Top economist warns Chancellor could be forced into major tax rise U-turn

Rachel Reeves may have to hike taxes she ruled out touching in the run-up to the general election, a top economist has warned, as the date for the autumn Budget was confirmed.

The Chancellor previously pledged there would be no future increases in income tax, national insurance contributions, or VAT. But Mohamed El-Erian, president of the Queens’ College, University of Cambridge, said she may be forced into what would amount to major U-turn.

Dr El-Erian said tax rises in the Budget - confirmed as November 26 - were now all-but inevitable. And he went on: “At the end of the day there’s only three ways to deal with a fiscal issue: you raise revenue, you cut expenditure, or you borrow more.

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“The government has made it very clear that it will not borrow more, we have already cut expenditure quite a bit and we all know that public services are stretched, plus we need to spend more on defence.

“So increasingly it looks like she’s going to have to increase taxes and increasingly it looks like she may have to resort to certain taxes that she ruled out in the run up to the general election last year.”

The Treasury’s plight has been made worsen by a rise in borrowing costs, fuelled by concerns about the economic outlook, along with higher costs for other governments around the world.

The yield - interest rate - on 30-year UK government bonds reached a new 27-year high of just over 5.70%., before falling by lunchtime on Wednesday.

With government debt soaring, and after a number of expensive policy U-turns, experts now believe tax rises in the autumn Budget are looking increasingly likely.

Dr El-Erian told BBC Radio 4’s Today programme: “The problem for the UK is every time interest rates go up in the rest of the world by a little, they go up by more here. They cough, we catch a cold.

“People are worried about a viscious cycle, what’s called a doom loop. Interest rates go up, the cost of borrowing goes up, the government has to raise more revenues to cover its interest costs, meanwhile companies find it more expensive to borrow, households find it more expensive to borrow, that lowers economic growth, as growth comes down revenues come down.”

In a video message, the Chancellor said: “Britain’s economy isn’t broken. But I know it’s not working well enough for working people. Bills are high. Getting ahead feels tougher. You put more in, get less out. That has to change.”

Listening Labour’s achievements in its first year, she insisted: “But I’m not satisfied. There’s more to do. Cost of living pressures are still real.

“And we must bring inflation and borrowing costs down by keeping a tight grip on day to day spending through our non-negotiable fiscal rules. It’s only by doing this can we afford to do the things we want to do.”

Ruth Curtice, chief executive of think tank the Resolution Foundation, said: “The Chancellor has officially fired the starting pistol on the countdown to one of the toughest second Budgets in living memory.

“With higher gilt yields currently adding over £3billion to debt interest costs, and over £6billion of policy U-turns announced since March, the Chancellor is already on track to miss her fiscal rules. With a growth downgrade also likely, significant fiscal tightening will be needed.

“The Chancellor should use this Budget to set out her tax strategy as well as raise revenue. While tax rises are likely to be necessary, this should aim to ensure they make the system fairer and more efficient, supporting higher growth and lower inequality.”

Health Secretary Wes Streeting told Sky News: "The Chancellor, since she came in last year, has been determined to restore stability to our economy, to get growth back into our economy, and to create the conditions where we can get the nation's finances back to health."

He said while there are "encouraging signs", there is "much more to do", and added: "Britain is not out of the woods, and that is why the discipline and the focus that she has brought on cost of living, on economic growth and creating the conditions for businesses to be successful is really important, and the discipline we show as a Cabinet in terms of public spending is really important."

Kathleen Brooks, research director at XTB, said the "focus is likely to remain on the Budget for some time" as bond markets look for reassurances on how Ms Reeves will plug a black hole in the nation's public finances - estimated by some to be as much as £51billion. She said: "UK bond yields have been on an upward trajectory for most of this year and have risen significantly since Labour took office.

"The bond market will need some hefty persuading that Labour will reign in public sector spending and bring the UK's finances under control. This is why we expect to see bouts of UK bond market volatility in the coming months."