Reeves’ spending spree could open £20bn gap – which taxes will rise?
Rachel Reeves splashed the taxpayer cash in her inaugural Spending Review, raising expectations the Chancellor may be coming back for more tax revenue in the Autumn if her growth ambitions are not met.
Reeves is set to hand out an extra £190bn in government spending over the course of the parliament, in what she described as a “credible plan for the renewal of Britain”.
Yael Selfin, chief economist at KPMG UK, said if growth was to fall in line with forecasts the government would require a top up of around £20bn, fuelling tax hike speculation.
Shadow Chancellor Mel Stride described Reeves’ actions as “spend now, tax later”.
Sarah Coles, head of personal finance at Hargreaves Lansdown, said the government was pegging their spending spree on growth, which would boost the tax take.
Reeves received a modest boost after data from the Office for National Statistics showed the UK economy grew 0.7 per cent in the first three months of the year.
But figures for the coming months are set to be defined by Reeves’ October 2024 tax hikes which came into effect in April.
Pensions
The Treasury’s Pension Schemes Bill, introduced last week, focused on key areas including giving the government a “reserve” power to force pension schemes to invest in the UK and a new mechanism for merging smaller, defined pots.
But questions have been raised about potential changes to salary sacrifice schemes, which allows members to curb income tax and National Insurance after giving up a chunk of their salary in exchange for money paid directly into pension pots.
Coles said: “If the government outlaws these schemes, it would make company pensions less tax-efficient for firms, so they may be tempted to cut the benefits.”
Ministers have claimed pension pots hold £160bn more than their estimated liabilities, with pension reform a key pillar of Reeves’ investment-led economic strategy.
But Department for Work and Pensions analysis suggests just around £11bn could be realistically extracted over a decade.
Investments
Cole said the government might steer away from policies that risk “denting people’s enthusiasm for the stock market” due its pro-investment position.
But a leaked memo obtained by the Telegraph in May revealed Angela Rayner had been privately lobbying for a hike to dividends tax.
The Deputy Prime Minister proposed scrapping the £500 tax-free allowance for dividends and hiking the rates paid on dividends by the wealthiest investors.
Inheritance tax
Reeves changes to inheritance tax in the Autumn Budget sparked outrage with farmers but Rayner’s memo proposed scrapping the relief entirely for AIM investments.
Inheritance tax benefits on London’s junior stock market are already set to be slashed in half from April 6, 2026.
Cole said: “The complexity of this tax means there are always tweaks and changes the government could make, but each one would have consequences that would need to be carefully considered.
“It might, for example, tweak the rule which means that gifts of any size can be given to anyone, and as long as you live for another seven years, it’s out of your estate for inheritance tax purposes”
Income tax
Income tax has been a historical target for Chancellors.
In 2021, Rishi Sunak froze the personal allowance rate at £12,570 and higher rate threshold at £50,270 until April 2026. Jeremy Hunt extended the deadline to April 2028 under his Chancellorship.
Cole said Reeves could find the option of extending the freeze “politically useful because it increases the tax take, without actually being a tax rise.
“The problem is that this will raise money in future years – beyond 2028 – so won’t help in balancing the books in the interim.”
U-turns incoming?
If Reeves chooses to steer clear of the previous options, she may be forced into another U-turn.
The government has already retreated on its changes to the Winter Fuel Allowance after facing a storm of backlash and poor local election results.
The backtrack marks a £1.25bn blow to Reeves’ wafer-thin £9.9bn in fiscal headroom.
After relentless promises “not to raise taxes on working people,” a U-turn on National Insurance or VAT would be a political mindfield for Labour but weak growth figures could lead to it to being an option on the table come October.
Cole said: “The government might decide in a world with no good options, it could be worth the backlash in order to put the country’s finances on a firmer footing.”