During the general election campaign, Paul Johnson of the Institute for Fiscal studies repeatedly accused both main parties of indulging in a “conspiracy of silence” over their economic policies. Neither Labour nor the Tories would admit, he complained, that if they won they would have to announce huge tax rises or spending cuts to restore the public finances to anything resembling good health.
On Wednesday, 118 days after Labour won the election, Rachel Reeves will prove Johnson right. In her first budget she will spell out plans to raise an eye-watering sum of about £40bn from tax rises and spending reductions to wipe the slate clean and to pump funds into public services. She will also confirm changes to debt rules that will release up to £50bn more to borrow for long-term investment in new national infrastructure.
In terms of raising immediate day-to-day spending, the chancellor’s problem is that promises were made to voters in before the election that, if honoured, would severely restrict her options. Taxes on working people would not rise, Labour told voters. There would be no return to austerity (no overall cuts to departmental budget and services). The very taxes that raise the most – income tax, VAT and national insurance – would not rise, yet services would not be subject to the real-terms cuts to which Tory plans would have led.
Without breaking some of her previous promises, either in letter or spirit, Reeves therefore faces a near-impossible task as she prepares to deliver the first budget by a female chancellor.
So what could she do?
Freeze income tax thresholds
Reeves is said to be seriously considering freezing the levels at which people starting paying tax (£12,570), and at which they move into higher tax bands as their pay increases, to beyond 2028. This would drag 400,000 more people into paying tax, according to the Institute for Fiscal Studies, and 600,000 more into paying it at higher or additional rates, raising about £7bn a year. But it would be highly controversial and seen by many as a broken promise.
When she was shadow chancellor, Reeves accused the Tories of “picking the pockets” of working people when they froze thresholds year after year. Labour sources insist any freeze they might enforce would not break promises, as their manifesto pledge was not to put up actual rates of income tax. Arguing this will be a hard sell.
Likelihood 8 Row potential 9
Raise employers’ national insurance contributions
National insurance is the second largest sources of revenue after income tax. It now seems certain that Reeves will increase employers’ contributions (rather than those paid by workers) by up to 2% – despite having said national insurance would not rise. She is also expected to cut the earnings threshold at which employers start paying national insurance. The combined measures will raise about £20bn and be the biggest fundraiser by far, with much of the money earmarked for the NHS.
Labour will inevitably be accused of breaking another manifesto pledge. Reeves will argue that the national insurance promise before the election referred to “working people” and that workers’ costs will not rise. But everyone knows that employers are likely to hand on the increase to employees in lower wages and some may cut jobs. Business and the Tories will call it a “jobs tax”.
Likelihood 10 Row potential 10
Impose national insurance on employers’ pension contributions
This move would also be a big fundraiser – bringing in up to £15bn – but would amount to a massive double hit on businesses if coupled with a rise in employer contributions. Former Labour cabinet minister David Blunkett has warned against the move, saying it could hit pensioners’ incomes in retirement because companies would simply cut the amount they paid into their pensions in response. Reeves is said to be cooling on the idea following the warnings.
Likelihood 2 Row potential 9
Raise some rates of capital gains tax
Keir Starmer has indicated that capital gains tax on the sale of shares and some other assets, currently set at up to 20%, will increase in the budget. The tax is expected to rise by several percentage points, but not so much as to discourage sales and lead to a negative net result for the exchequer. The Treasury is said to have rejected increasing capital gains tax on the sales of second properties because of the effect it would have on the housing market.
Likelihood 9 Row potential 3
Reduce tax breaks on pension contributions
Reeves has considered reducing the 40% rate of tax relief that higher earners enjoy on pension contributions, in a move that could raise £10bn a year. But public sector unions warned that doing so would hit almost 1 million of their members, erasing much of the pay increase for them that the government has just agreed. She is now understood to have backed off the idea. Opposition would come not only from higher earners, but also public sector workers, making the idea a probable non-starter.
Likelihood 1 Row potential 9
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Cut the tax-free lump sum that can be taken from pensions
At present, the maximum people can take out of their pension pots without paying tax is 25% of the total, capped at £268,275. A report by the Fabian Society said the government could raise £10bn a year if it capped the sum at £100,000. Such a move would be highly controversial. People who had paid into their pensions and saved for years to use the lump sum to pay off their mortgages would cry foul. If it were introduced, the cut would most probably be phased in over many years, limiting the income the Treasury would raise in the short term.
Likelihood 5 Row potential 9
Raise inheritance tax
Inheritance tax is paid on the estate of someone who has died. But only about 4% of people end up paying because it only kicks in after a £325,000 allowance has been exceeded. Reeves is understood to be examining tightening the rules on gifts given during a person’s lifetime and at limiting reliefs for businesses and agricultural land, which currently have exemptions.
Likelihood 9 Row potential 3
Deliver big new cuts to government departments
Reeves and Starmer have said there will be no return to austerity and that public services will not suffer. Spending departments are expected to receive increases of between 2% and 3% for day-to-day budgets, allowing them to avoid the real-terms cuts that would have resulted had they stuck to Tory spending plans. The NHS will get far more. Departments could, however, be asked to deliver significant extra savings through efficiency saving and by cutting back on the use of outside consultancies.
Likelihood 1 Row potential 10
Impose welfare cuts
The government is already under fire from poverty groups for failing to end the two-child limit on benefits (this will not be dropped in the budget), and for limiting winter fuel payments to only the poorest pensioners. It is also facing calls to drop Conservative plans that would hit the disabled.
Instead of cutting welfare, Reeves will announce that more than a million of Britain’s poorest households will be £420 better off thanks to a change to universal credit, which will see a cap imposed on the amount that can be cut from benefit payments to repay short-term loans and debts.
Likelihood 1 Row potential 10
Abolish non-dom status
Labour had declared in its manifesto that it would abolish the special tax status for wealthy non-domiciled residents. But it is understood that the Treasury has been reconsidering elements of the plans, because of fears that those people who benefit from the status could leave the country and that the move could even lead to a loss of tax revenue.
The Treasury has said recently that it would act “pragmatically”, leading to some doubts about its commitment to the measure. Previous estimates had suggested that about £3bn a year could be raised by the end of the decade. Reeves will press ahead with the main thrust of the plan, albeit perhaps with modifications.
Likelihood 10 Row potential 1