Britain’s struggle to emerge from the Covid-19 pandemic will result in pay packets being squeezed and taxes rising to fill a £40bn hole in the public finances, two leading thinktanks have warned. Despite record peacetime borrowing of £394bn this year, the Resolution Foundation and the Institute for Fiscal Studies said the run-up to the next general election would be marked by a hit to earnings and pressure on the government to balance the books. The Resolution Foundation, commenting on Rishi Sunak’s one-year spending announcement on Wednesday, said the government’s plans to rescue Britain from the Covid crisis would fail to end a decade-long squeeze on wages, and would leave average pay packets by the middle of the decade £1,200-a-year below the level forecast before the virus outbreak. Household incomes were on course to grow by just 10% in the 15 years since the start of the financial crisis in 2008, compared with the 40% growth in the 15 years up to the crisis, it said. The IFS expressed scepticism about the new forecasts from the independent Office for Budget Responsibility, which showed only limited long-term damage on the economy from the biggest slump in 300 years. The IFS director, Paul Johnson, said weaker growth and pressure on the NHS and welfare budgets would lead to worse than expected public finances over the coming years, necessitating tax increases or spending cuts of £40bn rather than the £27bn pencilled in by the OBR. Both thinktanks noted that Sunak had shaved £10bn from the planned £25bn increase in the budgets of Whitehall departments next year. The government has insisted there will be no return to austerity, but Johnson said it would feel very much like it for non-protected departments. Torsten Bell, the chief executive of the Resolution Foundation, said the pandemic was causing “immense damage” to the public finances and permanent harm to family finances as well. “The pandemic is just the latest of three ‘once in a lifetime’ economic shocks the UK experienced in a little over a decade, following the financial crisis and Brexit. The result is an unprecedented 15-year living standards squeeze.” Bell said there was the possibility of the economy growing more quickly in the short-term as consumers spent the money they had saved during 2020. He added it was unprecedented for the UK to have “gone through a crisis where household balance sheets have improved”, and it was good news there was so much pent-up spending power. The lesson from history was that after the first world war and the Spanish flu pandemic came to an end people were desperate to get out and spend. “It’s called the roaring 20s for a reason,” he said. However, Johnson highlighted the downside risks to the OBR’s estimate that by the middle of the 2020s the economy would be just 3% smaller than it would have been in the absence of Covid-19. “Those central scenarios are not great,” Johnson said. “But they are not terrifying. We have had much bigger economic shocks and fiscal tightenings before. See the last decade.” He added: “I’m not so sure this is really a central scenario though. There are clearly downside risks to the economy from Covid and our ability to respond to it and, as the OBR make clear, from a no-deal Brexit. “Of course, history need not repeat itself but remember that the long-term economic, and hence fiscal, hit from the financial crisis was far greater than predicted at the time.” Johnson added that despite allocating a “whopping” £55bn for Covid next year, Sunak had allocated “precisely zero” for subsequent years. “I hope he is right that we will no longer need to spend anything at all on test and trace, PPE and the rest, but I wouldn’t bet on it.” The Treasury’s current plans involve ending the temporary increase in universal credit from April. “It was intended as a temporary policy and it is government policy to end it. Experience suggests, though, that pressure will build for it to be kept and the government may change course in response,” Johnson said. He added that once all the pressures were added together, his central scenario was that borrowing would be at least 1% of national income higher in 2024-25 and thereafter.