Rachel Reeves could raise as much as £45bn in taxes without breaking Labour’s manifesto promises, according to a City report.
Economists at the US investment bank Morgan Stanley said they expected the chancellor to use next month’s budget to announce billions of pounds in tax increases to cover a potential £30bn shortfall in the public finances.
Amid speculation following Labour’s party conference in Liverpool, it argued Reeves faced a series of tough tradeoffs between tax rises, spending cuts and limiting the political and economic fallout of her decisions.
“Tax-wise, we can see [about] £25bn of measures that don’t breach the spirit of the Labour manifesto, are not outright inflationary, and can be implemented at a gradual pace,” Bruna Skarica, the bank’s chief UK economist, said.
Economists have said that a series of welfare U-turns, elevated borrowing costs and an anticipated productivity downgrade from the Office for Budget Responsibility could leave Reeves facing a shortfall against her fiscal rules of £30bn.
The OBR is expected on Friday to hand its “pre-measures” forecasts for the UK economy and public finances to the Treasury. The assessments contained in the key document will inform the broad shape of the 26 November budget.
Reeves this week used her conference speech to warn Labour figures against “peddling the idea” that the government could abandon fiscal responsibility, while Keir Starmer told delegates the fiscal rules were “non-negotiable”.
It came after Andy Burnham, the mayor of Greater Manchester, last week suggested that Labour should not be “in hock” to global bond markets, amid pressure to turn around the government’s dismal ratings in opinion polls.
The chancellor has also faced intensive lobbying from business leaders warning her against tax rises targeted at industry after last year’s autumn budget, while Labour is bound by manifesto pledges not to raise income tax, national insurance or VAT.
Some senior figures in government – including Darren Jones, the chief secretary to the prime minister – appeared this week to flirt publicly with the idea of breaching the tax pledges.
Morgan Stanley suggested Reeves could keep bond markets satisfied by breaking Labour’s promises, because this could help raise billions of pounds while limiting the impact on the UK economy.
“The most gilt market-friendly outcome is one where, perhaps in a breach of manifesto commitments, the government introduces [about] 1% of GDP in tax hikes next year,” it said.
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However, it suggested the chancellor could have scope to raise taxes elsewhere without stoking inflationary pressures. Tax increases that lead to higher consumer prices could weigh heavily on growth, while also forcing the Bank of England to maintain interest rates at higher levels.
In a table of possible tax hikes that it argued could raise between £25bn and £45bn, the investment bank said the biggest potential revenue-raising measure would be to extend the freeze of income tax thresholds by at least another year to generate between £7bn and £10bn.
Other measures included taxes on gambling, the banking industry, changes to council tax and an overhaul of pension taxation.
“Overall, we believe the budget is likely to be less bad than feared on the balance of 1) tax increase impacts spread across sectors (and therefore generally moderate), while 2) still being extensive enough to reduce the current level of market fiscal concerns (at least tactically),” Morgan Stanley said in its note to clients.
