Rachel Reeves has “one hand tied behind her back” as she considers how to balance the books next month in her first budget, a leading economic thinktank has said, after she ruled out increases to the four main taxes that account for 75% of all revenues.
The Institute for Fiscal Studies (IFS) said Labour had promised not to raise income tax, national insurance, VAT or corporation tax before the budget, heightening speculation that Reeves will seek to increase revenues from rises in capital gains tax, inheritance tax and stamp duty on property sales.
The IFS said there was a danger the chancellor would seek extra revenues from “economically damaging” tax rises that only bring short-term relief to the government’s spending deficit.
The IFS said Labour entered office faced with “unenviable arithmetic” given that the previous government had pushed tax revenues to the highest level since the 1940s, while also imposing “big cuts to public investment and some public services”.
“Merely avoiding spending cuts would – if debt is to fall – likely require raising tens of billions of additional revenue by 2028-29,” the report said.
Official data on Friday put further pressure on the government to raise taxes after it showed that Britain’s national debt had risen to the highest levels since the 1960s.
Soon after taking office, Reeves said the Conservatives had left a £22bn hole in the public finances, mainly from underfunded pay increases for public sector workers and a deficit of more than £6bn in the Home Office budget. This shortfall was only partly filled by the £1.4bn saving from restrictions to the pensioners’ winter fuel allowance.
Saying that “Reeves has not made life easy for herself”, the IFS said government spending could still be supported by large injections of funds from taxes outside the big four, but it would take courage to carry through the necessary changes. It said England could copy the example set by Scotland and increase the council tax that applies to homes ranked from band E to H, raising £1.5bn in extra revenue.
“Going further and increasing rates by 50% on the highest-value properties – bands F to H – would bring in closer to £3.5bn,” the IFS said in a report, Options for Increasing Taxes.
Changes to inheritance tax, which is on course to raise £7.5bn in this financial year, could increase the Treasury’s firepower, it said. “A good start would be ending, or at least capping, the unjustified exemptions for pension wealth, business assets and agricultural land – a change that would raise around £2bn a year assuming no behavioural response,” it added.
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Counselling against an increase in stamp duty on property sales, the IFS said this would repeat the mistake made by George Osborne, who increased insurance premium tax to a level that deters people from buying insurance. “[Stamp duty on property] … should be reduced or – even better – abolished, and certainly not increased,” the report said.
Isaac Delestre, an IFS research economist, said: “With large swathes of the tax system seemingly off-limits due to Labour’s manifesto commitments, the chancellor is going into this year’s budget with one hand tied behind her back. There will be a temptation to increase revenues in ways that would be economically damaging.
“But Rachel Reeves also has the power to fix some of the more glaring deficiencies of our tax system: taxes on pensions, capital gains and inheritances – to name just three – are all crying out for reform.
“If she takes the opportunity to improve taxes, as well as increase them, she could be rewarded not only with more revenue but also with a tax system that is fairer and less of an impediment to growth.”