Raising income tax is ‘least damaging’ option for Reeves, says think tank

Hiking income tax would be the “least damaging” option for Chancellor Rachel Reeves, whereas raising VAT could push down harder on people’s real incomes, according to new economic analysis.

The Government is under pressure to raise revenues and balance the books ahead of November’s autumn Budget statement.

Analysis carried out by the National Institute of Economic and Social Research (NIESR) suggests that it would be harmful for the Chancellor to find other ways to raise tax revenue beyond the “main” UK taxes.

The economic think tank analysed the economic impact of raising income tax, corporation tax and value added tax (VAT).

Of the three, NIESR said raising VAT would have the biggest negative impact on the UK economy by lowering real personal disposable income (RPDI) by nearly 3% and real gross domestic product (GDP) by nearly 1% in the first year of the tax being applied.

A higher rate of VAT would also push up inflation more than the other levers because of the impact it would have on prices in shops.

Raising corporation tax – which is charged on the profits made by businesses – would have a smaller short-term impact but drag on the economy in the long run by reducing investment, according to the analysis.

On the other hand, hiking income tax would have the lowest impact, bringing down GDP by about 0.05% in the first year after the tax is applied.

The scenarios in NIESR’s analysis are based on the assumption that the Government aims to raise total net annual revenue by £30 billion by 2029-30.

This is how much Ms Reeves needs to raise to fill an estimated black hole in the public finances.

NIESR said the “least bad” option therefore was for the Chancellor to increase income tax at her next Budget.

The think tank acknowledged that doing so would mean the Labour Government breaks its manifesto pledge not to raise taxes on “working people” – which it said was now widely interpreted to mean income tax, VAT, employee national insurance contributions, and corporation tax.

“We would argue that they could find other ways to raise tax revenue but doing so would be much more distortive, harming the economy in the longer run,” the report’s authors wrote.

Ed Cornforth, NIESR economist and main author of the analysis, said: “Our analysis clearly shows that a rise in income tax is the Chancellor’s least damaging, most reliable option for putting the economy on a sustainable, secure footing.

“VAT would put pressure on prices, an undesirable option given current inflation expectations, and additional business taxes would harm investment incentives, at a time when employer NICs have already dampened business confidence.

“Although it is politically unsavoury, avoiding raising income tax will force the Chancellor’s hand into worse options – tinkering around the edges simply won’t shift the dial.”