Rachel Reeves could hit middle-earners with a bombshell income tax increase as she lines up a Budget squeeze of as much as £60billion, forcing Britain into a fiscal ‘doom loop’, economists fear.
In trying to meet her Budget targets, the Chancellor may face a £20billion to £30billion black hole, according to analysis by the National Institute of Economic and Social Research (NIESR).
On top of that, she should build up ‘headroom’ of £30billion to try to bring debt down and provide a financial buffer in the event of future economic shocks, experts said.
Without a credible plan to repair the public finances, Ms Reeves could be in danger of facing a ‘Liz Truss moment’ – a bond market sell-off reminiscent of the aftermath of the mini-Budget of 2022, the think-tank warned.
NIESR said the scale of the money needed could mean an increase to the basic rate of income tax of 20p by a further 2p in the pound, raising £20billion, and a 5p to 10p increase to the higher rate of 40p, with 5p raising £10billion.
A potential 5p more in the ‘additional rate’ band – which is charged at 45p in the pound on incomes over £125,140 – would raise £500million.
But there were warnings – including from the Tony Blair Institute (TBI) – that tax increases threatened to send Britain into a ‘doom loop’.
The worry is that higher taxes hurt growth, which hits the public finances and means taxes have to go up yet again.
The TBI said tax increases must be linked to pro-business policies, such as changes to Labour’s workers’ rights plan and investment tax breaks.
The NIESR analysis came as Ms Reeves all but abandoned her election pledge not to put up income tax, National Insurance and VAT as the outlook for the public finances fell.
That means she could become the first Chancellor in half a century to put up income tax for the more than 39million basic-rate payers who earn more than £12,570.
But NIESR suggests it could be the more than seven million paid upwards of £50,270 who face an even bigger blow.
That would chime with reports that the Chancellor will consider anyone earning at least £46,000 as fair game.
The number of those subject to the higher rate has risen sharply as the threshold was frozen rather than going up in line with inflation, dragging many nurses and teachers and others who may not consider themselves high earners into paying tax at that rate.
Shadow Chancellor Sir Mel Stride said: ‘NIESR’s warning is another reminder of the mess Rachel Reeves has created. Her choices are hurting Britain.’
NIESR director David Aikman said high UK debt, elevated borrowing costs and weak growth had left Ms Reeves with a ‘large gap in the public finances’. He added: ‘This is the moment to start the process of bringing the debt ratio down.
‘If we don’t, we risk losing the capacity to respond to future crises, limiting our ability to invest, and leaving the economy more exposed to inflation and to market pressures.’
He suggested that MPs aghast at the scale of the pain being imposed by the Chancellor needed to face the stark reality of what might happen without it, adding: ‘The risk is that markets react badly to whatever comes out in the Budget later this month and we see … something more like the Liz Truss moment.
‘This is a large adjustment that needs to happen.’
NIESR deputy director Stephen Millard said breaking Labour’s manifesto pledge by raising income tax was ‘the least bad option for the economy’, adding: ‘I would just imagine given she’s a Labour Chancellor and she’s made points about working people, and this £46,000 a year, that it’s quite likely that we’ll see a larger increase on that 40 per cent rate than the base rate.’
NIESR estimated its suggested income tax rises would knock the economy, but the alternatives were far worse.
However, Martin Beck, chief economist at the consultancy WPI Strategy, said: ‘If tax hikes cause growth to falter and revenues disappoint, the Chancellor could find herself trapped in a self-defeating loop of higher taxes and weaker growth.’
