Budget 2025 income tax U-turn: What the hell just happened?

What the hell’s just happened? 

On Thursday night I was told that Chancellor Rachel Reeves and Prime Minister Sir Keir Starmer were now not going to raise income tax, having had anonymous briefings for weeks that a manifesto-breaking tax rise was coming, culminating in the speech in Downing Street by the chancellor last week alluding to that.

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I had also heard the prime minister was going to make a speech next week to the same effect.

The U-turn – first broken in the Financial Times – was not something the government wanted to leak, and there is anger in Downing Street.

I was told late last night by a source that the decision had been taken to back off income tax rises.

There is obviously some consternation, to say the least, that ministers, the party, the public have been marched up the hill, only to be marched back down again. It all adds to a sense of chaos and a government out of control. So what on earth is going on?

Read more: How No 10 plunged itself into crisis

Let’s first do the economics of it. I was told this morning by Treasury sources that the fiscal forecasts from the Office of Budget Responsibility are stronger than expected.

There had been expectations of a £30bn-£40bn black hole in the public finances.

But I’m told today that black hole is actually closer to £20bn: the chancellor also wants headroom of perhaps up to £15bn, but I’m told the change in forecasts has changed the calculation. I’m told wage growth has been stronger which has helped tax receipts and improved forecasts.

So, where does that leave the government? Treasury figures tell me that the change in forecasts mean the manifesto-busting income tax hike is now not necessary.

I don’t need to spell out the jeopardy for such a move: Rachel Reeves was poised to be the first chancellor in 50 years to raise the basic rate of income tax and break the core manifesto pledge that Labour made to voters last year.

It doesn’t mean taxes are not going up. The government is set to freeze tax thresholds for another two years from 2028. That will raise around £8bn as millions of workers are dragged into higher tax bands and end up paying more tax.

There will also be tax raising around pensions and salary sacrifice schemes and on electric vehicles, as well as other measures, as the chancellor casts around for £20bn.

But what about the politics? Well, one government figure today insists that the decision to drop the income tax plan is nothing to do with the self-inflicted leadership crisis at No 10 after anonymous briefings designed to see off any potential post-budget coup against the prime minister spectacularly backfired. The changed forecasts, I’m told, came in last week.

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But of course there’s tonnes of politics in this. The talk of higher wage growth perhaps offsetting some of the productivity downgrades was being flagged a couple of weeks back, before the chancellor made her speech.

It’s extremely unusual for a chancellor to pitch-roll their budget. But Reeves did it for a reason.

That was laying the ground for a massive budget that would bring manifesto-breaking tax rises.

She told us of the difficult environment, ruled out more borrowing or spending cuts before telling us “everyone must play their part”. She repeatedly refused to stick to manifesto promises on tax. It doesn’t get much more stark than that.

That the government has U-turned on that decision is about far more than just the fiscal framework.

Read more: What taxes could go up now?

With trust so low in the government, there were serious worries – and warnings – from the party that such a big manifesto break might be something from which the PM and the chancellor wouldn’t recover.

One senior party figure that thinks there could be a leadership challenge after the May elections told me this week that manifesto-breaking tax rises would only make that more likely because Labour would “need a clean skin” to try and rebuild with the public if Starmer broke his promises in that way.

Read more: Is Starmer ‘in office but not in power’?

Lucy Powell, the deputy Labour leader, fired a warning shot last week when she said the party should stick to the manifesto and not raise tax: “We should be following through on our manifesto, of course. There’s no question about that,” she told Matt Chorley on BBC Radio 5 Live.

“Trust in politics is a key part of that because if we’re to take the country with us then they’ve got to trust us and that’s really important too.”

The party will no doubt feel relief today that the chancellor is not going to break the manifesto.

It would have only made things a whole lot worse for a government that is in real trouble.

But the shambles of this week is staggering. From the self-inflicted leadership crisis to leaks over a massive budget U-turn, it all lends to the sense that this is a No 10 out of control, lurching from one mess to another. Strap in.