Rachel Reeves is set to abandon a plan to raise income tax in her budget with the chancellor reportedly “ripping up” the main measures in the wake of turmoil in the party.
A source told the Guardian that plans to break the manifesto pledge on income tax had been ditched by the prime minister, Keir Starmer, and the chancellor.
It comes after a week of extraordinary briefing wars in the party as allies of the prime minister suggested he would fight any leadership challenge, with some pointing to the health secretary, Wes Streeting, as a potential challenger, which he publicly denied.
The bombshell tax U-turn, first reported by the Financial Times, was sent to the Office for Budget Responsibility on Wednesday. Downing Street did not deny the reports but said it would not comment on budget matters.
Reeves had previously informed the budget watchdog of plans to raise income tax – breaking one of Labour’s key manifesto pledges.
The FT reported Reeves may now look at thresholds at which people pay tax, which is likely to be seen as an income tax rise by stealth.
Sources close to the chancellor had stressed her desire for significant headroom in the budget to avoid the swirl of speculation over whether she would breach the fiscal rules.
Reeves and Starmer are now likely to rely on several smaller tax-raising measures in order to fill an anticipated multibillion-pound “hole” caused by a downgrade in productivity and U-turns on other policies including cuts to the winter fuel allowances and disability benefits.
Among those measures are likely to be higher levies on gambling, pushed by the former prime minister Gordon Brown, to pay for the cost of ending the two-child benefit limit – another potentially large cost for Reeves.
Treasury sources have said there is no way that revenues from the levies would come close to funding an end to the cap.
The U-turn comes 10 days after Reeves gave a seemingly certain indication of her plans during a sudden Downing Street press conference in which she refused to rule out raising income tax.
“As chancellor, I have to face the world as it is, not the world that I want it to be,” she said, in remarks taken as pointing to tax rises.
Downing Street and the Treasury have been preparing the ground for weeks with Labour MPs for a breach of the manifesto. In particular, it has been stressed to Labour MPs that they should not speak out against the budget because of the effect any potential measures might have on the bond markets and the UK’s borrowing costs.
That message to MPs is likely to ring hollow if the chancellor has U-turned after days of internal warfare over a potential challenge to the prime minister’s leadership and the spotlight on briefings against the health secretary, Wes Streeting.
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Reeves is already expected to extend a freeze on personal tax thresholds that was introduced by the Conservatives.
In the last few weeks, the Treasury has attempted to win round Labour MPs to the income tax plan, holding round-table events with ministers and economists to convince them of the need for fiscal stability.
Despite Labour’s large majority, MPs had shown their parliamentary might at the welfare vote in July, forcing the government into a damaging U-turn.
Government sources initially felt their charm offensive was working, but many Labour MPs remained alarmed at the impact on their constituents and sceptical of the wisdom of breaking such a significant manifesto promise.
Months of discontent with Starmer and his political operation burst into the open over the plan, with MPs openly discussing whether it would be the end for the prime minister.
This week, Downing Street mounted an extraordinary operation to shore up his leadership by briefing the Guardian of the dangers of destabilising the government and insisting that Starmer would fight any challenge. But their efforts backfired dramatically when close allies of the prime minister shared speculation that Wes Streeting was planning to mount an imminent coup.
Labour MPs and ministers – including some in the cabinet – were astonished at No 10’s admission that the prime minister was vulnerable and believe that the action has fired the starting gun on the race to succeed him.
