Rachel Reeves should be brave and raise income tax

The Chancellor Rachel Reeves is having trouble making the numbers add up. The deficit just keeps getting worse. The public sector unions are demanding more money and Labour backbenchers are protesting that cuts are unacceptable. Meanwhile, the bond markets are insisting that borrowing has reached its limit.

Still, never mind. It seems that Reeves is cooking up a clever wheeze to get herself out of a tight spot with a raid on inheritance and capital gains tax. There is just one snag: it is very unlikely to work. Has the Chancellor learnt nothing from the catastrophe of her first Budget?

Whether it is £30 billion, £40 billion, or even £50 billion, it does not really matter. It is clear that by the autumn Reeves will have to raise a lot of extra revenue. With a promise not to raise income tax, VAT, or employee’s National Insurance, she is scrabbling around for something to fill the ‘black hole’. According to reports today, she has decided on one answer. She will tighten the rules on inheritance tax so that people can no longer give away assets seven years before they die tax-free. And she will increase Capital Gains Tax (CGT), potentially making it equal to income tax. Either will mostly be paid by the people ‘with the broadest shoulders’. Problem solved. 

Here’s the catch, though. Just like her first Budget, a set of badly designed, fiddly taxes on ‘wealth’ will end up backfiring on her. A lifetime limit on gifts will be hugely unpopular, with every Christmas present you give to your children being monitored by HMRC.

Just like the row over scrapping the winter fuel allowance, the backlash this will generate will most likely mean it has to be scrapped within months, and it will hardly raise any cash. At the same time, pushing up the rate of CGT will simply drive entrepreneurs abroad, just as her raid on the non-doms has done. Even worse, given that CGT is basically a voluntary levy – it only becomes due when you sell an asset – a 45 per cent rate will lead to lower revenues while making the UK even more unattractive to investors than it already is. 

Just as seriously, by flagging the tax rises, Reeves is encouraging people to give away their money now, or sell their assets before the rate increases. This also happened when she threatened higher levies in advance of introducing them last year.

Given that the Labour government wants to increase public spending significantly, Reeves should be honest about it and add 2 per cent to the basic rate, as well as the higher rates, of income tax. Instead, she keeps trying to find a clever way out of the corner she has boxed herself into, and it keeps going wrong. Her first Budget was a catastrophe – and it now looks certain that her second one will be just as bad.