Rachel Reeves is expected to approve above-inflation pay rises for millions of public sector workers next week, amid concerns over the cost of further industrial action if the Government refuses.
The Chancellor is set to respond to the recommendations of independent pay review bodies on Monday, when she will also argue in Parliament that the Tories left Labour with a dire spending inheritance, including a £20 billion black hole.
Reports have suggested teachers and some 1.3 million NHS staff could be in line for a 5.5% pay boost, which could cost about £3.5 billion more than had been budgeted for.
Economists believe this could rise to about £10 billion if other pay review bodies give similar advice on workforces such as police and prisons officers and doctors and dentists.
Sir Keir Starmer has previously acknowledged there would be a cost if failing to follow the recommendations of the pay review bodies led to a fresh wave of industrial disputes in the public services.
Labour did not deny reports that Ms Reeves could on Monday make the same argument as she signs off on the pay increases despite the shortfall in Government funding plans.
The findings of a Treasury spending audit she will detail on Monday will reveal “the true scale of the damage the Conservatives have done to the public finances”, a Labour source said.
An early assessment has reportedly found a nearly £20 billion annual gap between revenues and funding commitments.
Public sector pay rises well above the 3% expected by the Treasury will put extra pressure on spending under Ms Reeves’ self-imposed fiscal rules, which include having debt falling as a share of gross domestic product in five years’ time.
Extending the 5.5% pay boost to the entire public sector could cost some £10 billion a year, according to the influential Institute for Fiscal Studies.
As this cost has not been fully budgeted for in current plans, the cash would have to be raised through existing fiscal headroom, tweaking fiscal rules or tax increases.
Any tax hikes to meet those costs would not be expected before the autumn budget, the date of which Ms Reeves is also set to announce on Monday.
Labour has ruled out lifting income tax, VAT, national insurance and corporation tax, potentially leaving changes to capital gains or inheritance levies on the table.
The Labour Government will not “duck difficult decisions” in its budget, Health Secretary Wes Streeting said on Friday.
He told Times Radio: “What I think we have found shocking is the state of the public finances in the year that we’ve inherited and that means tough choices … as the Chancellor, (Ms Reeves) will continue to show iron discipline and she will have the full support of the entire Cabinet.
“Because these aren’t just tough choices for the Chancellor, these are tough choices for all of us and we’re determined to meet that challenge, to be honest with people, to not duck the difficult decisions and to make sure that we make the right choices now that set Britain up for the longer-term success that we need.”
Rishi Sunak’s Tory government was plagued by strike action protesting years of declining wages for public sector workers.
Most of the unions eventually struck pay deals with ministers, but Mr Streeting is currently negotiating with junior doctors in a bid to resolve their long-running pay dispute.
The Labour source said: “On Monday, the British public are finally going to see the true scale of the damage the Conservatives have done to the public finances.
“They spent taxpayers’ money like no tomorrow because they knew someone else would have to pick up the bill.
“It now falls to Labour to fix the foundations of our economy and that work has already begun.”