What’s behind Rachel Reeves’s hokey cokey on income tax rises?

After weeks of eager anticipation and recent heavy hints in the Budget that she would actually raise income taxes, Chancellor Rachel Reeves has now decided against the move, which breaches the manifesto.

Here’s what we know through the fog of budget speculation.

The plan, which would raise income tax rates by 2p but compensate workers with a 2p National Insurance deduction, was sent to the OBR earlier this month as an option to help fill what was then a £30bn gap in the public finances, caused mainly by a decline in productivity.

The so-called “2 up, 2 down” scheme, spearheaded by the Solution Foundation think tank, would raise several billion pounds, mainly from non-wage income such as homeowners and savings.

The OBR’s more recent assessments appear to have increased the projected strength of wages and tax revenues in the coming years, offsetting several billion pounds of this shortfall, bringing it to a total of closer to £20bn.

As a result, no plan to increase income tax rates was put forward in the final set of measures sent to the OBR for analysis.

While this “iterative” process is part of the normal round of forecasting ahead of the Budget, on Monday this week the chancellor suggested very strongly in an interview with the BBC that tax rates would rise.

On Friday, Health Secretary Wes Streeting confirmed a move away from anything that could be seen as breaking election promises:

“It’s really important that we keep our promises and stand by our manifesto. The fact that there is speculation about income tax shows how difficult the situation is in the public finances and, secondly, that the chancellor is determined to stick to his fiscal rules,” he said.

There is some irony in the health secretary making these comments, given Downing St’s overtures about leadership bids and the prime minister and chancellor’s claims of unique power over bond markets.

By the end of the week, bond markets were extremely nervous as a result of jokes about income taxes.

It is always dubious to assume that there is a single reason behind the magnificent financial strength of the debt markets, but let me try to guess what has happened in the last 24 hours.

Following the Financial Times reporting on the reduction of the tax rate plan, there was a significant increase in the Government’s effective cost of borrowing. There was an increase of 0.12% points for the 10-year gilt.

The chancellor’s tough financial speeches last month had reassured the markets.

Much of this was driven by expectations that Bank of England interest rates would fall due to a weakening job market. The chancellor’s willingness to endure political pain by making good on tax rate manifesto promises to simply restrict borrowing is a plus for the bond vigilantes.

But developments this week, including extra taxes on partnerships and other kites flying such as entrepreneurs leaving the UK, have cast doubt on the appetite to swap political pain for low bond yields.

Even as it was confirmed that better (or less bad) economic forecasts helped reduce the budget deficit and created room to avoid a tax rate increase, markets only calmed briefly before reaching even higher effective rates by the end of the day. Tensions are back.

Insiders said the chancellor’s Budget strategy “remains the same”, to increase the buffer or “headroom” to meet borrowing rules, significantly higher than the current £10bn a year, to combat cost-of-living pressures and to make “fair choices” on tax.

This appears to mean an extension of the £40bn annual freeze on tax thresholds; This means an extra £8bn a year as more workers’ wages fall into higher tax brackets.

Ministers have pointed to how they plan to increase the tax and its amount, suggesting that wealth, capital and income from these sources are being squeezed rather than long-suffering pay packets.

There are real questions about loose talk in Whitehall, any major tax reform and its impact on markets.

It is also worth noting that the final decisions regarding the budget have not been made yet and the process is ongoing. Everyone will hope things go more smoothly from here until the big speech on November 26th.