Rachel Reeves may have to ‘revisit’ manifesto tax pledges to meet fiscal rules, economists warn
Rachel Reeves may have to tear up Labour’s manifesto tax commitments to meet her tight fiscal rules, economists have warned, as the Chancellor battles to balance the books amid calls for higher spending on defence and welfare.
A suite of new day-to-day spending commitments made by the Treasury in recent weeks, including reversing cuts to winter fuel payments, scrapping the two-child benefit cap and increasing defence spending as a share of GDP are set to bulldoze through Rachel Reeves’ wafer-thin £9.9bn fiscal headroom.
That could be compounded by increased borrowing rates, which add an extra £10-11bn in debt service costs by the end of the decade, according to projections by Oxford Economics.
The combined changes could lead to an extra £30bn in fiscal tightening, Oxford Economics predicts, leading to tens of billions worth of tax rises to balance the books.
But in its manifesto, Labour had pledged not to increase “taxes on working people”, leaving the Treasury with a vanishingly small set of options to raise money.
“The government is likely to face tough fiscal choices in the autumn budget later this year, because of the prospect that – without corrective action – it will significantly miss its self-imposed fiscal rules,” Oxford Economics said.
“The need to raise revenues may require the government to revisit its manifesto commitments, which seemed to rule out increases in most major taxes.
“The threat of further tax hikes will probably weigh on private sector spending this year.”
Oxford Economics said the government could improve the fiscal outlook for the next few years by “being much bolder in implementing policies to lift potential growth in the next few years.
“But in practice, we regard this as unlikely.”
How much will taxes rise by?
The report adds Oxford Economics to a growing number of analysts and economists who have predicted major tax hikes before the end of the year.
Earlier this week, Deutsche Bank analysts said the Chancellor would raise taxes by at least £10bn in this year’s Autumn Budget as rising inflation and increased spending eat into the Treasury’s fiscal headroom.
“With a tough Spending Review due in June, we expect fiscal news to worsen over the coming months,” analysts said.
“By the time the Autumn Budget rolls around, the Chancellor’s fiscal headroom will have likely evaporated.”
Dr Ben Caswell, senior economist at the National Institute of Economic and Social Research, said it was highly likely that Reeves would extend a planned freeze on income tax bands to the end of the parliament – a move which would bring in billions as earnings rise.
The freeze, which is already planned to last until 2028, is projected to drag around two million workers into higher tax bands.
“It seems like that will actually generate quite a bit of revenue towards the end of the parliament so I’m almost certain that she will do that,” Caswell said.
“It’s a meaty tax but it’s a stealth income tax – because it’s done through indirect means rather than direct legislation, people view it differently.”
Another policy high up the agenda is to cut the current cash ISA limit from £20,000 to as low as £4,000, a move designed to push savers into investing in more productive assets like stocks. In the 2022/23 tax year, 7.9m Britons contributed a combined £42bn to cash ISAs with an average subscription of £5,296.
Taken with the income tax bands freeze, “These things together would cobble a little bit of money,” Caswell said. “[But] whether it’s enough to put her in an established position where she’s restored a lot of headroom, I’m not sure.”