Taxes must rise in the autumn if Chancellor Rachel Reeves is to meet her self-imposed borrowing rules, according to an economic think tank.
The government was on track to miss the target it has set itself by £41.2bn, according to the National Institute of Economic and Social Research (Niesr).
It recommended “a moderate but sustained increase in taxes” including reform of the council tax system to make up the shortfall.
The government said “the best way to strengthen public finances is by growing the economy”, but the Conservatives said Labour “always reaches for the tax rise lever”.
The think tank, which is not affiliated to any political party or movement, suggests the government could raise revenue through changes to the scope of VAT, pensions allowances and prolonging the freeze in income tax thresholds, which is set to end in 2028.
When she became chancellor, Reeves set out two rules for government borrowing, which is the difference between public spending and tax income.
The first rule was that day-to-day spending would be paid for with government revenue, which is mainly taxes. Borrowing can only be for investment.
The second rule was that debt must be falling as a share of national income by the end of a five-year period.
Reeves has repeatedly said these rules are “non-negotiable”.
The chancellor originally promised not to raise taxes further, but recently refused to rule it out after disappointing data on economic growth.
In its manifesto, Labour promised not to raise taxes such as income tax, VAT or national insurance on “working people”.
The chancellor now faced a “trilemma”, the think tank said, over which of her pledges to fulfil: meeting her spending commitments, her manifesto promises to avoid tax rises on working people or meeting the limits she has set on borrowing.
Stephen Millard, deputy director for macroeconomics at Niesr, told the BBC’s Today programme: “If she wants to raise £40bn then I think one of the big taxes is going to have to be raised.
“If she does that then it will break the labour promise about raising taxes on working people.”
Niesr argues that raising taxes would help build a “buffer” that would reassure investors about the stability of the UK’s public finances.
That in turn “may reduce borrowing costs” for the government, it said.
Niesr said the shortfall in the government’s budget was in part due to weakening growth over the past few months, resulting in a lower tax take and higher government borrowing.
But the reversal of welfare cuts, which were originally designed to save £5.5bn a year by 2030, had also had an impact, it said.
The welfare cuts were watered down, following opposition from within the Labour Party, and are now expected to save less than half the original amount.
It added that the government should also consider reducing welfare spending by speeding up plans to help people relying on benefits get into work.
Another challenge for Reeves is what US President Donald Trump is going to do next “in terms of trade and tariffs and what that could do to global trade flows”, according to Russ Mould, investment director at AJ Bell.
He also told the BBC’s Today programme that the rise in National Insurance Contributions for employers – which came into force in April – was putting firms off from investing.
Mr Mould pointed to Domino’s Pizza which, when it reported its results for the first half of its financial year on Tuesday, said that the rising labour cost of employment had impacted profits.
He added that its rate of Domino’s Pizza new store openings had slowed as potential franchisees were waiting for the Autumn Budget to “know what’s coming next”.
Niesr said the government’s other priority should be policies to promote growth and productivity, to boost living standards across the UK.
It said that the living standards of the poorest 10% of the population were now 10% lower than pre-Covid levels.
When Labour came to power a year ago, it said it wanted to make the UK the fastest growing country in the G7 group of nations.
However, the UK had faced trade policy uncertainty and geopolitical risk, as well as domestic challenges, the thinktank said.
Niesr said its analysis suggested the economy would grow “modestly” at 1.3% in 2025 and 1.2% in 2026, placing the UK in the middle of the G7 economies.
The IMF recently said it thought the UK was set to be the third fastest growing economy out the world’s so-called most advanced economies this year and the next, after US and Canada.
The chancellor should also consider reforming council tax or even replacing it altogether with a land value tax, Niesr suggested.
A Treasury spokesperson said: “As set out in the plan for change, the best way to strengthen public finances is by growing the economy – which is our focus.”
However, shadow chancellor Sir Mel Stride accused Labour of not understanding the economy.
“Experts are warning Labour’s economic mismanagement has blown a black hole in the nation’s finances which will have to be filled with more tax rises – despite Rachel Reeves saying she wouldn’t be back for more taxes,” he added.