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Rachel Reeves is being warned she may have to break Labour's promise not to raise income tax or national insurance to fill a £40bn black hole in her spending plans.
The concerns come after the chancellor warned cabinet colleagues this week that she needs to deliver spending cuts and tax rises of £40bn to balance the books – far more than the £22bn that, according to her, the conservatives left behind.
Ms Reeves was boosted on Wednesday by a fall in inflation to 1.7 per cent – the first time in three years it has been below 2 per cent – meaning benefit payments will not have to increase as much as was feared. However, it also means that it will not raise as much money as expected by freezing income tax band thresholds.
The conundrum has led to speculation that Ms Reeves will unveil a £25bn tax raid in her budget on October 30, while spending on benefits and even foreign aid, traditionally protected by Labour, is under threat.
He has already controversially withdrawn winter fuel payments from 10 million pensioners amid a plethora of cuts to balance the books after taking power from the Conservatives at a time when he has also been trying to meet the pay demands of the public sector.
But in a stark warning, Institute for Fiscal Studies (IFS) director Paul Johnson said he will struggle not to break Labour's commitment to keep income tax and national insurance at their current rates.
He warned that “in the end [Labour] “We will have no choice but to raise income taxes.”
He told BBC Radio 4 Today program: “If we get tax increases on that scale, it would be extraordinary, it would be unprecedented. They would be tax rises three times larger than those introduced by George Osborne in the depths of the aftermath of the financial crisis.
“That said, if you are a government that not only wants to protect public services but also a significant increase in the health service and an increase in spending on other things commensurate with the size of the economy, yes, there is a very big hole in public finance.
“Of course, we have always known that. We've had this discussion during the election when we were warning that there were these problems, and Keir Starmer and others were saying 'no, no, no, there aren't'. “£40 billion is a big figure.”
The warning came after Reeves' former boss at the Bank of England, former governor Mervyn King, called on him to increase national insurance despite Labor having promised to freeze it. There is speculation that Ms Reeves will keep employees' national insurance contribution as it is, but will increase the contribution paid by employers.
But falling inflation could give the Chancellor an extra boost by making it more likely that the Bank of England will cut interest rates again in November to 4.75 per cent.
Gov. Andrew Bailey had previously indicated his desire to lower rates, saying earlier this month that rate cuts could become “more aggressive” if necessary.
Chief Secretary to the Treasury Darren Jones said: “There is still much to do to protect workers, which is why we are focused on regaining growth and restoring economic stability to deliver on the promise of change.”
But her Conservative counterpart Laura Trott hit back, saying the figures “show that Labor inherited a strong economy, thanks to the difficult decisions we made to tackle inflation when it was at its peak”.
The government uses September's inflation figure to decide a series of tax and spending changes for next year, and it means state benefits will rise by just 1.7 per cent next year. Due to the triple lock, the state pension will increase by more than double that amount, by 4.1 percent.
Office for National Statistics chief economist Grant Fitzner said: “Lower airfares and petrol prices were the main factors behind this month's decline. These were partially offset by increases in food and non-alcoholic beverages, the first time food price inflation has strengthened since early last year.”
Rampant inflation in previous years has caused everyday costs to skyrocket, with the consumer price index (CPI) hitting a record 11.1 percent in October 2022. The latest figure marks a return to more common inflation , but it is still higher than the early rates. 2021, which were often below 1 percent.
David Murray, financial planning expert at abrdn, said: “All signs pointed to a decline in inflation in September, so rates will continue a downward trend to 1.7 per cent, the first time the inflation has been below the government's target of 2 percent.” in more than three years – it will be a great relief.
“This will leave many expecting an interest rate cut next month, meaning we will see two cuts before the end of the year, with some even suggesting the base rate will be reduced to 4.5 percent.”
