The pressing risk of the national debt becoming unsustainable will force Britain into the unenviable choice of paying higher taxes or the state doing less, a House of Lords committee has warned.

A report by peers said tough decisions and a new set of rules for the public finances were needed in order to put debt – currently just under 100% of annual national income – on a decisive downward path.

Lord Bridges, the chair of the House of Lords economic affairs committee, said peers were raising a “big red flag” on the need to reduce the national debt at a time when there were mounting pressures for the government to spend more on defence, the net zero transition and the care costs of an ageing population.

“This report highlights a grim reality: our national debt risks developing on an unsustainable path. This has not received the attention it deserves – partly because of a flawed debt rule, created by the last government, and adopted by the new government in a similar form,” Bridges said.

The report was welcomed by the government, which has said it inherited the public finances in a worse state than at any time since the second world war.

Darren Jones, the chief secretary to the Treasury, said: “The Lords could not have been clearer about the dire state of the country’s finances. We have inherited a decade of lost economic growth, an economy that isn’t working, a £22bn black hole in our public finances and unsustainable long-term debt.

“That is why we have to take tough decisions now to fix the foundations of our economy, so we can rebuild Britain and make every part of the country better off. To make sure this reckless overspending does not happen again we are strengthening the OBR (Office for Budget Responsibility) and will confirm our robust fiscal rules at budget.”

The Lords report said Britain could no longer rely on the trends – a higher working age population resulting from the baby boom generation, a peace dividend, strong growth and rising world trade – that pushed the debt ratio down in the decades after the second world war.

“If we wish to maintain the level and quality of public services and benefits that we have come to expect, we face a choice: taxes will need to rise or the state will need to do less. Addressing this will demand clarity as to the responsibilities and the role of the individual versus that of the state.

“Muddling through is not an option. If this choice is ducked in this parliament, the UK risks being on a path to unsustainable debt.”

The committee, which includes the former chancellor Norman Lamont and two former permanent secretaries to the Treasury, said that while Britain was not alone in having a high level of debt, changes to the way the government financed its borrowing had made it more vulnerable to shocks than it had been in the past.

“Successive rounds of quantitative easing have seen long-term debt exchanged for short-term debt, and a greater proportion of debt is index-linked and held by overseas investors. This has made the cost of servicing the UK’s debt more sensitive to rises in interest rates and inflation as well as sudden changes in investor sentiment,” the report said.

The report from the 14-strong committee said it backed Rachel Reeves’s aim of reducing the debt ratio but was waiting to see how the government’s plan to raise productivity and boost growth would bear fruit.

The Lords report said there should be a tougher rule governing debt. At present, the government is committed to reducing debt as a share of national income in the fifth year of a rolling forecast, which allowed it to rise in years one to four. Peers said the government should commit itself to debt in five years’ time being lower than its current level.