Worries about the UK economy are justified, but can the government afford to gamble on raising taxes?

Gloomy economic figures^[1] have heaped more pressure on the British government and its promise to improve growth. And if that wasn’t enough, there have also been some stark warnings^[2] about public finances and the country’s ability to service its debts.

All of this has led to a growing expectation that the UK chancellor Rachel Reeves will have to bring in some significant tax hikes later this year, or reduce government spending.

But both of these options could worsen the long-term economic outlook, by further constraining GDP growth. That was precisely the fate of governments that pursued an agenda of “austerity”^[3] – cuts in spending and higher taxes – to tackle the expanded public debt after the financial crisis of 2008.

It was a strategy that ultimately led to higher public debt^[4]. Put simply, when governments spend less, GDP tends to fall^[5]. And when GDP falls and a country is less productive, tax revenues^[6] go down too.

Get your news from actual experts, straight to your inbox. Sign up to our daily newsletter^[7] to receive all The Conversation UK’s latest coverage of news and research, from politics and business to the arts and sciences. To make things even more complicated for the chancellor, the UK government has also widened its debt risk by changing its fiscal rules^[8] to acknowledge extra financial responsibilities. This adjustment gave the government more financial assets, including student loans and public pension holdings. But it also meant taking on more liabilities, including the pension schemes it would have to bail out if necessary. In July 2025, the Office for Budget Responsibility (OBR) identified several other sectors^[9] – including universities, housing associations^[10] and water companies^[11] – whose large debts could become government liabilities in the future. A bigger balance sheet automatically means more public financial risk. And climate change further raises these risks, the OBR says, by forcing the government to spend more^[12] on dealing with environmental damage and eroding fossil-fuel taxes, which still raise around £24 billion^[13] for the Treasury. The OBR is also concerned^[14] about the rising cost of pensions for an ageing population. In fact, the UK’s system is not particularly expensive, partly due to its reliance on private pensions (funded by employers and employees). Yet this reliance brings a different kind of government cost. For these private sector schemes have attempted to insulate themselves against the strains of an ageing population, as more employees retire than join the workforce (and as retirees live longer). Often this has involved shifting from “defined benefit” plans, which guarantee retirement income, to “defined contribution” plans, where payouts depend on how much members pay in and how well funds are invested. But that shift has also made it harder for the government to borrow the money it needs for public spending. Defined benefit funds, seeking a steady long-term return, used to be big buyers of UK government bonds (gilts) – the financial assets that the government sells to raise money. In contrast, defined contribution funds invest mainly in equities (company shares), which promise a higher return on investment that can grow pension pots faster. UK industrial policy supports this shift from gilts to other assets. It wants pension funds to invest in innovation and infrastructure^[15] as a way of stimulating its often mentioned mission of economic growth. Yet the move by pensions towards equities is steadily deflating demand^[16] for new government bonds. This then forces the government to pay higher interest rates to attract enough buyers, often from overseas. There is also pressure on the government to relax the “triple lock” on state pensions. This pledge – to raise the basic state pension by at least 2.5% every year, and maintained by all parties since 2011 – is costing around three times as much as was projected at launch, despite fewer pensioners escaping poverty^[17] since it was introduced. Overall, inflation and an ageing population have lifted state spending on pensions to around 5% of GDP^[18].

These pressures all strengthen the view that the government will need another tax-raising budget this year. How else will it pay for its plans for spending on healthcare, housing, infrastructure and defence?

Reeves sought to assure voters^[20] that £40 billion in tax hikes^[21] in October 2024 rises were enough to plug an inherited “black hole”. But she is already struggling to preserve those projections, after a politically painful retreat^[22] from welfare changes designed to save £5 billion.

Hopes that a faster-growing economy would narrow the deficit, by boosting tax receipts and reducing spending requirements, have not been fulfilled^[23].

Yet calls for significant tax increases – which could dampen growth – may still be be resisted.

Under pressure, she may well consider a compromise like a “wealth tax” targeting the richest, that would also satisfy the Labour left. Yet the only way to really raise significant extra funds is to increase income tax, VAT or national insurance, which would be extremely risky politically.

But all economic policy comes with risk. And she may end up sticking with her position and putting her (taxpayers’) money on the hope that today’s deficit will eventually be narrowed by faster growth. Relying on more investment to solve economic problems depends on investors trusting the economic stability of the UK, which is a gamble. But it is a gamble the government may still be willing to take.

References

1. ^{^} economic figures (www.bbc.co.uk)
2. ^{^} stark warnings (obr.uk)
3. ^{^} agenda of “austerity” (theconversation.com)
4. ^{^} higher public debt (cepr.org)
5. ^{^} GDP tends to fall (www.forbes.com)
6. ^{^} tax revenues (oecdstatistics.blog)
7. ^{^} Sign up to our daily newsletter (theconversation.com)
8. ^{^} changing its fiscal rules (www.instituteforgovernment.org.uk)
9. ^{^} several other sectors (obr.uk)
10. ^{^} housing associations (www.spglobal.com)
11. ^{^} water companies (committees.parliament.uk)
12. ^{^} spend more (obr.uk)
13. ^{^} raise around £24 billion (obr.uk)
14. ^{^} also concerned (obr.uk)
15. ^{^} innovation and infrastructure (www.pensionspolicyinstitute.org.uk)
16. ^{^} deflating demand (www.pensionsage.com)
17. ^{^} fewer pensioners escaping poverty (ifs.org.uk)
18. ^{^} around 5% of GDP (inews.co.uk)
19. ^{^} AmbrosiniV/Shutterstock (www.shutterstock.com)
20. ^{^} sought to assure voters (www.bbc.co.uk)
21. ^{^} £40 billion in tax hikes (theconversation.com)
22. ^{^} politically painful retreat (theconversation.com)
23. ^{^} not been fulfilled (www.ons.gov.uk)