There were always two camps in the internal government debate over what to do at this month’s budget, one of the most consequential in recent history. One set of advisers believed that given the scale of the fiscal challenge facing the chancellor, she should do what no chancellor has done in 50 years and put up income taxes. The other worried that breaking a key manifesto pledge would be political suicide and that Reeves should find multiple other ways to raise taxes – what some called a “smorgasbord”.
For weeks, Reeves had appeared to side with the first camp, delivering speeches warning of difficult choices to come and telling a BBC interviewer that keeping her manifesto promises would mean cutting spending.
Then on Wednesday all that changed. With Keir Starmer facing a political backlash after a botched attempt by aides to shore up his leadership, he and the chancellor agreed that the planned income tax rise should not go ahead.
Government insiders say the dramatic U-turn was made after official forecasts showed the government’s shortfall was closer to £20bn than £30bn, allowing the chancellor to take a less politically risky path.
Some officials say, however, that the forecasts did not change drastically in the last week and that the last-minute change of approach was motivated by a desire not to exacerbate the sense of political turmoil surrounding the government. “There are good economic reasons not to raise income tax,” said one government official. “But politics played a part – it always does.”
For several weeks, ministers and officials have juggled various options during budget discussions, working up some plans that included an income tax rise and some that did not.
They knew the Office for Budget Responsibility was planning to downgrade its forecasts for the UK’s economic productivity, leaving a £21bn gap in the government’s financial plans.
As a result, various tax rises were considered and many made their way into the press, before what some have called the most leaked budget in history.
Those calling for a rise in income tax rates were particularly motivated by a desire to increase the chancellor’s headroom against her own fiscal rules, meaning she would not have to come back for more tax rises even if forecasts changed again.
One option was to raise income tax by 2p and lower national insurance by 2p, which would have raised £6bn but allowed the chancellor to stand by her claim of not raising taxes on working people – with the brunt of the tax rise being felt by pensioners and landlords.
Others wanted to limit the national insurance cut only to those earning about £50,000 and below, in an attempt to maximise the amount of money that would be raised.
Some planned tax rises were scrapped after the OBR judged they would not raise significant money, including plans to remove tax breaks from professionals such as lawyers and doctors who are employed through partnerships.
Others remained as options to be pursued should the chancellor decide not to raise income tax rates – such as freezing thresholds for longer, which would mean hundreds of thousands more people paying income tax, raising an estimated £7.5bn.
On 31 October, the OBR presented its major economic forecasts to the government, which would have included the crucial data on wage growth that would shape the decisions to come.
The chancellor responded by confirming to the OBR that a rise in income tax rates was among the “major measures” under serious consideration and signalling publicly that she was prepared take tough decisions.
In a rare pre-budget speech on 4 November, she argued: “I could do what previous governments have done, which is to sweep those challenges under the carpet, to cut capital spending, to make the numbers up. But then we’d be back here in a year, in five years’ time, with productivity still on its knees, growth underperforming, national debt continuing to rise. So I’m being honest with people.”
On Monday the OBR presented its latest forecasts to government, including projections of the impact of the chancellor’s plans. Even after that point, Reeves continued to hint at an income tax rise to come, telling the BBC on Monday afternoon: “It would, of course, be possible to stick with the manifesto commitments, but that would require things like deep cuts in capital spending.”
Some economists have criticised her openness about her plans, but officials say it was essential to prepare the markets and avoid a Liz Truss-style meltdown in the days afterwards.
Some experts have even suggested the chancellor may have allowed speculation about an income tax rise to mount in order to reduce government borrowing costs just as the OBR was drawing up its forecasts.
This claim has been denied by officials – though the OBR confirmed on Friday it had chosen to base its assumptions about the cost of government borrowing on a period when costs were particularly low.
It was on Wednesday that everything changed. That morning, Starmer had woken up to headlines about his allies warning of a possible leadership coup by his health secretary, Wes Streeting. As the day progressed, the prime minister came under fire for the behaviour of his own advisers. Some Labour MPs called for him to sack his chief of staff, Morgan McSweeney.
It was against this backdrop that he and his chancellor decided to drop the plan to raise income tax – a plan that Streeting himself had warned risked alienating the trust of voters.
Advisers insisted it was the rosier-than-expected OBR forecasts that prompted the abrupt change, but others pointed out that the chancellor had continued to prepare the ground for an income tax rise even after seeing them.
The U-turn was revealed by the Financial Times on Thursday and by Friday Reeves and Starmer were facing a market sell-off, with government borrowing costs rising and the pound weakening.
Some in government believe these market jitters paled in comparison with the potential political ramifications of breaking a major manifesto pledge on tax. “This has been handled chaotically,” said one. “But we’ve got to the right place in the end.”
