IFS Warns of £25 Billion Tax Hikes as Labour Prepares to Restore Public Services

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The IFS says an additional £16 billion in tax hikes on top of manifesto pledges is not required if public service spending only increases in line with inflation.

Keir Starmer’s commitment to end austerity and restore public services will need according to the IFS, £25 billion tax increases annually in the upcoming budget, even if debt rules change to allow for more investment spending.

The Institute for Fiscal Studies (IFS) stated in its preview of the first Labour budget in 14 years that Rachel Reeves would need tax increased to an all-time high to achieve the government policy objectives. The chancellor was also cautioned of a Liz Truss-style meltdown if the city responded poorly to significantly higher borrowing.

Reeves would face a challenge finding £25 billion of tax rises because the election manifesto excluded raising VAT, income tax, and employee national insurance contributions.

The opposition leader, Rishi Sunak, challenged Prime Minister Starmer twice during Prime Minister questions to rule out an increase in employer NICs that would rise annually to nearly £8 billion. However, Starmer declined to do so.

Labour announced tax increases of £9 billion, but the IFS stated that Reeves would need to raise an additional £16 billion to meet daily spending funded by tax receipts to increase public service spending in line with national income.

The think tank stated that she might find it difficult to raise taxes on that scale since she has pledged not to increase the rates of income tax and corporate tax nor to raise national insurance or VAT.

It would surpass the net tax increases between £13 to £14 billion put into effect in October 2010 and July 1997. In that case, she has to live with daily spending on many public services, a small portion of national income.

Even though the incoming government might offer tax increases and a reduction in spending in the first budget after an election, IFS said that due to the aging population, less fuel duty and tobacco revenue as people switch to electric vehicles and reduced smoking might lead to more harsh packages in the future.  

The Office of Budget Responsibility estimated that the share of tax in the GDP would rise to 37.1% by 2028, the highest level since 1948, and an additional £25 billion tax increase would bring taxes to 38% of GDP.

The IFS says an additional £16 billion in tax hikes on top of manifesto pledges is not required if public service spending only increases in line with inflation.

Simply maintaining daily spending in areas like skills, courts, and prisons may prove insufficient, given the strain on public sector pay and the desire to improve the quality of service.

The pre-budget speculation focus was whether Reeves would adopt a different debt guideline to increase the scope of additional spending on infrastructure projects. Now, the rule requires the debt to decrease as a share of national revenue within five years, except for Bank of England operations.

However, the chancellor intends to change the method of debt calculation to generate an extra £50 billion in spending capacity.

The IFS stated that Reeves would increase taxes to prevent spending cuts and only borrow for investment, even if the fiscal rules were changed so that debt increased in the final year of the forecast.

Ben Nabarro, the chief UK economist at Citi, the bank in charge of the economic forecasts supporting the tax, spending, and borrowing assumptions in the IFS, warned that unless Reeves clarified that any increase in investment spending would be gradual, there was a risk of a buyer strike or a run on government bonds.

The gilt market is seriously concerned about an unrestrained demand for investment. International investors are not giving the benefit of the doubt to the gilt market after the disastrous mini-budget made by Truss two years ago.

The interest rate for the 10-year UK gilts has increased since last month from 3.75% to 4.2%.

According to Nabarro, the UK faced budgetary constraints that many other advanced countries do not because of its stock of outstanding debt and current account deficit.

The first budget of this new administration may be the most significant since 2010, according to IFS head Paul Johnson. If the next chancellor wants to fund public services and increase investment spending, they have to borrow money and raise taxes.

Fuel and tobacco duty revenues will decline, and health and pension spending will only increase.

It will make it more difficult for the parliament to stay on course for the present budget balance, and Reeves may experience another sting by the next election if she fails to understand it.

Treasury is committed to making the most out of pro-growth Treasury in history, despite the discovery of a £22 billion black hole in public finances. It includes implementing strict budgetary policies and building upon the foundation of economic stability.