Starmer and Reeves drop proposal to increase income tax rates in Budget

Sir Keir Starmer and Rachel Reeves have ditched their manifesto-busting plan to increase income tax rates, in a dramatic U-turn ahead of the Budget on November 26 that sparked a sell-off in the gilt market.

The prime minister and chancellor have “ripped up” earlier proposals to raise the basic and higher income tax rates, according to officials briefed on the move, amid fears it would anger voters and further antagonise mutinous Labour MPs.

Gilts sold off steeply at the open on Friday as investors balked at the U-turn, pushing the 10-year yield up as much as 0.13 percentage points to 4.56 per cent. It later recovered a little to 4.54 per cent. Yields move inversely to prices.

The move put gilts on track for their worst one-day sell-off since July. The pound also dropped sharply before paring its losses to trade 0.1 per cent lower at $1.318.

The decision to change tack, taken this week, was communicated to the Office for Budget Responsibility on Wednesday in a submission of “major measures” set to be announced by Reeves in her Budget.

One person briefed on the proposals said the original Budget tax plan had been ripped up, while a second confirmed that the fiscal statement had been rewritten since the first set of measures by Reeves was sent to the UK fiscal watchdog earlier this month.

The Treasury said on Friday: “We do not comment on speculation around changes to tax outside of fiscal events. The chancellor will deliver a Budget that takes the fair choices to build strong foundations to secure Britain’s future.”

Reeves is now exploring alternative ways to fill a fiscal hole that was previously estimated to be up to £30bn, but is now expected to be closer to £20bn given better than expected OBR forecasts.

One option to raise revenue would involve cutting the thresholds at which people pay different rates of income tax, while leaving the headline basic and higher rates of the tax unchanged.

Reeves was pictured leaving Downing Street earlier this month with her diary on display, with a single word written in relation to a meeting: “Thresholds”.

Reeves had already been expected to extend a freeze on personal tax thresholds that was introduced by the Conservatives. Prolonging this freeze by another two years would raise £8bn to £10bn a year, depending on details in the OBR’s forecasts that will be set out at the Budget. 

But cutting the personal tax thresholds would raise billions of pounds more in additional revenue.

People briefed on the revised plans said Reeves would also rely heavily on what has been dubbed the “smorgasbord” approach of increasing a range of narrowly drawn taxes. 

They cautioned that parts of this package could still change, but a new gambling levy and higher taxes on expensive properties are expected to be included.

Kallum Pickering, chief economist at Peel Hunt, said using a patchwork of smaller tax increases “would be a bad outcome”, calling such measures “anti-growth”.

“It would add to uncertainty, further damage the government’s already tarnished credibility and complicate any [Bank of England] judgment to potentially offset tax rises with rate cuts,” he added.

Lee Hardman, senior currency strategist at MUFG, said: “Without the income tax hike, the package of fiscal-righting measures could be judged [by investors] as less credible.”

He added that such a move would give the impression that the government is prioritising its “own popularity and stability of [the] party over fiscal finances”.

For weeks Reeves had been preparing the ground to break Labour’s election manifesto pledge not to increase the rates of income tax, national insurance or value added tax, with many Labour MPs fearing it would happen.

Downing Street officials insisted the Budget had not been rewritten in response to the leadership crisis that has engulfed Starmer in the past few days, after the prime minister’s allies briefed that he could soon face a coup attempt. Some Labour MPs believe Starmer’s days in Downing Street are numbered.

The original tax plan pursued by Starmer and Reeves, based on an idea from the Resolution Foundation think-tank, carried heavy political risks for the embattled prime minister and his chancellor.

It would have involved income tax rates rising by 2p on the pound, albeit with an offsetting 2p cut in national insurance rates.

The “two up, two down” policy would have broken one of Labour’s key manifesto promises, even if it would have left “working people” seeing no impact in their monthly pay slips.

Others would have been hit hard by the policy. It would have raised £6bn from the income of non-workers such as landlords and pensioners, who pay income tax but not national insurance, according to calculations by the Resolution Foundation.

Additional reporting by Ian Smith

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