Rachel Reeves may need to raise taxes by more than £20bn in the autumn budget after figures showed the government’s spending deficit reached £17.7bn in May, the second highest on record for the month.
Analysts said a sharp increase in tax receipts had still fallen short of forecasts by the Office for Budget Responsibility (OBR) and given an indication of the weakness underpinning the public finances.
The chancellor’s plans are also likely to be upended in the autumn when the budget watchdog is expected to revise down economic growth, further limiting the rise in tax receipts, and include higher borrowing costs, which are already above £100bn a year.
The combined effect would be to wipe out Reeves’s £10bn “rainy day” buffer in the public finances and create another large financial hole, possibly as large as £10bn to £20bn.
Alex Kerr, a UK economist at Capital Economics, said the OBR downgrade could force the chancellor to implement either further spending cuts or tax rises.
He said a recent U-turn on cuts to the winter fuel allowance, downward revisions to the OBR’s growth forecasts and higher borrowing costs “may mean that to maintain her current £9.9bn buffer, Reeves has to raise £13bn-£23bn later this year”.
The OBR said income tax and national insurance contributions reached £37.2bn in May, up 9.5% on a year earlier.
It said it had expected the current budget deficit – the measure of the monthly shortfall in day-to-day spending – to be £13bn in May but it was £12.8bn, the second consecutive month when the deficit fell below its forecasts.
Rob Doody, the deputy director for public sector finances at the Office for National Statistics, said the deficit widened after a rise in inflation that pushed welfare payments higher.
“While receipts were up, thanks partly to higher income tax revenue and national insurance contributions, spending was up more, affected by increased running costs and inflation-linked uplifts to many benefits,” he said.
Thomas Pugh, an economist at the accountancy company RSM UK, said figures for April and May were better than many expected but the longer-term outlook was likely to be more difficult.
“Looking ahead to the budget in the autumn, the underperformance of the economy and higher borrowing costs mean the chancellor may already have lost the £9.9bn of fiscal headroom that she clawed back in March,” he said.
“Throw in the tough outlook for many government departments announced in the spending review and U-turns on welfare spending, and the chancellor will probably have to announce some top-up tax increases after the summer.”
Reeves has introduced extra taxes on businesses – including a rise in national insurance contributions – which were implemented in April. At the budget statement in March, the chancellor said she needed to cut the welfare bill to maintain a near-£10bn buffer in the current budget.
Backbench Labour MPs are expected to rebel against cuts to benefits worth more than £5bn in the welfare bill introduced to parliament on Wednesday.
Most economic forecasters, including the International Monetary Fund and the Bank of England, have downgraded the UK’s growth prospects this year, potentially reducing tax receipts over the longer term and forcing the chancellor to make further spending cuts or raise taxes to bridge the gap.
Pugh said tax increases would probably need to fill a deficit of up to £20bn based on lower OBR forecasts for growth.
“We are pencilling in tax increases of £10bn-£20bn. The good news is that with interest rates likely to be about 4% at the time of the budget, there is plenty of scope for the Bank of England to cut rates to offset the impact of any fiscal consolidation on the economy.”
Darren Jones, the chief secretary to the Treasury, said: “Last week’s spending review showed how we are investing in the UK’s security, health and the economy through our plan for change, so that people are better off.”
