Reeves expected to extend stealth raid on income tax

Telegraph

11 hours ago

Rachel Reeves is expected to freeze income tax thresholds in her autumn Budget to fill a £40 billion black hole.
The Chancellor has been put under pressure by three policy U-turns by Sir Keir Starmer, which are set to increase public spending by about £4 billion later in the year.
Some within the Labour Party believe she may not survive the year if she is forced to raise taxes and impose further cuts at the same time.
The latest policy reversal, on benefit cuts, will mean the Government will save just half of the £5 billion it hoped to recoup from sickness and disability payments.
But Ms Reeves has left herself with few options to raise funds. As well as committing not to increase the rates of income tax, National Insurance or VAT, nor to raise corporation tax, she has insisted she will not break Labour's fiscal rules.
Freezing the threshold for the additional rate of income tax was one of the suggestions in a memo from Angela Rayner, the Deputy Prime Minister, to Ms Reeves which was leaked to The Telegraph last month.
The current freeze, which was due to be lifted in 2028, dragged seven million people into higher tax brackets last year, raising around £15 billion.
Paul Johnson, the director of the Institute for Fiscal Studies, an independent think tank, said a further freeze in thresholds would be 'pretty high up the attractiveness scale' in this year's Budget.
'I think it's fairly likely, as a politically easy way to raise something of the order of £10 billion in additional revenue by the end of the Parliament,' he told The Telegraph.
One Labour MP said the Chancellor was now 'in deep trouble' because she has already ruled out several of the easiest ways to raise revenue.
'It's hard to forgive her for where we are now. She locked herself in, foolishly, to a set of commitments that have become unsustainable,' the MP said.
The Treasury was already facing a black hole of between £20 billion and £30 billion because of lower-than-expected growth forecasts, partly driven by Donald Trump's imposition of tariffs.
The £4 billion cost of Sir Keir's U-turns is expected to be compounded by a revision to the Office for Budget Responsibility's (OBR) medium-term productivity forecast this summer and growth forecast this autumn, which could have an impact on revenues of between £7 billion and £8 billion.
This week's decision to maintain benefit payments for existing claimants has cost the Treasury £2.5 billion, while the U-turn on winter fuel payments for pensioners cost a further £1.25 billion.
Ms Reeves is facing backlash from Labour MPs over her proposal to cut benefits, which was designed to bring down the cost of welfare at the expense of thousands of claimants.
Sir Keir, who watered down the measures to avoid the biggest rebellion of his career, insisted that his 'common sense' welfare reforms now strike 'the right balance'.
But the situation leaves the Chancellor with little choice but to freeze income tax thresholds, which were due to rise in line with inflation from 2028.
The policy would likely raise around £8 billion a year in tax receipts, but would cost a worker earning on an average salary thousands more in income tax by the end of the decade.
Independent economists say a further freeze in the autumn is now all but certain, and that further increases on smaller taxes or a new raid on pensions could be required to make up the shortfall.
Downing Street refused to rule out further tax rises on Friday, with a spokesman saying: 'As ever, as is a long-standing principle, tax decisions are set out at fiscal events.'
However, Ms Reeves's team remains optimistic that good economic performance between now and the Budget will reduce the £105 billion cost of servicing government debt, which currently accounts for 8.2 per cent of public expenditure.
The Bank of England is widely expected to cut interest rates at its next meeting on Aug 7, although gilt yields are not directly determined by the base rate.
Treasury officials also hope that the cost of energy will continue to fall, although it is acknowledged that instability in the Middle East could drive up the price of crude oil once again.
Ms Reeves is adamant that she will not break her fiscal rules – to increase public sector borrowing as a percentage of GDP or raise money on the markets to fund day-to-day spending – and believes that maintaining market stability should be the Government's primary goal.
Balancing the books with a stealth tax on income has been a favoured policy lever of successive chancellors. The current freeze to 2028 was introduced by Sir Jeremy Hunt in his 2022 Budget.
But the policy results in more people paying higher rates of income tax as their wages increase – an economic phenomenon known as fiscal drag.
OBR figures show that in 2024-25, some £15.3 billion extra was due to be raised thanks to the frozen thresholds.
In the same year, the OBR predicted that the total welfare bill was set to shoot up by £16.6 billion.
Figures released on Thursday show that seven million people have been dragged into paying higher rates of income tax as a result of the stealth raid on wages.
Frozen thresholds forced an extra 520,000 taxpayers into the 40p bracket in the last year, according to estimates by HMRC.
It brings the total to just over seven million in 2025-26, a 60 per cent rise from the 4.4 million in 2021-22 when income tax thresholds were first frozen under the Tories.
The number of 45p additional-rate taxpayers has more than doubled from 520,000 to 1.2 million over the same period.
Last November, Ms Reeves told MPs she would not raise taxes again or increase borrowing and that the Government would need to 'live within the means we've set ourselves' for the remainder of the Parliament.
'We're not going to be coming back with more tax increases, or indeed more borrowing,' she told the Treasury select committee.