The Starmer government has chosen to rapidly increase public spending and borrowing and has no credible economic growth agenda. In order to avert a future fiscal/current crisis its least bad option now is to increase the basic rate of income tax by 2p. A restoration of fiscal credibility would end the doom loop of endless tax rise speculation and enable the BoE to safely lower interest rates. Such a broken promise would probably seal its fate as a government but is the right thing to do.
As a low tax free-market economist of long standing I can scarcely believe I am writing these words, but Rachel Reeves would be right, and brave, to raise the basic rate of income tax rate by 2p in the forthcoming Budget. Why? Well, I am also a fiscal conservative. I have argued previously that the only long-term solution to the UK’s excessive fiscal deficits and national debt is to raise the UK’s sustainable growth rate. This would require tax reform and lower taxes, an aggressive deregulation programme, more pragmatic net zero policies, and major cuts in public spending, particularly on welfare. This is broadly the approach being successfully followed by President Trump in the USA. However, the fact must be faced that there is zero chance of this government adopting such a market friendly agenda, with the massive Labour majority decisively rejecting even very modest cuts to out-of-control welfare spending.
I wish it were not so, but in these circumstances an increase in the basic rate of income tax is the least worst option for the Chancellor. Of course, such a tax rise would further damage the economy in the short term, but failing to curtail the UK’s excessive borrowing would be even more damaging. In the absence of decisive action – particularly considering the UK’s huge off balance sheet liabilities – a major bond market and/or currency crisis seems inevitable. The tax increases the Chancellor has chosen so far have been counterproductive, either raising little or no revenue (e.g VAT on private schools, higher taxes on non-doms) or being particularly damaging to employment and business investment (e.g national insurance hike and higher oil and gas windfall taxes). In contrast a higher basic rate of income tax is simple to administer, raises large amounts of revenue and deters consumption more than investment.
There is speculation that the Chancellor might partially offset a 2p increase in income tax by a 2p reduction in National Insurance Contributions, in effect limiting the tax hike to pensioners, the self-employed and landlords. This would be a mistake. It would destroy the “we are all in this together” argument. Furthermore, if the government is going to break a major manifesto promise it may as well go all in, because there will be a massive political backlash anyway. A full 2p tax rise would raise approximately £22bn annually by 2028/29 and go a very long way to eliminating the “shortfall” that the OBR will have informed the Treasury it faces on current trajectories. Together with other lesser tax changes and modest spending cuts the economy might then escape the doom loop of constant damaging speculation about what tax increases are coming next. The international bond vigilantes will focus on other debt incontinents such as France, and the BoE can then help counteract renewed recessionary pressures with lower interest rates. The electorate would also be directly confronted with the consequence of electing politicians who cannot control public spending.
Historically, governments that break major manifesto pledges get thrown out at the next election. There are current parallels with “Black Wednesday”, when the then Tory government was forced to withdraw from the ERM (Exchange Rate Mechanism). That government’s fate was then sealed, but it proved a major positive turning point for the economy. The mistake made was joining the ERM in the first place, not withdrawing from it. This government has already made the mistake of vastly increasing borrowing and spending. I would urge Ms Reeves to “screw her courage to the sticking place” and act decisively. The Starmer government’s fate may already be sealed, but she will go down in history as having done the right thing.*
Robert Lee November 5th, 2025
*The Chancellor should avoid making the ridiculous claim that tax rises are partly due to Brexit. UK economic performance since the Referendum, or since the Trade and Cooperation Agreement (TCA) came into force, has been considerably better than Germany and in line with the rest of the EU. Any damage caused by initial disruption to UK/EU trade has long since been absorbed, while better links with the rest of the world through recent major trade agreements will be increasingly beneficial. Our weak productivity growth is largely down to a large drop in public sector productivity, which even the most ardent Remainer can hardly pin on Brexit. The UK Treasury has received additional import tariff revenue of nearly £20bn since the TCA, while gross membership contributions of £88bn have been saved. No Ms Reeves, the major deterioration in fiscal and economic performance since this government took office is entirely down to the damaging policy decisions it has taken.
Rob Lee is a retired economist and investment manager
