UK Chancellor Rachel Reeves has abandoned plans to increase income tax rates, a reversal from her recent hints, as improved economic outlooks have eased budget pressures, though the uncertainty has unsettled financial markets.
For weeks, Chancellor Rachel Reeves had fueled speculation that she might break Labour’s manifesto pledge by raising income taxes to address a significant fiscal shortfall. However, in a sudden shift, she has now ruled out such increases, opting instead to seek revenue from other sources. This decision comes amid a volatile pre-Budget period where various tax options were being floated and tested for public and market reaction. The change of heart highlights the delicate balancing act facing the government as it prepares its first major fiscal statement.
The proposed plan, informally dubbed “2 up, 2 down,” involved raising income tax rates by 2 percentage points while simultaneously cutting National Insurance contributions by the same amount. This approach, championed by the Resolution Foundation think tank, was designed to generate several billion pounds primarily from non-wage income, such as rental earnings and investment returns. It was submitted to the Office for Budget Responsibility (OBR) for costing earlier this month to help close what was then estimated as a £30 billion gap in public finances, largely due to downgraded productivity forecasts.
New assessments from the OBR have since painted a more optimistic picture, with stronger projected wage growth and tax revenues reducing the fiscal hole to around £20 billion. This improvement provided the chancellor with the leeway to step back from the politically contentious income tax hike. The iterative nature of Budget preparations means such adjustments are common, but Reeves’s public comments earlier in the week had strongly suggested tax rises were imminent, making the U-turn particularly notable.
The bond markets reacted sharply to the uncertainty, with UK government borrowing costs spiking by 0.12 percentage points for 10-year gilts following reports of the dropped plan. Investors, who had been reassured by Reeves’s tough fiscal rhetoric, grew nervous as the government appeared to waver on its commitment to fiscal discipline. The episode underscored the sensitivity of financial markets to political signals and the challenges of managing economic expectations in real-time.
In response, the government is now focusing on alternative measures to raise revenue, such as extending the freeze on income tax thresholds, which effectively increases tax bills as inflation pushes more earners into higher brackets. Ministers have emphasized that any tax changes will target wealth, capital, and non-wage income rather than directly impacting workers’ pay packets. This approach aligns with Labour’s manifesto promises to protect “working people” from tax hikes, but it raises questions about the fairness and efficiency of the tax system.
The political fallout has been significant, with Health Secretary Wes Streeting publicly affirming the importance of keeping election promises. Internal tensions and speculation about leadership dynamics within the government have added to the drama, highlighting the high stakes of fiscal policy in a weak economic environment. The chancellor’s ability to maintain credibility with both the public and financial markets will be crucial as the Budget date of November 26 approaches.
Looking ahead, the government must finalize its Budget plans amid ongoing economic uncertainties. The goal remains to increase fiscal headroom, address cost-of-living pressures, and make “fair choices” on taxation. However, the recent volatility serves as a reminder that clear and consistent communication is essential to avoid further market jitters and ensure a smooth rollout of policies that support long-term economic stability.
