Rachel Reeves is preparing to set out a Budget at the end of this month that could end up defining the future of the Labour Government.
After repeated complaints about what she says is a big black hole in the public finances, she has warned of hard choices on taxes and spending.
As well as its political impact, the Budget on 30 October will directly affect all taxpayers and anyone who uses public services – and determine whether the UK continues to enjoyed a relatively stable economy.
Before the general election, Labour had promised not to raise taxes on “working people”, not to return to the era of austerity with major cuts to services, and not to break strict rules on how much the state can borrow.
Ben Zaranko, a senior research economist at the Institute for Fiscal Studies (IFS), told i that it may prove impossible to keep all three of those pledges in the Budget. He said: “Given that the Government was elected on something like a blank state, there wasn’t loads of detail on what they would do on gaining office. It was much more slogans than it was detailed policy information in their manifesto. This is where some that detail gets filled in and we see where the chips fall.”
How taxes could go up
The Chancellor has promised that she will not increase income tax, national insurance or VAT, saying she does not want a bigger tax burden to fall on “working people”. She has also ruled out putting up corporation tax.
Between them, those four taxes make up around three quarters of the Government’s revenues, meaning that if Ms Reeves wants to raise more money she will need to target smaller levies. Mr Zaranko said: “There are things like inheritance tax, where they might seek to raise a little bit more. There is capital gains tax, which a tax paid on if you own an asset and it goes up in value, when you sell it, you pay tax on the increase in value that you see.”
Ms Reeves is considering hiking fuel duty by 5p a litre, reversing a decision made by Rishi Sunak that was supposedly always intended to be temporary. It is likely that duties on alcohol and tobacco will also be increased.
Inheritance tax and capital gains tax fall mostly on wealthier households. Some other possible tax rises, such as making businesses pay national insurance contributions on the money they put into workers’ pension pots, do not directly affect individuals but would have an indirect effect over time, [for] example, by reducing wages slightly.
The Chancellor has been preparing the ground for tax rises by claiming that the Conservatives have left an unexpected shortfall of £22bn in the public finances for this year, although the Tories point out that nearly half of this is due to higher pay rises for public-sector workers, which is a choice made by the new Government.
Raid on pensions
One plausible way of raising more money from the Exchequer is by limiting the tax relief available for pension savers. Currently, workers pay no tax at all on any earnings they put into their pension pot; possible changes include cutting the relief to a flat rate of 20p, leaving payers of basic rate income tax (anyone on a salary of less than £50,270) unaffected, but meaning that higher earner must pay some tax on their pension contributions.
Another option is to scrap a clause that allows pensioners to take out one quarter of their savings after retirement without paying income tax on them, or to limit the maximum amount of tax relief on this type of withdrawal.
Experts have also suggested that the law allowing people to pass on their entire pension pot without inheritance tax could be abolished, which would reduce the value of the money received by the heirs of big savers.
Squeeze on spending
The last Government set out spending plans for the next few years, which implies that many services will have to find cuts.
Mr Zaranko of the IFS said: “Unless they find significant sums of money in the Budget to provide extra cash, there will be a lot of public services facing cuts. Overall spending is growing [by 1 per cent], but once you take into account the fact there has been money promised to the NHS, to defence, childcare, for overseas aid – that more than eats up the increases.
“And so to stick to 1 per cent overall, something else has to be cut – and that something else is your local government, it’s your courts, it’s further education colleges, it’s prisons, it’s HMRC. All those things would be facing a squeeze. It looks like as it stands, there will be a return to austerity for some bits of government unless they can find significant sums of extra cash.”
To avoid those cuts, the Chancellor would either have to find £10bn-£20bn more through higher taxes or more borrowing – or hope that the economy starts growing so quickly that the tax revenue she receives increases even without higher rates.
Ms Reeves has been tight-lipped about where exactly cuts will fall. But she does say she hopes to reduce the welfare bill by getting more people back into work, meaning that anyone on benefits should expect more encouragement to look for and take up a job.
New borrowing rules
Much of the debate in Westminster has focussed on whether or not the Chancellor will change her fiscal rules – self-imposed guidelines on how much the Government can borrow.
She has said she may introduce tweaks to the way these are calculated, which makes it easier to exempt money borrowed for the purposes of long-term investment, such as building roads or new hospitals, rather than to fund day-to-day Government expenses.
Mr Zaranko suggested that changing the definition of borrowing and debt could give the Treasury tens of billions of pounds more to spend, making heavy spending cuts or tax rises less likely.
He said: “These are very technical details, but the reason why they matter when it comes to deciding what those constraints are is that they limit how much she can spend or how much she can tax in the upcoming Budget. It’s a bit of an arcane discussion, but it could determine the policy path this Government takes for the rest of this parliament and make a big difference in people’s lives.”
The danger when Government borrowing goes wrong is that it risks destabilising the economy, in a way that directly impacts individuals by driving up the cost of borrowing and encouraging businesses to lay off workers. This is what began to happen in 2022 as a result of Liz Truss announcing tax cuts and spending increases without saying how they would be paid for.
