Labour Chancellor Faces Tax Rise Pressure as Economic Headroom Disappears

Rachel Reeves’s £9.9bn fiscal buffer has been completely eroded due to sluggish economic growth and rising market interest rates, economists at the National Institute of Economic and Social Research (Niesr) have warned. The Labour Chancellor may be forced to consider income tax increases to manage future economic shocks.

The situation has become increasingly precarious, with the Office for Budget Responsibility downgrading its growth forecasts and confirming the disappearance of Ms Reeves’s fiscal headroom. This development places significant pressure on her pledges to borrow only for investment purposes and reduce debt as a proportion of GDP.

The economic outlook appears particularly challenging with the looming threat of Donald Trump’s trade war. Niesr estimates suggest US tariffs and subsequent global retaliation could reduce Britain’s GDP growth by 0.25 percentage points in both 2025 and 2026, resulting in growth of just 1.25% instead of the projected 1.5%.

Stephen Millard, Niesr’s interim director, emphasised the political complexity of the situation, stating: “The Chancellor needs to appreciate that there are circumstances in which taxes might have to go up.” This stance directly conflicts with Labour’s previous commitments against raising income tax, VAT, or National Insurance contributions.

The inflation outlook remains concerning, with economists estimating January’s rate at 3.2%. The potential implementation of tariffs could add an additional 0.4 percentage points to the headline rate, pushing price rises further from the Bank of England’s 2% target.

Capital Economics has adopted an even more pessimistic stance, dramatically reducing its growth forecast to just 0.5% for the year, less than half its previous projection of 1.3%. The consultancy attributes this reduction to increased business taxation, ongoing effects of previous interest rate increases, and diminished overseas demand.