Unexpected growth in the UK economy isn’t enough to detract from the gaping hole in the country’s public finances. Speculation is ramping up about what steps the chancellor of the exchequer, Rachel Reeves, might take to plug the gap come the budget in autumn – and there are no shortage of ideas. The trouble is, each comes with risks and unknowns. Our experts have weighed up the evidence to offer their suggestions.

Bite the bullet – raise income tax

Maha Rafi Atal, Adam Smith Senior Lecturer in Political Economy, University of Glasgow

Rachel Reeves and the Labour party made three promises to the electorate last summer: to repair broken public services, to reduce immigration and to avoid an income tax hike. Unfortunately for Reeves, the three promises are at odds with one another.

To raise the revenue needed to invest in public services without a tax rise, the government needs economic growth. This is so it can raise the funds by taxing the same share of a larger pie. Restrictions on migration, however, are a drag on the growth of key sectors of the economy. This includes areas such as finance, the creative industries and higher education.

The chancellor has instead tried to raise other taxes, including employer national insurance contribution rates. But because these taxes hit businesses (which may pay for them by cutting back elsewhere) they can be a drag on growth too. In more prosperous global times, Reeves might have got around this by borrowing, but the UK’s borrowing costs are much higher than those faced by the last Labour government.

At some point, then, Reeves will have to choose between raising income tax and allowing cuts to public services. Voters tell pollsters they would much rather face the tax rise. This might take the form of a raise in the basic rate (a change of just 1% could raise as much as £8 billion), or it might take less direct forms like an extended freeze on the tax thresholds.

If the money is used to rebuild services, there’s time for that to bear political fruit before the next election. Holding off on income tax to avoid political blowback in the short term is penny-wise, pound-foolish in the long run.

Inheritance tax – progressive vote-winner or punishing aspiration?

Conor O’Kane, Senior Lecturer in Economics, University of Bournemouth

One of the things Labour is thought to be considering is changes to inheritance tax (IHT). The view is that, given property has appreciated so much in recent years, changes to the thresholds and rules around gifting could raise the revenues required to eliminate the shortfall. As an example, gifts given seven years or more before someone dies are not currently liable for IHT. This approach may appease those Labour backbenchers who have been calling for a wealth tax to finance public spending.

However, IHT brings political as well as economic risks. In the 2024 autumn budget, cuts to tax breaks for farmers passing on their businesses drew fierce criticism and angry protests. Opposition parties are likely to label any change to IHT as a “death tax”.

Economically, it will be difficult to predict how much revenue IHT changes would raise, as there may well be loopholes that can be exploited to avoid the new charges. But Labour could sell changes to IHT as progressive – put simply, those who benefited more from increases in property values pay a little more. Opposition parties, however, could frame it as a tax on aspiration.

There are no easy solutions here. Labour will need to tread carefully and will be keen to avoid policy rollbacks like those they recently experienced with winter fuel allowance and disability benefits.

---

Read more:
Wealth taxes don’t always work the way governments hope they will. Here are some alternatives

---

Keep freezing income tax bands – and hope voters don’t notice

Steve Schifferes, Honorary Research Fellow, City St George’s University

Rachel Reeves faces a challenging task in the budget this autumn. Based on her own fiscal rules, there is a large hole in the public finances that will need to be filled. And as she has ruled out major changes to these fiscal rules, while also facing pressure to increase spending from within the Labour party, it is clear that she will have to raise taxes.

So it is likely that, whatever else she does, continuing the freeze (which is due to expire in 2028) on the basic and higher rate of income tax for another two years is likely to top her agenda. The freeze on thresholds is already projected to have increased income tax receipts by £40 billion per year by 2028, and extending it to 2029-30 could increase government tax receipts by an additional £7-£8 billion a year. This would make a substantial contribution to bridging the fiscal shortfall.

For one thing, it is the continuation of an existing policy and will not take effect until the 2028/29 fiscal year, when the current freeze ends. This makes it harder for people to gauge its real effects on their income. Although it will attract criticism for breaking her income tax pledge, it would be politically easier to justify than direct changes in tax rates. And unlike wealth taxes, it is difficult to avoid.

Cutting tax relief for pensions could be a hidden pot of cash

Jonquil Lowe, Senior Lecturer in Economics and Personal Finance, Open University

Debates about tackling government debt typically centre on cutting spending or raising taxes. But a third option, often overlooked, is restricting tax reliefs. An obvious candidate is pension tax reliefs over and above the basic rate, which benefit the better-off and are skewed towards men (since women’s ability to save is often suppressed due to unpaid care work).

The various income tax and national insurance reliefs for pension schemes (tax relief on contributions, tax-free income and gains for pension funds and tax-free lump sum at retirement) cost the government £52 billion in 2023-4.

By design, any system that gives people tax relief up to their highest marginal rate is regressive (it benefits the better-off more than those who are less well off), and around two-thirds of pension tax reliefs go to higher-rate and additional-rate taxpayers.

Advocates may argue that tax reliefs are necessary to encourage people to save for retirement. But the evidence does not support this. First, the only step up in UK pension saving in modern times has been due to the introduction of auto-enrolment in 2012 – not tax reliefs.

Second, research suggests that when tax-relieved savings schemes are introduced, they prompt a shift of existing savings. That is to say, people tend to move other savings into their pensions for the tax benefits rather than actually putting more money away overall for the future. But clearly, tax relief does not help people to save more if they don’t have the extra funds in the first place. And on social justice grounds, does it make sense for the mass of taxpayers to subsidise the relatively well-off who can readily save anyway?

Invest – and outgrow the fiscal black hole

Guilherme Klein Martins, Lecturer in Economics, University of Leeds, and Research Associate at the Research Center on Macroeconomics of Inequalities (Made/USP)

The UK should pass a modern golden rule focused on investment. The government should write into law a multi-year minimum for net public investment – at least 3% of GDP – so that capital spending can’t be raided when money for everyday spending is tight. Britain’s main constraint to economic growth is weak supply – service backlogs, infrastructure bottlenecks and lasting scars from under-investment that hold down productivity and labour supply. This will not recover by itself.

International evidence shows that each 1% of GDP in public investment raises output by roughly 1.5% over a few years. The combination of a higher GDP and increased tax receipts should make this policy at least neutral in terms of the debt-GDP ratio.

And Reeves must think strategically. Alongside sectors where the UK aims to build a comparative advantage – areas such as clean energy, life sciences, advanced manufacturing and digital/AI – it must also cover social and general infrastructure. This means the NHS, schools and skills, care and local transport.

To keep choices disciplined and transparent, the government could publish a list of projects, ranked and updated regularly. Spending watchdog the Office for Budget Responsibility could then scrutinise the assumptions behind the growth and revenue payoffs. The message is simple: protect and stabilise investment to raise growth and help Britain outgrow the fiscal hole.