Prime Minister Andy Burnham will have to raise taxes or cut spending to deliver on his key pledges on defence and the cost of living, a leading think tank has warned, as it forecast persistently higher inflation and no interest rate cuts until 2028.
The National Institute of Economic and Social Research (NIESR) said in its latest economic outlook that the public finances will remain under severe strain because of more stubborn inflation driven in part by the ongoing Iran war. It said the prime minister had not "fully thought through" how his promised cost-of-living measures would be funded.
"There is clearly no scope for increasing borrowing, so it is about choices," said Stephen Millard, NIESR deputy director for macroeconomics, in a direct challenge to the new Labour government fiscal strategy.
Burnham has announced a series of new measures since taking office last week, including cuts to electricity bills and restoring the bus fare cap in most parts of England to 2 pounds. But the think tank analysis suggests these commitments will collide with the reality of stretched public finances.
Labour manifesto pledge was not to increase taxes for working people, covering income tax, VAT and national insurance contributions. Burnham has said he will uphold that commitment. Millard said NIESR was advocating for cost-of-living measures to be funded through higher taxes "which could involve tax reform rather than higher marginal rates" or through spending cuts elsewhere.
"People have talked a lot about the welfare bill – that is an obvious place to look," Millard said. "The triple lock on pensions, that is very, very expensive, and will get more expensive as we age."
He also pointed to potentially reforming council tax to move towards a land value tax system, or scrapping some VAT exemptions. "Once you have done all of that, then I am afraid I would break the manifesto promise and would be looking at the income tax rate."
The think tank economic outlook painted a challenging picture for the new administration. NIESR said it expects inflation to keep rising until February 2027, peaking at 3.8% before falling back to the Bank of England 2% target. That is significantly above the central bank goal and suggests the cost-of-living crisis is far from over.
NIESR said it does not believe the Bank of England will cut interest rates until 2028, a much later timeline than financial markets have been pricing in. Higher-for-longer rates would heap additional pressure on households with mortgages and on businesses carrying debt.
The think tank director, David Aikman, said that "treading water is not enough" to prevent the national debt from rising. "Every major shock this century has ratcheted the debt ratio higher, and none of that increase has been reversed."
That warning echoes concerns across fiscal watchdog bodies that Britain debt trajectory is unsustainable without corrective action. The war in Iran has added to inflationary pressures globally, pushing up energy costs and disrupting supply chains, which has complicated central banks efforts to bring inflation under control.
The new prime minister came to power on a platform of change and economic competence, but the NIESR report underscores the narrow room for manoeuvre he faces. Borrowing costs remain elevated, tax revenues are under pressure from a slowing economy, and spending demands are rising across defence, healthcare and social services.
Business groups reacted cautiously to the think tank findings. The Confederation of British Industry said the report reinforced the need for a clear fiscal plan that supports growth while maintaining credibility with financial markets. The Institute of Directors said firms needed clarity on tax policy to plan investments.
The report also highlighted the tension between the government defence spending ambitions and its domestic cost-of-living pledges. Burnham has committed to increasing defence spending in response to global instability, but NIESR analysis suggests meeting both goals simultaneously would require either higher taxes, deeper cuts elsewhere, or a combination of both.
The inflation forecast of 3.8% would represent a significant deterioration from current levels and would keep real wages under pressure. It would also complicate the Bank of England task, potentially trapping the economy in a cycle of stagnant growth and above-target inflation.
Treasury officials declined to comment directly on the NIESR report but pointed to the government stated commitment to fiscal responsibility. A spokesperson said the government would set out its full fiscal plans in the upcoming budget, which will be accompanied by a new forecast from the Office for Budget Responsibility.
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