IFS warns Rachel Reeves against ‘half-baked dash for revenue’

Rachel Reeves must avoid “a half-baked dash for revenue” or risk damaging economic growth as the chancellor seeks to close a large gap in next month’s budget, the Institute for Fiscal Studies has said.

The tax and spending thinktank has warned there was a danger the chancellor would create “unnecessary economic damage” if she chooses to stitch together unrelated tax-raising measures to cut the shortfall in government revenues and keep within her fiscal rules.

In a chapter from a report due to be published later this month, the IFS said Reeves could raise tens of billions of pounds in extra revenue without breaking Labour’s manifesto pledges, but cautioned that higher rates on longstanding, poorly designed taxes would have a detrimental effect on incentives to work, productivity and economic growth.

“A budget focused purely on the politics could prove considerably worse on the economics,” the thinktank said.

Reeves has ruled out increases in income tax, national insurance and VAT before the budget next month, which is being viewed as a make-or-break reset for the government after a torrid first 15 months in office.

While there is potential to close the budget gap with spending cuts or higher borrowing, the chancellor has come under pressure to avoid using them to improve the UK’s financial position.

Rebel Labour MPs have forced the government to backtrack on spending cuts, most recently reductions in universal credit payments. Meanwhile, the interest rate on government borrowing has remained high this year, deterring the chancellor from increasing debt levels.

Treasury officials are understood to be considering several tax-raising options in an effort to close a spending gap of £20bn to £30bn.

Adding to the need for higher tax receipts, Reeves is keen to double a near £10bn budget buffer to about £20bn to allow for greater flexibility when the public finances come under pressure.

The IFS said the UK was “in a fiscal bind” but could raise significant funds by adopting far-reaching reforms to taxes on savings and investment income, such as rental income, dividend income, interest income, self-employment profits or capital gains.

Analysis by IFS researchers for a chapter of the IFS Green Budget shows an increase in the tax on pensions, including levying national insurance on employer pension contributions and limits on the ability of retirees to access 25% of their savings tax-free, could raise billions of pounds.

“Employer [national insurance contributions] could be levied in full on all employer pension contributions, and replaced with a 10% subsidy on all employer pension contributions. This would raise around £6bn a year,” the report said.

The report said there was also a potential windfall of £10bn from closing a tax gap that had opened up in recent years. It said small businesses were paying only 40% of the tax they owed.

“In 2029–30 terms, a corporation tax gap of that size would represent more than £24bn of forgone revenue; just returning the gap to 2017–18 levels could raise more than £10bn,” it said.

Isaac Delestre, a senior research economist at IFS and an author of the chapter, said: “Revenue-raising seems likely to be a major goal of the coming budget. But if Rachel Reeves limits her ambition to collecting more revenue, she will have fallen short.

“Almost any package of tax rises is likely to weigh on growth, but by tackling some of the inefficiency and unfairness in our existing tax system, the chancellor could limit the economic damage. The last thing we need in November is directionless tinkering and half-baked fixes,” he said.