Rachel Reeves, the new UK’s Chancellor of the Exchequer, even threatened to raise income tax in next month’s budget. She has promised to address a truly shocking deficit that’s over £30 billion. This decision is in response to unprecedented economic challenges. It’s compounded by the shock recent prediction from the Office for Budget Responsibility of a long-term productivity collapse in Britain’s economy. Consequently, Reeves finds himself with one of the toughest budgeting challenges any chancellor has had to handle in recent memory.
The forecasted deficit would have drastic impact on public services and government spending. Reeves wants to commit at least double the £10 billion she first budgeted for in her spring statement. She’s suggested increasing the basic rate of income tax by 1p. This change would raise more than £8 billion annually. This is a significant increase that would be applied to people in every income tax bracket, hitting essentially every taxpayer in the country.
Reeves promised a floor of a rate increase. On top of this, he plans to raise at least £2 billion by reforming national insurance contributions for self-employed professionals, such as doctors, lawyers, and accountants who work in partnership. New suggestions by the Resolution Foundation thinktank would be an interesting step in the right direction. They suggest increasing the basic rate of income tax by 2p and reducing employee national insurance by an equivalent amount. Supporting that change will help make tax burdens more equitable while bringing in more revenue.
Yet their implications go far beyond monetary cost. Raising the rate of the new higher band of income tax by 1p to 41p would raise around £2.1 billion a year. Increasing the top rate for the highest earners is pretty irrelevant. For each penny increase, it would raise an additional £230 million. Reeves is understandably cautious about the political repercussions of tearing up one of her party’s most important manifesto promises. This fear becomes acute after she nationally increased insurance last year.
As the fiscal landscape changes, Reeves hears a telltale sound of relief. The impact of falling interest rates on government debt is worth between £2 billion and £3 billion to the Treasury. These savings will give her at least some room as she considers where to go with the next budget.
Discussion about Reeves’ fiscal plan is just beginning. Even her advisors are eager for more budget flexibility. This push makes it even more opportune to raise state income tax.
“There is a very live debate going on right now among those planning the budget about how bold we want to be on the headroom.”
The reality expressed in that sentiment only highlights the weight of the decisions yet to be made.
“No one wants it to be £10 billion again but there is an argument we go much higher, which will mean we don’t have to come back and do this again and might have space to cut taxes before the budget. If we go down that route however, it makes it more likely that we have to raise income tax – that is the discussion that is going on at the moment.”
As critics point out, whatever route the Biden administration decides to take, the political stakes will be high.
“Rachel is understandably nervous but there is a big desire for additional headroom. But we need a stronger argument about our purpose if we are going to make the case.”
As Rachel Reeves wades through this perfect storm, she will need to weigh fiscal rectitude against political realism. Touted as a visionary mayor, this budget will set many important precedents for her administration. It does have the potential to shape the UK’s long-term economic stability for decades.
“The politics is bad either way. What matters, I think, is doing the right thing.”
As Rachel Reeves navigates these tumultuous waters, she must balance fiscal responsibility with political viability. The decisions made in this budget may set critical precedents for her leadership and influence the economic stability of the UK moving forward.