It hasn’t yet been widely picked up, but this week Rachel Reeves substantially changed the government’s argument for putting up income tax, despite Labour’s explicit manifesto pledge to the contrary. It looks like much of the proceeds will now go to ending the two-child benefit cap, an expensive welfare change which she had hitherto resisted precisely because it would require a big tax increase.
The chancellor didn’t put it quite like that, of course. But join the dots and that’s where you end up. And coming after the government’s high-profile U-turn earlier this year on changes to Personal Independence Payment (PIP), which had a similarly big price tag, it looks as if the budget will make welfare reform an even more controversial battleground. I doubt this will play to Labour’s advantage.
First, a note on budget maths and chronology. On the maths, the cost of ending the two-child benefit cap is estimated at between £2.8 and £3.5bn a year. This is a large chunk of the proceeds (estimated at around £6bn) from increasing the basic rate of income tax by two pence while cutting National Insurance by an equivalent amount, which is the key budget measure that has been widely briefed. This move would break Labour’s manifesto commitment not to increase the rate of income tax.
Until this week, the chancellor’s argument for another big tax increase—on top of the increases in her first budget last year—was based on the need to fill a new, unforeseen “black hole” created by the decision of the independent Office for Budget Responsibility (OBR) to downgrade its productivity growth forecasts in the wake of Brexit. As one of her aides briefed the Financial Times last month: “The downgrade increases the likelihood that the chancellor will be forced to breach Labour’s election manifesto pledge on tax, with speculation growing that an income tax increase is looming on November 26.”
To ram the point home, the same FT story quoted a “Labour official” as saying there was “fury in Number 10 and the Treasury that the OBR has decided to deliver the downgrade now rather than before the 2024 general election.”
As for the two-child benefit cap, Reeves has resisted removing it precisely because it would involve a tax increase, given her own fiscal rules and the absence of growth or any other fiscal windfall. As she put it after last July’s election: “If we’re not able to say where the money is going to come from, we can’t promise to do it. That’s true when it comes to the two-child limit and anything else.”
Yet this week Reeves has indicated that the benefit cap is likely to be lifted. And the only place that “the money is going to come from” is from her projected tax increases—including the income tax rise—which had previously been billed as required to fill the OBR “black hole” without cutting essential spending.
Add in the cost of the government’s climbdown earlier this year on PIP, one of the fastest rising parts of the welfare budget, and the cost of these two welfare items alone—the two-child cap being lifted and the PIP changes abandoned—account for much of the proceeds from the projected two pence income tax increase.
None of this is to downplay the case for ending George Osborne’s two-child benefit cap in terms of fairness and reducing child poverty. As a public policy priority it arguably ranks higher than a lot of other public spending. The point is that to govern is to choose. And one of the biggest and most glaring choices the government is about to make is to put up income tax at the same time, and by an almost equivalent amount, as it adds to welfare costs by its decisions on the two-child benefit cap and PIP. The Tories and Reform will doubtless put this at the heart of their budget response, given opinion polls which suggest that the two-child cap has the support of a majority of the public. According to YouGov, half of Labour voters are in favour.
That still leaves one unanswered point in the chronology. Why Reeves’s apparently sudden change of heart on the two-child limit? Particularly since the trade-off with income tax is going to be so stark.
This is a trade-off which appeals to one constituency alone, which is not the public but rather Labour MPs. Ending the two-child limit is seen by a critical mass of Labour MPs and activists as a litmus test of social conscience, particularly on the left. These are the same MPs who will decide whether Keir Starmer—and by extension his chancellor—stay in office next year if May’s local elections are as bad for the party as forecast.
The trouble is the unpopularity of an increase in the basic rate of income tax is unknown because it hasn’t happened yet. And Labour MPs have no memory of what happened when a Labour government last went down this road, because it was so long ago (in 1975). But for the record, Margret Thatcher made it a defining issue in the following election, and the rest is history
