Rachel Reeves has opened the door to raising taxes to fund higher defence spending.
The Chancellor warned that pressures to fund the sector were "only going in one direction", as she ruled out borrowing more to pay for the Government's multibillion-pound investment plan.
Instead, Ms Reeves signalled that raising taxes to increase defence spending was better than adding to Britain's nearly £3tn debt pile , which she said would push up borrowing costs for households and businesses.
Speaking at a conference organised by Peel Hunt on Tuesday, Ms Reeves said: "We are in a constrained fiscal world, and I think we'll be honest about that, and we're going to have to spend more on defence."
While she said keeping a grip on public spending was a priority, Ms Reeves signalled that she would rather keep raising taxes than borrow more.
"I would argue that despite the pain of higher taxes, better to do that than to get into a situation that we were in before, where we had interest rates climbing and the risk premia for the UK climbing too," she said.
Ms Reeves's intervention comes amid tensions over how to pay for the Government's delayed defence investment plan .
Downing Street has reportedly ordered Whitehall departments to find spending cuts to help pay for an additional £15bn of spending in the next four years.
However, this remains far short of the £28bn demanded by army chiefs.
The defence investment plan is expected to be published as soon as this week, before a Nato summit in July. The plan was originally expected last autumn.
The negotiations have caused a bitter Cabinet row between the Ministry of Defence, the Treasury and No 10 about how much money is needed to ensure Britain's defences remain fit for purpose.
Ms Reeves said: "The first duty of the Government is to keep its people safe, and in the world in which we live today, it's increasingly clear that the US and other European countries are going to have to spend more on defence, but crucially spend that money better.
"The money has to come from somewhere, and borrowing cannot always be the answer."
Ms Reeves signalled that raising defence spending beyond the 2.6pc of GDP pencilled in next year meant other priorities had to be squeezed, including help for first-time buyers to get on the housing ladder.
Asked if Labour had planned to revive George Osborne's Help to Buy scheme that helped families with small deposits to get on the housing ladder, the Chancellor said: "If defence is the number one priority, and we live in a dangerous world, that means you can't make commitments everywhere, because then you end up in the position that previous governments have ended up in, where you over-commit, and then you under-deliver, and you end up with high interest rates."
The threat of further tax rises is likely to alarm many. The Chancellor has already launched repeated raids on households and businesses, which are expected to push the UK's tax burden to a peacetime high of 42.1pc of GDP by the start of the next decade.
The Confederation of British Industry, Britain's biggest business group, this week warned that companies couldn't bear any further increases.
James Cartlidge, the shadow defence secretary, said the Chancellor should cut welfare spending rather than raise taxes to fund defence.
He said: "It is truly extraordinary that Labour still won't consider cutting welfare to fund defence. This isn't just about finding the money for our armed forces – our nation would be more resilient if the growth of the bloated benefits bill was reversed.
"But instead of tackling welfare spending head-on, Rachel Reeves is suggesting yet more tax rises on top of the over £60bn increase so far.
"The fact that Starmer is still unable to make any savings from welfare is the single reason why the Defence Investment Plan is so chronically delayed. Our country and our armed forces deserve better."
