Rachel Reeves told to find £40bn through ‘sustained’ tax increases – who will have to pay more?
Rachel Reeves will need to raise taxes ‘substantially’ to plug a £40billion blackhole, economists have warned.
Worsening geopolitical tensions paired with domestic challenges mean the nation’s finances are in an even more perilous state.
The National Institute of Economic and Social Research (NIESR) said the Chancellor faces an ‘impossible trilemma’ and will be unable to meet her fiscal rules, fulfil her spending commitments, and avoid tax rises.
Reeves will now need to make ‘unenviable decisions’ to meet the costs of weaker economic forecasts and higher spending.
With little room to manoeuvre, which taxes could Reeves increase and who will be most affected?
Difficult decisions: Rachel Reeves will need to find £40bn, senior economists warn
Income tax
The Chancellor has boxed herself in with her manifesto commitments, including keeping income tax, national insurance and VAT at their current level.
Keeping basic, higher and additional rates of income tax the same means Reeves misses out on around 25 per cent of the Government’s source of tax revenue.
She may be forced to renege on her promise as she’s confronted with worsening growth prospects and increased spending, because of U-turns on welfare spending and winter fuel payments.
The NIESR said Reeves may have little choice but to raise income taxes or VAT to ‘really shift the dial and build a reasonably sized buffer against her fiscal rules’.
While VAT is the ‘least distortionary tax’, it is also the most ‘regressive’, says the NIESR, making rises in income tax rates the ‘best answer’.
Reeves could extend the freeze on income tax thresholds, which has been in place since 2021, beyond 2028, as an indirect way to increase taxes. But this will not raise as much as she needs.
In the 2024-25 tax year, frozen thresholds raised an additional £10.1billion, but NIESR says it is expected to raise only £5.8billion by 2029-30.
She would also face backlash as the freeze particularly affects poorer households, ‘and is at odds with the Government’s manifesto pledge not to raise taxes on working people’.
National Insurance
Elsewhere, Reeves could reverse the previous government’s two percentage point National Insurance (NI) cut.
The OBR estimates this could raise approximately £10.3billion per year, but this would again breach Labour’s manifesto pledge not to raise taxes on working people.
NIESR also warns that it has ‘strong distortionary effects via discouraging job creation and so would likely increase unemployment.’
Capital gains tax
Reeves hiked capital gains tax (CGT) rates in her first Budget last autumn, from 10 to 18 per cent for basic rate taxpayers, and higher rate taxpayers now pay 24 per cent, up from 20 per cent.
CGT has traditionally been applied at lower rates than income tax, because profits tend to be made by people taking risks.
Campaigners have called on the Chancellor to raise CGT rates in line with income tax rates, which would see the wealthiest pay 45 per cent on the profits of their assets.
NIESR says this would ‘not necessarily raise that much money and could act as a disincentive to saving’.
Alternatively, she might consider changing how capital gains are treated after death.
Currently, CGT liability effectively ends when an individual dies. Inheritance tax is then charged depending on the value of the total estate.
However, this could be changed so that CGT is charged either when assets are sold on someone’s death, or when they are eventually sold by their beneficiary.
Inheritance tax
The Government introduced huge changes last autumn in bringing unused pensions into a person’s estate for inheritance tax purposes.
She could tighten the rules on gifting by increasing the seven-year rule to 10 years, or cutting the gifting allowance from its current level.
Given the backlash to changes to agricultural and business relief, she may leave further inheritance tax changes in the next Budget.
Pensions
There has been plenty of speculation that the government could make further changes to pension contributions.
NIESR says Reeves could lower the rate of tax relief on pension contributions, which it estimates could raise as much £15billion.
However, this would mean pensioners would face double taxation on their pensions, because they already pay income tax on their pensions exceeding £12,570.
Given the backlash after the winter fuel payment changes, she may want to avoid angering pensioners further.
These higher tax charges also pushed more doctors and consultants into early retirement, and Reeves will want to avoid any further conflict with doctors, nurses and others with large NHS pensions or risk further strikes.
> Double tax hit on inherited pensions confirmed
Isa changes
Speculation that the Treasury could go after cash Isas reached fever-pitch ahead of the Spring Statement.
Reeves shelved immediate plans to cut the cash Isa limit to encourage more people to invest in stocks and shares, but she could revisit this in the autumn.
‘Reducing the tax-free cash Isa allowance from £20,000 to £4,000 would raise less than £1billion per year,’ says NIESR.
She could also increase the rate of CGT on the profit made from the sale of shares, but this too could disincentivise investment.
Council tax
Households are facing higher council tax bills after the Government gave the green light to some councils to increase rates by as much as 9 per cent earlier this year.
She could oversee an overhaul of the entire council tax system, which plenty of experts have said is outdated and punitive.
The system is still based on the value of house prices in 1991, two years before council tax was introduced.
Reeves may look at reforming the bands, or NIESR suggests she could consider replacing the whole system with a land value tax, although this could be ‘extremely difficult politically’.
It is unlikely that Reeves will tackle wholesale reform of the system, mainly because it would involve revaluing every single home and be hugely controversial and logistically difficult.
She could, however, introduce higher bands or bring in a minimum average council tax band that others are based on, driving up costs in areas with lower bills.
