Chancellor Rachel Reeves is reportedly considering a politically explosive income tax rise in next month’s Budget as she grapples with a multibillion-pound hole in Britain’s public finances, raising the prospect of Labour breaking one of its flagship election promises.
Treasury insiders have confirmed discussions are underway about hiking income tax to address a shortfall exceeding £30 billion, with some advisers arguing it may be the only reliable way to generate sufficient revenue without triggering further tax increases later in the parliamentary term. The move would mark a significant U-turn on Labour’s manifesto pledge not to raise the headline rates of income tax, National Insurance or VAT.
The Chancellor faces mounting pressure after the Office for Budget Responsibility slashed its productivity forecasts, a revision expected to wipe around £20 billion annually from the public finances. Combined with policy reversals since the spring Budget, including the partial restoration of winter fuel payments and the scrapping of planned welfare cuts, Ms Reeves must now find tens of billions to meet her fiscal rules.
Ed Cornforth, economist at the National Institute of Economic and Social Research, said raising income tax represents the Chancellor’s least damaging and most reliable option for establishing economic stability. The think tank’s analysis examined multiple tax-raising scenarios to close the fiscal gap, comparing the economic impacts of increasing income tax, corporation tax and VAT.
Treasury sources acknowledge the political sensitivity of breaking Labour’s manifesto commitment, particularly after the Chancellor faced criticism for increasing employer National Insurance contributions last year. However, senior officials suggest the fiscal arithmetic leaves few alternatives if Ms Reeves wants to maintain adequate headroom against her borrowing rules beyond the £10 billion cushion she secured at the spring statement.
Several options are under active consideration within the Treasury. Adding one penny to the basic rate of income tax could raise more than £8 billion annually, though economists warn this would intensify cost-of-living pressures for millions of working families. Alternatively, the Chancellor could target higher earners by increasing the 40 per cent and 45 per cent rates, aligning with her stated principle that those with the broadest shoulders should bear the greatest burden, though this would generate far smaller sums of approximately £2 billion and £230 million respectively.
The Resolution Foundation has proposed a different approach, recommending Ms Reeves add 2p to income tax rates whilst cutting employee National Insurance by 2p, a switch that would raise £6 billion annually from pensioners, landlords and the self-employed. Adam Corlett, principal economist at the foundation, argued this would protect workers’ pay packets whilst broadening the tax base.
A senior Treasury official speaking on condition of anonymity revealed the intensity of internal deliberations. The source said there is considerable debate about how much fiscal headroom the Chancellor should secure, with some arguing for significantly more than the £10 billion buffer previously established. However, this approach would likely necessitate income tax rises, creating a challenging political calculation.
Another insider acknowledged the Chancellor’s nervousness about the political fallout, stating there is strong desire for additional headroom but requiring a stronger argument about purpose to make the case. A third source suggested the politics are damaging either way, but emphasised the importance of doing the right thing.
The Chancellor’s dilemma has been compounded by the OBR’s productivity assessment. Andrew Goodwin, chief UK economist at Oxford Economics, suggested the fiscal watchdog is almost certain to downgrade its overly optimistic productivity assumptions, potentially delivering a £15 billion to £20 billion blow to the public finances. He noted the OBR cannot maintain its position as the most optimistic forecaster whilst serving as the sober judge of economic policy.
The Institute for Government has entered the debate, arguing that substantial revenue increases will require broad-based tax rises paid by large numbers of people. The think tank stated that raising the main rates of VAT, income tax and National Insurance would be the best candidates for generating significant sums, even if this means undoing Labour’s manifesto commitments, which it described as rash.
Ms Reeves has sought to generate revenue through smaller measures, including raising approximately £2 billion by extending National Insurance contributions to doctors, lawyers and accountants working through partnerships. Falling government borrowing costs have provided some relief, with interest rates on public debt at their lowest level in over a year, potentially saving £2 billion to £3 billion. The Chancellor also hopes to pass planning reforms in time for them to be factored into the OBR’s projections.
However, economists warn these incremental changes will prove insufficient. Cornforth noted that whilst politically unpalatable, avoiding income tax rises would force the Chancellor into worse options. He said VAT increases would push up inflation at an undesirable time, whilst additional business taxes would harm investment incentives when employer National Insurance rises have already dampened business confidence. He concluded that tinkering around the edges simply will not shift the dial.
The timing could scarcely be worse for the Government. Britain’s economic outlook remains challenging, with inflation at 3.8 per cent, unemployment at 4.8 per cent, and interest rates holding at 4 per cent. The OECD projects UK inflation will average 3.5 per cent by year-end, easing to 2.5 per cent in 2026, placing additional strain on household budgets and business costs.
Both Ms Reeves and Prime Minister Sir Keir Starmer have repeatedly insisted Labour’s manifesto pledges remain intact, though neither has explicitly ruled out breaking them when the Budget is announced on 26th November. The Chancellor is preparing what observers describe as one of the most difficult Budgets in recent memory.
During recent interviews, Ms Reeves has framed potential tax rises in terms of fairness, stating that those with the broadest shoulders should pay their fair share of taxes. When pressed on specific measures, she has consistently declined to rule out various options, insisting the public must wait until Budget day for full details.
The political ramifications of an income tax rise would be substantial. Labour won the general election partly on promises of fiscal responsibility without punishing working families through higher taxes. Breaking this commitment risks undermining public trust and handing ammunition to opposition parties who argue the Government lacks economic credibility.
Treasury sources suggest the Chancellor faces an impossible choice: breach her fiscal rules, implement severe spending cuts, or break her tax pledges. With Ms Reeves having made fiscal discipline central to her political identity and spending commitments already locked in through the recent Spending Review, tax rises appear increasingly inevitable.
Some Conservative voices have criticised the Government’s position. Shadow Chancellor Mel Stride rejected attempts to blame the previous administration for fiscal pressures, arguing that every time the numbers fail to add up, Rachel Reeves blames someone else. He added that markets are losing confidence and so is Keir Starmer, who is now building his own Treasury team in Downing Street.
The National Institute of Economic and Social Research has issued stark warnings about the scale of fiscal consolidation required, suggesting Ms Reeves may need to find up to £50 billion through tax increases or spending cuts by 2029-30 to meet her targets whilst maintaining adequate headroom. The Chancellor has disputed these projections, though she acknowledges significant challenges lie ahead.
Financial markets are watching closely. Any perception that the Government cannot control the public finances risks pushing up borrowing costs further, creating a vicious cycle of deteriorating fiscal conditions. This dynamic makes decisive action more urgent but politically more treacherous.
Ms Reeves told Sky News before heading to the International Monetary Fund meeting that the economy continues to suffer from the impacts of Brexit, austerity policies and Liz Truss’s mini-budget. When asked if she was in a doom loop of constantly hiking taxes to fill a black hole, the Chancellor said she would not use those words but nobody wants that cycle to end more than she does.
As the Budget approaches, Ms Reeves faces a defining moment for her chancellorship. The decisions she makes will shape not only Britain’s fiscal trajectory but also Labour’s political fortunes heading into the next election. Whether she prioritises manifesto commitments or fiscal sustainability will reveal much about the Government’s priorities and risk appetite.
The coming weeks will test whether the Chancellor can navigate these treacherous waters without capsizing either her Budget or her party’s electoral coalition. With economists, think tanks and Treasury insiders all pointing towards income tax rises as the least damaging solution, the question may no longer be whether Labour breaks its manifesto pledge, but when.
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Image Credit:
Rachel Reeves — photo by Zara Ferrar / HM Treasury, licensed under the UK Open Government Licence v3.0.
