We know tax rises are coming in the Autumn Budget next week. We also know it matters which taxes the Chancellor raises – not just for the businesses and individuals those taxes will fall on, but for the whole UK economy. We’ve modelled three scenarios to illustrate how different tax choices could lead to markedly different outcomes in the next few years. Ultimately, these scenarios show that a deflationary Autumn Budget would have a much smaller impact on the economy than an inflationary one that forces the Monetary Policy Committee (MPC) to keep interest rates unchanged throughout 2026.

Fiscal contraction imminent, how it’s done matters

The Chancellor looks set to raise taxes by around £30–40bn at the upcoming Autumn Budget. While that’s a similar figure to last year’s, the big difference is that the Chancellor doesn’t have the space to offset tax rises with increased spending. It means that this year’s Budget could have a significantly bigger impact on UK growth than last year’s. How much depends on three crucial factors.

First, is how much taxes dampen demand. Our current estimate is that the net fiscal contraction (how much taxes will go up more than spending) will be around £25bn by 2029–2030. This is smaller than the £30–40bn headline increase in taxes because we assume that around £10bn will be used to increase benefits and fund tax cuts elsewhere. However, this could easily be closer to £30bn if the Chancellor decides to leave more headroom than we’re currently expecting. A bigger fiscal contraction simply means a bigger hit to the economy in the coming years.

The second is the question of timing. When these tax rises come into effect matters. A backloaded Autumn Budget, which also relies heavily on fiscal drag, won’t have much impact over the next couple of years. However, it could have a bigger impact in the medium term.

Third, how that money is raised matters. Stagflationary tax hikes, such as VAT or duties, will hurt the economy more. That’s for two reasons. First, inflationary taxes increase input costs for firms, which makes the cost of doing business more expensive. Second, higher inflation means the MPC will probably need to keep interest rates on hold for longer if the economy faces another year of 3.5%+ inflation.

In theory, the Bank of England (BoE) should be able to ‘look-through’ a one-off, tax-related increase in prices because they’re not reflective of underlying inflationary pressures. Monetary policy also can’t do much to dampen current levels of inflation because rate cuts take time to feed through into the real economy. In practice, however, we think the MPC actually has limited scope to ignore tax-induced inflation. Five years of above-target inflation mean inflation expectations are looking too high to return inflation to target. What’s more, at some point a ‘one-off’ inflationary Budget stops being a ‘one-off’. If the MPC damages its credibility by not stepping in to weigh on inflation, then this could lead to inflation expectations de-anchoring further.

Estimating the hit to the UK economy from the 2025 Autumn Budget

For the Autumn Budget to be credible, the Chancellor will have to commit to significant tax rises next year. We’ve pencilled in £15bn as the net figure for belt-tightening (tax increases, less spending increases) in 2026 and looked at the potential impact on the economy of different ways of raising that.

In scenario one, the Chancellor focuses on deflationary income-tax hikes and uses some of the revenue to lower inflation by cutting VAT on energy bills, for example. In this scenario, we think the economy would be around 0.3% smaller, relative to the baseline, by the end of the year – all things being equal. That’s a relatively modest hit to the UK economy and would allow the BoE to step in with an additional rate cut next year, taking the base rate down to 3.25% rather than 3.5%. That might not soften the blow much next year, but it would allow for a quicker recovery in 2027.

What’s more, this scenario would also be better for the public finances. A Budget that lowers inflation will help to reduce debt interest costs, which could free up even more headroom for the Chancellor in future.

Scenario two is our upside scenario. Here, the Budget is the same as scenario one, but households reduce their saving levels to offset around half of the impact from tax hikes. The outcome is a much smaller impact on consumption. In this scenario, the economy is only 0.1% smaller.

Scenario three is a stagflationary Autumn Budget, similar to last year’s. This boosts inflation by 0.5ppts, prompting the MPC to keep rates on hold at 4%. The MPC’s inability to offset a Budget like this with rate cuts would leave the economy around 1% smaller at its peak, with the economy still 0.1% smaller relative to baseline in three years’ time.

Ultimately, these scenarios are illustrative and should be taken with a pinch of salt. However, the point stands that if we’re going to have a contractionary Autumn Budget on 26 November, then from an economic perspective it would be far better to have as much of the adjustment as possible come through deflationary taxes, such as income tax. That would allow the Bank of England to cut interest rates to offset much of the impact, which would limit the blow to the economy and provide a platform for growth in 2027.

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