Interest rates and taxes will have to rise if Labour wins the next general election, an influential group of economists has argued.

In its report published over the weekend, the Ernst and Young Item Club argued that increased regulation and a growth in public spending jeopardised economic stability.

With public spending at £33 billion for 2004-5, the group argues that, based on the Treasury's model of the UK economy, chancellor Gordon Brown could face a potential £4 billion hole in his finances if tax revenues fall short of expectations.

By the end of the economic cycle in 2005-6, this could increase to £9 billion, they warned.

"The scale in the increase in the tax burden foreseen by the Treasury does pose a significant threat to longer-term growth prospects in the UK," the report said.

"Coupled with business worries about increasing regulation, it implies that incentives for enterprise and investment are being undermined."

However, the Item Club did agree with growth forecasts of three to 3.5 per cent both this year and in 2005.