Rachel Reeves ‘will need to raise income tax by at least 2p’ to plug Budget hole | Personal Finance | Finance
Rachel Reeves the country will need to plug a £50bn gap in its public finances and an increase of at least 2p in the basic income tax rate will be needed, a leading economic think tank has warned.
The National Institute for Economic and Social Research (Niesr) has further expressed concern about potential tax rises in the upcoming 26 November Budget, saying it believes one of the Chancellor’s fiscal rules will fall behind by as much as £38.2bn in 2029-30. This is before taking into account the approximately £10 billion needed to restore the wiped-out fiscal buffer, according to the group. In its latest economic outlook, Niesr predicts that the Office for Budget Responsibility (OBR), the UK’s independent fiscal watchdog, will predict a smaller deficit of around £20bn when its final forecasts are published alongside the Budget.
But Niesr is urging the Chancellor to target a buffer of at least £30bn on top of that to protect finances against future shocks, which would still leave him needing to come up with £50bn.
The think tank suggests the Chancellor will probably need to break his manifesto promise and raise income tax rather than “play around” with changes to marginal taxes, which he argues will do more damage to the economy in the long term.
Niesr estimates that a 2p increase in the basic income tax rate of 20 per cent would be the minimum amount needed to repair Britain’s battered public finances, bringing in around £20bn of additional revenue.
It was noted that a 5p increase at the higher rate of 40 per cent could add an additional £10 billion, while a similar increase to the upper band could be an increase of around £500 million.
This may affect economic growth; The forecast for next year could drop by about one percentage point to 1.1 percent in 2026, leading to a 0.3 percentage point decline in year three.
However, he warned that the alternatives could be much worse, that a VAT increase could lead to higher inflation by passing the costs on to consumers, while corporate tax increases could “deter investment, leading to a permanent decline in GDP”.
Niesr said that unless confidence in public finances is restored, borrowing costs will remain high and debt will reach “unsustainable” levels.
Deputy director of macroeconomics Stephen Millard said Ms Reeves needed to make “bold choices”.
He said: “Rather than trying to fill the gap by making lots of changes to marginal taxes, he will probably need to break his manifesto commitment by increasing income tax because that would be the least bad option for the economy.
“A mix of tax rises and spending cuts is needed to get the UK economy and public finances back on track, which will help the Government focus on its mission of delivering higher economic growth and better living standards across the country.”
Ms Reeves had promised in Labor’s general election manifesto that it would not increase taxes on working individuals; this was a commitment widely understood to include income tax, VAT, employees’ national insurance contributions and corporation tax.
Instead, he increased employers’ national insurance contributions (NIC) in last autumn’s budget and promised at the time that he would not repeat such a tax increase “again”.
But in his pre-Budget speech on Tuesday he laid the groundwork for backtracking on Labour’s manifesto promise by refusing to rule out potential tax rises and warning “we must each do our bit”.
David Aikman, a director at Niesr, said: “The economy is clear; what is needed now is political will and a readiness to make tough decisions on tax and spending in this Budget in the long-term interests of the UK economy.”
In his forecast, Niesr increased the 2025 growth outlook to 1.5% from 1.3% in August, but kept his forecast for next year at 1.2%.
He predicts the bank will keep interest rates at 4% this week but cut them again in February as inflation is expected to fall from the current 3.8% to 2.7% in the second quarter of next year.
