Britain’s chancellor Rachel Reeves faces competing pressures to balance the books at her first Budget next week. She reckons that the UK has a £40bn gap in its day-to-day spending needs. Her estimate includes an admirable effort to protect key departments from real-terms spending cuts, and to build up a fiscal buffer. It also covers her own commitment to public sector pay rises; part of a £22bn “black hole” she claims the previous government left behind. Savings must be found, and painful tax rises are expected.
The problem is that Reeves has made her job more difficult by pledging not to raise tax rates on the bulk of the tax base. Labour’s manifesto promised not to raise income tax, national insurance, VAT, or corporation tax. What remains is both harder to raise revenue from and to square with the government’s pitch for growth and investment.
Prime Minister Sir Keir Starmer has warned that those with “the broadest shoulders” will bear the largest burdens. But Britain must also remain competitive for highly mobile investors, businesses and entrepreneurs, who prop-up the tax base, drive economic growth and create jobs. Small tax rises may be tolerable, but the cumulative burden on wealth-creators has to be considered. Reeves has already made plans to raise taxes on the private equity sector, and wealthy non-doms.
How can Reeves thread the needle? Unless she goes back on her tax pledges, there are limited options to raise big sums. She may raise employers’ NI and, or introduce NI to employers’ pension contributions (Reeves’s allies say the party’s tax promise focused on employee’s NI). Either would raise business costs, and risks a resulting push by employers to lower worker salaries and pension savings. Reeves would need to calibrate any rises. But, combined with a continued freezing of personal tax thresholds, she could close much of the gap.
Improved economic forecasts and government savings — including by streamlining the welfare system and cutting back on consulting contracts — could help at the margin. That then leaves Reeves with other tax tweaks, which may raise a few billion more. Here, the chancellor should focus on revenue-raisers that at least nudge the tax system in a more rational and simpler direction. For instance she could raise fuel duty. That would support the shift away from gas-guzzlers. She might consider removing some loopholes from inheritance tax, perhaps with a view to lowering the headline rate later. Significantly raising the capital gains tax rate would be unwise, but Reeves could taper uplifts at death which may help discourage asset hoarding.
Broader reform of Britain’s byzantine tax system — including IHT and CGT — is needed. But Reeves must assess the impact of multiple rushed changes at this Budget in one go. Still, she should kick-start consultations to update and simplify the tax system, so that it supports growth better. This includes reforming property taxes, particularly council tax and stamp duty, and easing cliff-edges that can discourage economic activity, such as in income tax and business VAT thresholds. This would send a positive signal that the government has a long-term plan for taxes, rather than annual fiddling.
The chancellor might also find space for some sweeteners including cutting stamp duty on shares or widening the scope of full expensing for business investment. Both would raise near-term costs, but would support long-term growth and receipts.
After winning a significant parliamentary majority at July’s election, many were hoping Labour’s first fiscal event would boost the nation’s animal spirits. The government’s broader plans to raise public investment will help, but it may not be enough to lift the mood if tax rises also make doing business in Britain less worthwhile. On October 30, the chancellor must tread carefully with her book balancing while demonstrating bold thinking about the future of the tax system. Investors and entrepreneurs are watching closely.
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