by Reeves last fall.

Neither the economic forecasts nor the public finances have improved from last year, according to Paul Johnson, the director of Institute for Fiscal Studies, but “rather the reverse.”

“Reeves is now going to have all her fingers and all her toes crossed, hoping that the OBR will not be downgrading their forecasts in the Autumn. With spending plans set, and “ironclad” fiscal rules being met by a gnat’s whisker, any move in the wrong direction will almost certainly spark more tax rises,” he warned on Thursday. 

“Nobody should be in any doubt that the chancellor has had some incredibly tough decisions to take and balancing acts to perform,” he added in post-Spending Review analysis, noting that “the fiscal constraints are all too real and we can’t have everything we might want.”

Life is only going to get harder for the Treasury as it looks to maintain that balancing act throughout the summer, with clouds already forming over the country’s growth.

The government has already backtracked on some unpopular spending cuts — such as the scrapping of pensioners’ winter fuel payments — and this week announced big boosts to public services and departmental spending, with health and defense getting billion-pound boosts.

With spending cuts unlikely and Reeves’ mantra on not resorting to borrowing to fund day-to-day spending, tax rises are her only real option.

That would break Reeves’ pledge to avoid a further tax grab, and would break a Labour Party manifesto promise not to raise income tax, national insurance (social security) contributions or to raise VAT, a tax added to most products and services.

Labour Party insiders now fear months of speculation as to where tax hikes could land, Mujtaba Rahman, managing director of Europe at the Eurasia Group, noted Thursday.

“The easiest route fiscally would be to breach Labour’s manifesto pledges not to raise income tax, national insurance for employees or VA. But [Prime Minister Keir] Starmer does not want to do that, fearing a backlash over ‘broken promises’,” Rahman said in emailed comments.

Reeves will likely scrabble together several smaller-scale rises — for example, extending the current freeze on income tax allowances and thresholds for another two years to 2030, he said.

Other options include restricting tax relief on pensions for high earners, a £3 billion levy on the gambling industry and a shake-up of council tax, which is based on 1991 property values.

“For Reeves, there will be no easy answers to the question of how to make her sums add up,” Rahman said.