What can Rachel Reeves do to pay for Starmer’s welfare U-turn?

Taken together, the cost to the public finances of recent reversals on welfare payments is estimated to be around £4.5bn. Restoration of the pensioners’ winter fuel payment for most recipients will cost some £1.2bn, while keeping the present arrangements on personal independence payment and the health element of universal credit will mean the chancellor loses some £2.1bn and £1.1bn, respectively.

While these aren’t catastrophic changes in a total public spending universe of about £1.3 trillion, Rachel Reeves allowed herself very little fiscal headroom.

So she’ll be looking to make up for the cost of the recent U-turns. Given that she’s only just delivered a spending review that set out plans for the next three years, including tighter budgets for many government departments, she is reportedly more willing to consider tax hikes. The uncertain outlook for economic growth will make her even more cautious. Despite constraints, she has some options…

All the signs are that she won’t make any further changes that could be interpreted as a direct contravention of the 2024 general election manifesto promise: “We will ensure taxes on working people are kept as low as possible. Labour will not increase taxes on working people, which is why we will not increase national insurance, the basic, higher, or additional rates of income tax, or VAT.”

The 2 per cent hike in employers’ national insurance at the last Budget hit smaller businesses quite hard, and will affect wage rises, so it was very close to the letter of that pledge. She’s not going to go there again. But bear in mind that the freeze on tax thresholds will remain in place until 2028 – a hidden rise in income tax for many.

Lots: there’s a whole herd of sacred cattle that she can’t touch, politically. These include the rate of corporation tax, about which the manifesto says: “Labour will cap corporation tax at the current level of 25 per cent, the lowest in the G7, for the entire parliament”. Slapping VAT on zero-rated items is effectively ruled out, as are increases in most other business taxes. There’s zero chance of any further capital gains tax being applied to homeowners, which would make eminent economic sense but would be electoral suicide.

Reeves may also have run out of scope for squeezing rich non-doms – for fear of ending up with lower tax revenues due to flight and increased avoidance. Council tax procedures are being tweaked, but there is little chance of any thorough reform of the eccentric system of local government finance; memories of the imposition of the poll tax remain raw, almost four decades on.

The big picture here is that the UK tax base is artificially narrow, for historical and political reasons. For example, personal taxation in the UK is still low by international standards, even when the overall tax burden is near a post-Second World War high, but UK business rates are correspondingly high and uncompetitive. Wealth is taxed marginally and haphazardly. This is bad for long-term growth, and every year means taxes are loaded too high onto a too-narrow base.

Capital gains tax, as usual, but again Reeves will need to be careful not to go too far and risk discouraging savings and encouraging avoidance. The same goes for changing the rules on personal pensions: higher-rate tax relief on contributions and reducing the tax-free allowance for a cash withdrawal from a pension pot. Given the need for orderly retirement planning, radical changes would be undesirable and unpopular. But there could be adjustments.

It certainly should. Unbelievably, fuel duty has been frozen since 2011, at 57.95p per litre, with an additional 5p per litre “temporary” cut in 2022 to ease the cost of living crisis. Technically, this is due to be ended next year, with the duty now scheduled to rise. For Reeves to raise more than planned she’d have to up it by, say, 10p per litre. It would raise enough to pay for the U-turns, but would attract the scorn of the motorist and “white van man”. The wider problem here is that the switch to electric vehicles is already depressing fuel duties.

Alcohol and tobacco are mostly maxed out, but there’s still some scope with online gambling and duties on sugary and fatty foods. The sugary drinks levy worked very well on health grounds alone, but any “tax on food” has always been anathema to the British public (albeit VAT is levied on confectionery). Reeves will also be mindful of the great “pasty tax” fiasco of 2012 when George Osborne tried to make some rational changes to the VAT regime, including on “ambient” takeaway food. His “omnishambles” Budget soon collapsed, and Greggs customers have steadily got flabbier in the succeeding years. Rachel will be steering clear.

A wealth tax: a 2 per cent levy for those with assets in excess of £10m. No chance.

That does crop up as a suggestion. It’s very abstruse stuff, but this basically boils down to another tax on the commercial banks. It isn’t paid by “rich bankers” as such (though it might dent some bonuses) but by the banks themselves. Other things being equal, it would mean lower returns for savers, less availability of business finance and mortgages, and a less resilient banking system. The Bank of England says it could make managing monetary policy more difficult. But it could reduce the cost of borrowing to the Treasury by maybe £10bn a year. The chancellor may find the temptation irresistible.