Britons could face a major “stealth tax” raid that may help John Healey balance the books at the Budget.
According to the Institute for Fiscal Studies, rising inflation linked to the crisis in the Middle East is likely to pull more workers into higher tax bands.
Although wages may fail to keep up with rising prices, the long-standing freeze on tax thresholds means households will still hand more money to the Treasury.
The think tank estimates that this could increase the Chancellor’s income tax receipts by about £9billion a year by 2029-30, with the final figure potentially even higher.
The Government is also expected to receive substantial additional revenue from VAT and property taxes, although the IFS warned that the outlook remains highly volatile.
The extra revenue is expected to largely cushion a significant reduction in the Government’s “headroom” against its main fiscal rule, which requires the current budget to be in surplus in 2029-30.
That headroom stood at £24billion at the time of Rachel Reeves’ Spring Statement in March. Without the tax windfall, however, it could have been almost entirely eroded by rising interest payments on the Government’s debt and additional spending commitments.
Britons face a major “stealth tax” raid that could help John Healey, pictured with Andy Burnham, balance the books at the Budget
The tax windfall is expected to offset much of the hit to the Government’s headroom against its fiscal rule, which requires a current-budget surplus in 2029-30
The IFS may revise its wage forecasts upwards because inflation is expected to be higher
However, the IFS warned that it would not be “credible” for Mr Healey simply to keep the additional revenue in his October 28 package, because inflation will also place substantial pressure on departmental spending.
The report said the Chancellor would face a choice between raising taxes and increasing borrowing if he wants to lift defence spending to 3 per cent of GDP by 2030 while protecting departmental budgets.
The think tank cautioned that borrowing should not be increased at this point, with debt levels still high and financial markets unsettled.
Mr Healey appears likely to sidestep the defence issue for now, having said that a plan for defence investment will not be set out until a spending review expected next Autumn. This comes just months after he resigned from Keir Starmer’s Government in protest at the lack of a timetable for reaching the 3 per cent target.
Nick Ridpath of the IFS said inflation would add £24billion to the cost of preventing real-terms cuts to departmental budgets, while a further £11billion would be needed to meet the defence target by 2030-31.
IFS director Helen Miller said that if Mr Healey funded the full £35billion through taxation, he would need to increase the rate of income tax or VAT by 3 per cent. Uprating benefits is also expected to create around £10billion in additional costs.
“John Healey is likely to face a forecast showing that borrowing is still expected to fall in the coming years and that the fiscal rules are still being met,” she said.
“Despite that, a ‘steady-as-she-goes’ Budget is not an option available to the Chancellor.
“Choosing to stick with the inherited tax and spending plans would mean allowing inflation to push departmental budgets off course.
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“That would amount to accepting significant cuts to the quantity or quality of some public services—cuts that would be even larger if defence spending were increased from within existing budgets.”
She said: ‘If he chooses the path of squeezing public spending, he should be transparent that there are tough years ahead for some public services.
‘Simply pencilling in implicit cuts that he has no intention of delivering would make the Budget a work of fiction.’
The Tories introduced the freeze on tax thresholds in 2022. It was originally due to end in April 2026, but Jeremy Hunt extended that until 2028.
Ms Reeves than pushed that back another three years until April 2031.
The policy is already estimated to increase taxes by more than £50billion a year by the end of the decade.
Downing Street has played down vague suggestions from Andy Burnham that he would like to see the personal allowance go up soon.
The Tories said Labour should get welfare costs down to reduce borrowing rather than increase taxes.
The IFS pointed out that higher wages have a significant impact on the Treasury’s revenues
Shadow Chancellor Andrew Griffith said: ‘Labour raised taxes by £66billion in its first two Budgets.
‘Families cannot afford to be lumbered with even more tax rises… Labour should cut welfare instead of dumping on working people.’
It comes as Mr Healey has reportedly ruled out a ‘warehouse tax’ raid following pressure from high street shops.
In one of his first pledges as Prime Minister, Mr Burnham said he would ramp up taxes on warehouses to fund tax cuts for pubs and restaurants.
He is also thought to have abandoned plans to expand the scope of the ‘mansion tax’ to cover properties worth over £1.5million, instead of £2million as originally proposed.
The Chancellor is set to visit Bangkok for the IMF annual meetings this week, where he will tell international counterparts that major economies need credible plans to get borrowing under control.
‘The consequences of conflict in the Middle East and Europe are hitting countries worldwide, leading to higher prices at the pumps and more expensive mortgages at home, but Britain and our allies can face up to these challenges together,’ he said.
‘I will work with our international partners to keep trade moving, support families and businesses, and make Britain’s economy stronger and more resilient to deliver good growth in every postcode.
‘My Budget will build on this approach with fiscal discipline helping to deliver economic resilience. This means breathing space for today, and hope for the future.’