Tax rises will follow UK election unless fiscal rules are ripped up, says thinktank

Niesr’s quarterly economic health check finds that fiscal rules limiting state borrowing restrict the medium- to long-term investment needed to lift UK GDP. Photograph: Andy Rain/EPA

The next government will be forced to hit voters with post-election tax rises and delay net zero investment unless it is prepared to rip up Treasury rules for managing the state finances, a leading thinktank has said.

The National Institute for Economic and Social Research (Niesr) called for a radical overhaul of the self-imposed constraints imposed on government borrowing and debt as it warned that persistently weak growth and lower inflation would make hitting the rules more difficult.

In its quarterly health check, the thinktank said the economy had emerged from recession but the “not-fit-for-purpose” fiscal rules meant there was no scope for Jeremy Hunt to offer fresh tax cuts before polling day.

After the general election, Niesr said a future chancellor would be faced with a choice: raise taxes to maintain the existing provision of public services or rewrite the rules so that they served the UK’s medium- and long-term needs and objectives – including raising the growth rate, levelling up the regions and greening the economy.

Official growth figures are due out on Friday and Niesr said it expected output to have risen by 0.4% in the first three months of 2024. For 2024 as a whole, it is pencilling in growth of 0.8%, down slightly on the 0.9% it predicted three months ago.

Although it believes the annual inflation rate will fall below the government’s 2% target over the next few months, the thinktank said the Bank of England would delay cutting interest rates until August this year, and would only reduce borrowing costs once more in 2024. The Bank is widely expected to hold rates at 5.25% when it meets on Thursday.

Prof Stephen Millard, Niesr’s deputy director for macroeconomics, modelling and forecasting, said: “Despite the welcome fall in inflation, UK growth remains anaemic. This will make it difficult for any incoming government to carry out the much-needed investment in infrastructure and the green transition, as well as increase spending on public services and defence, without either raising taxes or rewriting the fiscal rules.

“This makes clear the need to reform the fiscal framework to enable the government to do what is needed for the economy in a fiscally sustainable way.”

The current fiscal rules state that the debt-to-GDP ratio – which is now just below 100% – should be falling within a five-year horizon and the annual deficit-to-GDP ratio should be below 3% by the end of the same period.

Niesr said debt would still be rising as a percentage of national income in five years’ time, and the government would still be borrowing more than 5% of GDP to balance its books. Its forecasts do not include the additional £75bn over the next six years needed to increase the defence budget to 2.5% of GDP by 2030.

The thinktank said there was essentially no scope for pre-election tax giveaways, as the government’s spending plans did not meet the fiscal rules. Any future tax cuts or increases in public investment would require a revision to the current fiscal rules.

Niesr said: “The existing framework is not fit for purpose and inadvertently creates an incentive structure which arbitrarily constrains sound government borrowing plans. Instead, a revised set of fiscal rules would better serve the United Kingdom by incorporating medium- to long-term economic objectives. For example, the United Kingdom is legally obligated to reach net zero by 2050. This target will only be met if supported through well-judged public investment in green infrastructure.”

The thinktank’s quarterly outlook said there were few signs of levelling up and that there was some evidence of widening regional disparities.

After the squeeze caused by the cost of living crisis, living standards are expected to rise by 6% on average in 2024-2025 relative to 2023-4 but with differences between poor and well-off households.

Above-inflation rent increases would mean those in the bottom income decile would see a 2% drop in their living standards, while those on middle and higher incomes would enjoy a 7-8% rise.