Tax rises are the sensible solution to the Chancellor's trilemma
The UK economy is limping into the second half of 2025. Growth is anaemic, inflation stubbornly high, and households are still feeling the strain. Some of this reflects global forces - volatile energy markets, President Trump’s tariffs, geopolitical tensions - but the biggest headaches for the Treasury are home-grown.
At the heart of the problem is a fiscal bind: the Chancellor can’t meet all three of her main promises at once - obey the fiscal rules, honour existing spending commitments, and keep the manifesto promise of no tax rises for working people. One will have to give.
Our latest NIESR UK Economic Outlook puts GDP growth at just 1.3 per cent this year, slipping to 1.2 per cent in 2026. Inflation is set to remain well above the Bank of England’s target, at 3.3 per cent in 2025 and 2.8 per cent next year. While the Bank cut rates at its August meeting, further reductions now look less certain than previously expected.
On the fiscal side, the picture is even starker. By 2029–30, we forecast a current deficit of £41.2 billion. The Government is no longer on course to meet its “stability rule” - covering day-to-day spending from tax revenue and borrowing only to invest. That would be problematic in itself. But combine it with a tight Spending Review settlement that caps departmental budgets until 2029, and the Chancellor’s room for manoeuvre is vanishing.
She could cut spending further - but with justice, local government, and social care already under strain, this risks visible damage to public services.
She could loosen the fiscal rules - but that would risk spooking markets, triggering another Liz Truss moment, making government borrowing more expensive and tightening the bind further.
That leaves tax rises as the only realistic option. Given the size of the gap, it is hard to see how one of the “big three” - income tax, VAT, or national insurance - can be spared. Yes, that would break a manifesto pledge. But it would also be the responsible choice.
This is not a purely technical debate. Our research shows the poorest 10 per cent of households face another year of falling living standards. Inflation is still eating into pay packets, and rents and mortgage costs remain high. In this environment, squeezing social security or local services would be felt immediately and painfully.
What’s the way forward? The priority must be to rebuild fiscal resilience. That means creating a much wider buffer than the £10 billion headroom the Chancellor left herself in March. This is needed not just to deal with the next shock, but also to avoid the current pattern of “neurotically fine-tuning” tax and spending plans to meet short-term forecasts, as former Bank of England Deputy Governor Charlie Bean has warned.
Rebuilding that buffer will involve difficult choices. Gradual but sustained tax rises are unavoidable, and the Government will need to be upfront about that with voters. While there is scope for innovative measures like gambling levies, an increase in income tax should form part of the package.
Where spending cuts are unavoidable, they should fall where they do least harm to future growth and to the most vulnerable households. That means safeguarding public investment in infrastructure and skills, and protecting the basic services that underpin social cohesion.
The Autumn Budget will be the moment of truth. If the Chancellor continues to pretend that all three corners of the trilemma can be met, she risks being forced into a crisis-driven choice later - when the political and economic costs will be higher. In the long run, fiscal honesty is the surest way to restore confidence - in the markets, in the economy, and in politics itself.
Dr David Aikman is Director at the National Institute of Economic and Social Research (NIESR).
