Chancellor Rachel Reeves is considering breaking one of Labour’s key election promises by raising income tax in next month’s budget to plug a £30bn budget deficit, according to senior government sources.
Three figures familiar with the budget process told The Guardian that discussions between the Treasury and No 10 had intensified in recent weeks, with officials considering how to deliver a sustained increase in revenue without resorting to further tax rises later in Parliament.
Although a final decision has not yet been made, advisers believe an income tax increase could be the only way to raise enough money to restore public finances and create “headroom” for possible future tax cuts before the next election.
The fiscal challenge has been compounded by the Office for Budget Responsibility’s (OBR) decision to downgrade the UK’s productivity forecasts, a move expected to cost the Treasury around £20 billion a year.
Reeves must also find ways to reverse the winter fuel allowance cut, scrap planned welfare cuts and end the child benefit cap – all measures previously criticized by Labor backbenchers.
Although falling gilt yields have reduced the government’s debt servicing costs by an estimated £2 billion to £3 billion, the reprieve is limited. Smaller measures, such as increasing national insurance for partners in law and accounting firms, are unlikely to raise more than £2 billion.
According to sources, the Finance Ministry is debating several configurations of income tax changes:
• A 1p rise in the property tax rate from 20p to 21p would raise around £8.2bn a year but could stoke public anger during a fragile recovery in the cost of living.
• A 1p increase in the higher tax rate from 40p to 41p for income over £50,271 would generate around £2.1 billion.
• An additional tax rise for those earning more than £125,000 would raise just £230 million per penny.
Reeves is said to be torn between keeping her promise to protect working households and ensuring public finances meet her strict fiscal rules. A senior Treasury source said:
“There is a live debate about how much leeway we want. If we aim high, we may not need to raise taxes again – but that makes it more likely that we will need to raise income tax now.”
While the Chancellor and Prime Minister Keir Starmer continue to insist that the commitments in Labor’s manifesto “exist”, they have not explicitly ruled out tax rises.
Reeves is aware of the political consequences of reneging on her earlier promise, especially after she broke another promise last year by increasing Social Security. Aides say they want to ensure that any new revenue plan is framed as a “one-time, responsible measure to preserve economic stability.”
The Budget Committee – co-chaired by Finance Minister Torsten Bell and the Prime Minister’s chief economic adviser Dame Minouche Shafik – is currently weighing up the competing options.
A proposal backed by the Resolution Foundation would see the basic rate of income tax rise by 2p while workers’ national insurance contributions fall by 2p, shifting more of the burden to pensioners and landlords who do not pay national insurance contributions.
Ruth Curtice, director of the think tank, said:
“Of all the major taxes, the introduction of income tax best fits the UK’s current economic problems of low growth and stubborn inflation. Whether tax rates change or not, we need wider tax reform to reduce the imbalance between earned and unearned income.”
Next month’s Nov. 26 budget is expected to be one of the most politically contentious in years. Reeves is under pressure to demonstrate fiscal discipline to markets while maintaining the government’s credibility as voters still reeling from years of austerity and rising living costs.
As one Treasury official put it, “The policy is bad either way. What matters is doing the right thing.”
