Financial market turmoil and slower pay growth have blown a hole in George Osborne's plans to balance the books by 2020, according to the Institute for Fiscal Studies.
The IFS said the Chancellor was “boxed in” by a rule that requires the government to run a budget surplus every year from 2019-20 “in normal times” - or when annual growth is above 1pc.
This means Britain faces the prospect of “big tax rises or spending cuts with very little notice to ensure the rule is met”, the IFS said in its annual Green Budget.
The think-tank said the recent turbulence meant tax receipts could be much weaker than the Office for Budget Responsibility (OBR), the Government’s fiscal watchdog, forecast just three months ago.
The IFS calculated that if the UK economy was just 0.7pc smaller in 2020 than currently forecast by the OBR, this would erase the surplus of £10.1bn currently pencilled in by official forecasts.
Last week, the Bank of England downgraded its projections for growth, wages and inflation amid a gloomier global outlook.
The IFS said subdued pay growth was likely to reduce tax revenues by £5bn over the next four years compared with current forecasts.
The turbulence in global markets could lower capital tax receipts by a further £2bn unless share prices recovered, the think-tank said.
This, combined with £8bn worth of unfunded tax cuts to come this parliament meant Mr Osborne “could be forced into additional spending cuts or tax rises if economic and fiscal forecasts again turn out unfavourably”.
Gemma Tetlow, an economist at the IFS, said it was “risky” to commit to a budget surplus rule that could be hit by swings in UK borrowing costs or inflation that could fluctuate wildly in the coming years.
Even if the Chancellor’s plans remain on course in 2019, the IFS said past errors in official forecasts meant there was a one-in-four chance more belt tightening would be needed by the end of the decade.
“There may be more tough decisions to come,” said Paul Johnson, IFS director.
The uncertain fiscal outlook was presented against a backdrop of “sub-par” growth, with the UK economy expected to grow by 2.2pc this year, according to Oxford Economics.
Andrew Goodwin, lead economist at Oxford Economics, said UK growth would be “at best solid and certainly not spectacular” over the next four years.
While falling oil prices are expected to boost real incomes, helping to “prolong the 'sugar rush’ enjoyed by UK consumers over the past year”, Mr Goodwin said cuts to benefits were likely to result in a “sea change” for consumer spending growth, which is expected to slow from 3pc to 2pc over the next few years. “The risks are very much skewed to the downside,” said Mr Goodwin.
He also said the government could afford to further the pace of austerity in order to foster “stronger economic growth”. This is because Oxford Economics believes Britain still has a “sizeable” output gap, meaning the economy has more space to grow before inflationary pressures emerge.
The IFS also warned that “radical reforms” to Britain’s pensions system could leave a black hole in the public finances in future years depending on the Chancellor’s policy choices.
The Government has consulted on how pensions should be taxed, and is due to present changes in the Budget next month.
The IFS said changes were likely to be “substantial”, and could prompt big behavioural responses. Changing the system so contributions to private pensions would be taxed on the way in but received tax-free on retirement could impact revenues in future years significantly, it said.
“The government will need to be careful to distinguish between what is genuinely a permanent increase in revenues and what is only a temporary windfall,” the IFS said. “Relying on temporary revenues to achieve a budget surplus in 2019–20 would not be in keeping with the rationale underpinning the Chancellor’s stated fiscal objectives.
It urged the OBR to publish the impact of pension changes beyond its usual five year forecasts.
The Chancellor used a £27bn windfall in the Autumn Statement, gained from lower debt interest payments and changes to the way it measures VAT and national insurance receipts, to relax Britain's austerity drive.
Despite reducing the spending squeeze, the Government is still expected to post a £10.1bn surplus by the end of the decade.
However, Mr Osborne has expressed concerns about the Government's ability to meet its budget surplus targets.
In a letter to Mark Carney, the Governor of the Bank of England last week, Mr Osborne said the prospect of weaker nominal growth meant tax receipts may not grow as quickly.
The OBR believes the government has a 55pc chance of balancing the books by the end of the decade.
