The government closing its furlough scheme this autumn is a “mistake” that will drive up unemployment by 1.2 million by Christmas, one of the UK’s leading economics thinktanks has warned.

Sounding the alarm over the mounting risk to jobs, the National Institute of Economic and Social Research (NIESR) said extending the wage subsidy scheme until the middle of next year would dramatically cut the number of redundancies across Britain and would probably pay for itself.

The chancellor, Rishi Sunak, confirmed at the summer statement that the furlough scheme would be wound down from August before it is removed entirely by the end of October, despite calls for an extension from Labour, trades unions and business leaders.

As many as 9.5 million jobs have been furloughed at 1.2m companies since March, at a cost to the exchequer of £31.7bn so far.

To ease the transition from the scheme, the government will offer £1,000 bonuses to companies for every worker they bring back from furlough and retain in employment until January, at a total cost to the Treasury of up to £9.4bn.

However, NIESR said extending the furlough scheme until the middle of next year would have about the same cost – with a direct cost of £10bn – and would be more effective at saving jobs.

Britain’s oldest economics research institute said without an extension it expected unemployment to surge to 3 million by the end of this year. However, it said keeping the furlough programme open would protect as many as 1.2 million workers who are set to lose their jobs, and would reduce unemployment in Britain in every year up to 2024.

Despite the initial high costs for the Treasury, NIESR said extending the scheme could pay for itself. This is because furloughed workers would still pay tax, would be more likely to spend in the economy with income from the scheme, and would not need to receive unemployment benefits.

The rolling back of government support for jobs comes as the British economy slowly recovers from a 25% drop in economic output in March and April at the onset of the pandemic. With the gradual relaxation of lockdown restrictions, growth in gross domestic product (GDP) returned in May, albeit at a weaker pace than first hoped.

NIESR said it expected UK GDP to fall by 10% this year and rise by 6% in 2021. However, it said the level of economic activity at the end of 2019 – before the crisis struck – is unlikely to be regained before the second half of 2023.

“The planned closure of the furlough seems to be a mistake, motivated by an understandable desire to limit spending,” said Garry Young, the NIESR deputy director. “The scheme was intended by the chancellor to be a bridge through the crisis and there is a risk that it is coming to an end prematurely and this increases the probability of economic scarring.”