Tax Rises and Tighter Spending to Hold Back UK Growth, OECD Warns

The UK’s economic recovery is set to face renewed pressure from rising taxes and tighter public spending, according to the latest global outlook from the Organisation for Economic Co-operation and Development (OECD). In a report published less than a week after the government unveiled its Budget, the influential policy body warned that fiscal consolidation and weak structural fundamentals will weigh on the country’s growth prospects through 2026 and beyond.

The OECD expects the UK economy to grow 1.4% in 2025, before slowing to 1.2% in 2026, as households continue to feel the squeeze from frozen income tax thresholds, persistent inflation, and muted productivity. While the projection marginally improves on the OECD’s earlier estimate, it still paints a more subdued picture than the government’s own forecasts, intensifying the political debate around the UK’s economic direction.

A Recovery Facing Tight Constraints

Unlike the rapid rebound experienced by the US and some other G7 economies, the UK’s trajectory remains restrained. According to the OECD, Britain will be the second-fastest growing G7 economy in 2025, behind the United States, but its ranking slips to third place in 2026 as Canada overtakes.

Growth is then projected to edge up slightly to 1.3% in 2027, but the OECD's outlook points to a recovery that is stable rather than dynamic.

The organisation notes that fiscal policy will be a major factor shaping this slowdown. The Chancellor’s Budget introduced £26bn in tax rises over the next five years, including the continued freeze on tax thresholds—often described as a “stealth tax” because rising wages push more workers into higher tax bands even as nominal rates stay the same.

The OECD summarised the impact bluntly:

“Fiscal consolidation will be a headwind to the economy, with past tax and spending adjustments weighing on household disposable income and slowing consumption.”

With consumer spending making up roughly two-thirds of UK GDP, this squeeze on households remains one of the most significant barriers to stronger growth.

Inflation: Highest in the G7, but Falling

The UK’s inflation story continues to stand out for the wrong reasons. The OECD expects inflation to average 3.5% in 2025, the highest rate among advanced G7 economies. This is unchanged from its previous forecast, underscoring the challenge the government faces in bringing prices back under control.

However, the organisation does predict a gradual easing:

2.5% in 2026 (revised down from 2.7%)
 

2.1% in 2027, close to the Bank of England’s 2% target
 

The fall is partly attributed to recent government measures lowering energy and fuel costs, and to the continued softening of global commodity prices.

Despite the improvement, inflation remains elevated compared to peers, reflecting the UK’s unique cocktail of post-Brexit trade frictions, labour shortages, and supply constraints that have pushed prices higher than elsewhere.

Interest Rates: Relief Ahead, but Only Slight

The OECD expects two more interest rate cuts from the Bank of England over the next year, bringing the base rate down to 3.5% by late 2026.

While lower rates should ease mortgage pressures and boost business investment, the OECD cautions that the effect will be modest. Higher taxes and slow productivity growth will continue to offset much of the stimulus normally expected from monetary policy easing.

The short-term relief may also be partially muted by rising unemployment. The OECD predicts UK joblessness will reach 4.9% in 2026 and 5% in 2027, reflecting cooling demand among employers and a slowdown in economically active workers.

Structural Weaknesses Continue to Drag the UK Down

Beyond fiscal pressures and inflation, the OECD identifies two long-running structural issues that continue to hamper the UK’s potential:

1. Sluggish Productivity

The UK has struggled with low productivity growth since the 2008 financial crisis. While some countries experienced a post-pandemic productivity rebound, the UK’s recovery remained weak, constrained by:

low business investment,
 

fragmented infrastructure planning,
 

skills shortages, and
 

persistent regional inequalities.
 

The OECD warned that this “sluggish productivity” continues to limit growth potential even during periods of strong consumer demand.

2. Weak Working-Age Population Growth

The UK workforce is expanding more slowly than in previous decades. The OECD attributes this partly to lower levels of inward migration compared to pre-Brexit patterns, combined with a rise in long-term sickness and economically inactive adults.

With fewer workers contributing to the economy, labour shortages grow and the tax base narrows, increasing fiscal pressure.

Budget Politics Intensify

The OECD’s report lands at a politically delicate moment for Chancellor Rachel Reeves, whose first Budget triggered intense scrutiny over claims she presented an overly optimistic view of government finances.

Responding to the OECD assessment, Reeves emphasised the positive elements:

“Last week, my Budget cut waiting lists, cut borrowing and debt, and cut the cost of living… the OECD has upgraded our growth and cut its forecast for inflation next year.”

But Shadow Chancellor Mel Stride argued the opposite:

“Growth is expected to weaken next year because of her choices. This is the cost of policies that punish work, businesses and investment.”

The clash underscores the broader political debate: whether tax rises are a responsible step toward long-term stability, or an unnecessary drag on households and businesses that will undermine the recovery.

OECD: Proceed with Caution

While the OECD acknowledges the deficit should improve “substantially,” it warns that the government must tread carefully when introducing new tax or spending changes.

The risks, it says, are two-sided:

Downside risks to growth if taxes or cuts go too far
 

Upside risks to inflation if stimulus is excessive
 

The report emphasises that future tax and spending packages should prioritise boosting productivity and investment—especially in areas such as infrastructure, planning reform, and financial services regulation.

Global Growth Outlook: Stable but Fragile

Zooming out, the OECD notes that the global economy has shown resilience in 2025 but remains vulnerable in the face of multiple risks.

Key projections include:

3.2% global growth in 2025
 

2.9% in 2026, unchanged from earlier
 

3.1% in 2027, a slight rebound
 

However, the organisation warns the outlook “remains fragile,” citing several global threats:

Rising Trade Barriers

Any escalation in protectionism could seriously disrupt global supply chains already strained by geopolitical tensions.

A Potential AI Bubble

The OECD joins the Bank of England in warning of “abrupt price corrections” in AI-related equities, where valuations have surged significantly ahead of fundamentals. A sharp correction could spill over into global financial markets.

US Leadership, Again

The OECD now expects the US economy to grow faster than previously forecast:

2% in 2025 (up from 1.8%)
 

1.7% in 2026 (up from 1.5%)
 

The US remains the clear outperformer among rich nations, thanks to strong consumer spending, robust productivity in tech-heavy sectors, and high levels of private investment.

Conclusion: A Slow and Uneven Path Forward

The OECD’s latest assessment reinforces a picture of an economy that is recovering but constrained. While the UK avoids recession, growth remains modest and vulnerable to policy missteps. Tax rises and tighter spending may help stabilise public finances, but they simultaneously risk limiting household consumption and business investment.

Inflation will continue to ease, but only gradually. Unemployment will tick higher. Productivity remains the UK's most persistent challenge—one that no Budget can solve overnight.

The message is clear: the UK has stabilised, but it has not yet found the momentum needed to return to the robust growth of earlier decades. Until the underlying structural weaknesses are addressed, the economy is likely to continue moving forward—just not very fast.

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