The Chancellor faces three major choices on what was supposed to be an uneventful Spring Statement later this month.
Rishi Sunak will have to contend with borrowing more to offset soaring inflation and the cost of living crisis made worse by the ongoing Russian invasion of in Ukraine.
IFS director Paul Johnson said that he will have to decide whether to borrow billions more or allow households to face what could be the biggest hit since the 1970s.
He said: “At the Spring Statement Rishi Sunak has to make a huge judgment call.
“Will he do more to protect households from the effects of energy prices which have risen even further in the last two weeks?
“If he doesn’t then many on moderate incomes will face the biggest hit to their living standards since at least the financial crisis.
“If he does, then there will be another big hit to the public finances.
“While he had little choice over big state action through the pandemic, his response to this crisis will tell us more about how he sees the limits of government in protecting citizens from buffeting by external forces.”
The cost of living is set to soar this year, not least due to the rising price of energy, which has been pushed up by Russia’s invasion of Ukraine.
Without intervention, public sector workers face an average real-terms pay cut of around £1,750 due to inflation, while many households will struggle to keep up with bills.
He will also have to impose severe real-term pay cuts on teachers, nurses and others in the public sector, borrow even more to pay them better or cut back spending on other public services.
As war rages in eastern Europe the Chancellor will also have to decide whether to allow defence spending to fall over the next three years, or again borrow to boost it.
The jump in energy prices since Russia launched a full-scale invasion of Ukraine is likely to add to already high household energy bills.
In all, energy prices are set to add around £43 billion to households’ costs, meaning that the Chancellor’s £9 billion package will offset only around one fifth of the rise.
If Mr Sunak wants to achieve the same level of protection as he announced earlier this year, soaring prices will need around £12.5 billion on top of the £9 billion already committed, the IFS said.
According to forecasts, someone on a median salary of £27,500 is likely to be around £800 worse off, that’s £300 more than earlier forecasts.
