Prime Minister Andy Burnham is facing mounting pressure to raise taxes or cut public spending to pay for his Government’s growing list of commitments, after a leading economic think tank warned Britain has no room for more borrowing.
The National Institute of Economic and Social Research (NIESR) said higher and more persistent inflation following the Iran conflict has dramatically tightened the Government’s fiscal position ahead of October’s Budget.
The think tank warned ministers would have to make “difficult choices” to fund new spending promises, including cost-of-living support and higher defence spending.
Mr Burnham, who entered Downing Street last week pledging to lead a “cost-of-living Government”, has already announced plans to cut VAT on electricity bills from October and maintain the £2 bus fare cap throughout 2027.
However, NIESR deputy director for macroeconomics Stephen Millard said there was no capacity to finance such measures through additional borrowing.
“There’s clearly no scope for increasing borrowing, so it is about choices,” he said.
“I’m yet to be convinced that how these things will be funded has been fully thought through, but there is going to be a Budget in October.
Our advice would very much be to fund these through higher taxes – which could involve tax reform rather than higher marginal rates – or cuts in spending elsewhere.
The warning comes as Mr Burnham and Chancellor John Healey also seek to honour Labour’s commitment to increase defence spending to 3.5% of GDP by 2035.
Mr Burnham has said the Government is working to ensure its defence investment plans are fully funded before the Autumn Budget.
NIESR suggested ministers could look at reducing welfare spending, reforming the state pension triple lock, overhauling council tax towards a land-value system or removing some VAT exemptions.
Mr Millard also argued that if those options proved insufficient, ministers should consider breaking Labour’s manifesto pledge not to raise income tax for working people.
Despite the fiscal pressures, the think tank slightly upgraded its economic growth forecast, predicting GDP will expand by 1.1% in 2026, up from its previous estimate of 0.9%.
But it warned the recovery remains fragile, estimating the Middle East energy shock has already cost the UK economy around £15 billion in lost output.
NIESR expects inflation to peak at 3.8% in February 2027 before gradually returning to the Bank of England’s 2% target in early 2029. It forecasts interest rates will remain at 3.75% throughout 2026 and 2027.
The report leaves Mr Burnham facing an uncomfortable political reality: delivering on promises to ease the cost of living and strengthen national defence may require either unpopular tax rises or politically painful spending cuts.
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