Rachel Reeves: Why she may have to raise UK taxes in October

UK Shadow Chancellor Rachel Reeves unveiled her UK economic plans in her spring fiscal statement and is on track to meet her self-imposed public finance rules, which she calls "non-negotiable." On the surface, this seems like a good thing. So why are people saying she may struggle to meet these targets, and the only way to do so may be to raise taxes?

The situation is complex, but there are basically five steps from where we are now to raising taxes. Before the spring fiscal statement was released, the Shadow Chancellor was under pressure as people speculated about how she would meet her self-imposed fiscal rules, one of which is not to borrow to fund day-to-day spending.

Last October, the government's official economic forecasting body, the Office for Budget Responsibility (OBR), said Reeves would be able to meet the rule with a surplus of £9.9 billion. The subsequent increase in government borrowing costs has meant that this surplus has disappeared. Now, significant welfare cuts and spending reductions in the spring fiscal statement have restored this surplus.

Nearly £10 billion may sound like a lot, but in an economy that spends £1 trillion a year and has roughly the same tax revenue, it's a relatively small amount. In fact, it is the third lowest safety margin a Chancellor has given themselves since 2010. During this period, the average surplus was three times that, at £30 billion.

Richard Hughes of the OBR told the BBC: "It's only a small part of the risks to the outlook." He said many factors could "wipe out" the Shadow Chancellor's surplus, including an escalation of trade wars, a slight downward revision of growth forecasts, or rising interest rates. "All forecasts are ultimately wrong. Weather forecasts are ultimately wrong," Mr. Hughes said. Predicting what will happen in the future, especially in five years, is difficult and subject to revision. For example, it is forgivable not to predict wars or pandemics.

The highly respected think tank, the Institute for Fiscal Studies (IFS), has stated that "economic and fiscal forecasts are very likely to deteriorate significantly between now and the autumn budget." A prime example is that just hours after Reeves made her statement in Parliament, US President Donald Trump announced new 25% tariffs on cars and car parts entering the US. Reeves acknowledged that the car tariffs would be "bad for Britain" but insisted the government was engaged in "extensive" negotiations to avoid the tariffs being imposed in the UK.

According to the OBR, these import taxes would directly affect goods accounting for about 0.2% of GDP. Before Trump's announcement, the OBR had warned of the risk of escalating trade wars, and while these proposals do not fully meet the agency's worst-case scenario, in which the UK would take retaliatory action, Hughes said they contained some of the factors. While 0.2% is a small number, it will still affect the economy. In the OBR's worst-case scenario, economic growth would be reduced by 1%.

Trump's trade policies, and the fact that no one knows if he will follow through on his threats, change his mind, or how he will react to others, are just one reason why his presidency makes the world so uncertain. Despite Trump's promises to end the war in Ukraine, the war continues. Britain and Germany have both said they will increase defense spending. Trump has long called on European NATO members to increase defense spending, and there are also concerns that if the US reaches a deal with Russia to end the war, it could leave Europe vulnerable.

Domestically, businesses are also facing worrying times as they prepare for rising costs in April, when employers' National Insurance contributions, the National Minimum Wage, and business rates will all rise. Some companies have said they have postponed investment decisions, and many have warned of price increases or layoffs. If these things happen, then it will hit economic growth.

Given all of the above, why does it matter if the Shadow Chancellor's surplus disappears? Reeves has staked her reputation on adhering to her fiscal rules, promising to bring "iron discipline" and provide stability and reassurance to financial markets, in contrast to former Prime Minister Liz Truss, whose unfunded tax cuts spooked markets and raised interest rates. Therefore, if she is still to abide by her rules and not borrow to fund day-to-day spending, that will mean more spending cuts or tax increases.

The government has already announced significant cuts to welfare spending, as well as plans to cut civil servants and abolish several quasi-official bodies, including NHS England. But as Paul Dales, chief UK economist at Capital Economics, said: "There's only so much non-defense spending can be cut."

Paul Johnson of the IFS said that because she has left herself so little room for maneuver and the economic outlook is so uncertain, "we can certainly expect that in the autumn there will be six or seven months of speculation about which taxes might or might not rise." He said that speculation itself could cause economic damage. Reeves has not ruled out tax increases, but told the BBC that the UK economy has both "opportunities" and "risks."