Drastic cuts of £20 billion in public spending, or a rise in income tax of as much as 5p in the pound will be needed within three years as financial turmoil and the economic downturn drive the Government’s finances deep into the red, a leading think-tank said yesterday.

In the latest in a raft of warnings over the toll on the public finances from the severe shocks buffeting the economy, the National Institute of Economic and Social Research emphasised the tough choices confronting Gordon Brown and Alistair Darling as the downturn undercuts Treasury tax revenues.

As market upheavals, tumbling share prices, plunging house prices and the severe squeeze on consumer spending power all sap economic growth, the weakness of tax receipts, and higher bills for benefits as unemployment climbs, are set to send government borrowing soaring, the Institute and other experts believe.

With borrowing already at very high levels, the still sharper plunge into the red faced by the Treasury as growth remains weak in coming years will force spending cuts or tax rises by 2011 at the latest, the think-tank said yesterday.

Cuts of 3 per cent in planned levels of public spending could be needed by 2011-12, with swingeing rises in tax required if these were not made, the Institute’s economists estimated ahead of what are expected to be grim figures for the Government’s finances due to be released tomorrow.

“The Government needs to be seriously rethinking spending plans given what has happened over the past year,” Ray Barrell, the Institute’s senior fellow, said. “Either spending needs to be cut or taxes must rise.”

The Institute’s warning came on the heels of estimates from the Institute of Fiscal Studies that government borrowing will be £65 billion higher than is planned over the next three years if economic growth is in line with the Bank of England’s latest forecasts.

That would raise total national debt by 3.4 per cent of GDP, pushing it decisively above the 40 per cent of GDP ceiling prescribed under the Treasury’s so-called sustainable investment rule, the IFS calculations suggested.

By 2010, the extra borrowing needed would be the equivalent of £467 for every Briton, the figures also indicated. The projected worsening in the state of the Government’s finances would be still worse were the economy to suffer an even more severe downturn than the Bank of England has so far forecast.

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