Chancellor Rachel Reeves has reversed her decision to raise income tax rates in the upcoming budget, opting instead to freeze tax thresholds for two years. This move comes after the Office for Budget Responsibility (OBR) provided more optimistic economic forecasts, reducing the projected public finance gap from £30bn to £20bn.

Economic Forecasts and Fiscal Strategy

Initially, Reeves had signaled a potential 2p increase in income tax rates, coupled with a 2p cut in National Insurance, to address the fiscal shortfall. However, improved projections for wages and tax receipts have allowed the government to reconsider this approach. By freezing income tax thresholds, the government aims to raise £7.5bn, although this measure will effectively increase the tax burden on workers due to inflation and wage growth.

Political and Market Reactions

The decision to abandon the income tax hike follows significant internal political pressure and concerns about breaking Labour's manifesto promises. Health Secretary Wes Streeting emphasized the importance of adhering to these commitments, stating, "It is really important that we keep our promises and we stand by our manifesto." The reversal also comes amid speculation about leadership challenges within the Labour Party, with Prime Minister Keir Starmer facing scrutiny.

The bond markets reacted to the fiscal uncertainty, with government borrowing costs initially rising before stabilizing. The Financial Times reported a spike in the effective borrowing cost for a 10-year gilt, reflecting market sensitivity to the government's fiscal decisions.

Alternative Revenue Measures

To address the remaining fiscal gap, Reeves is exploring additional revenue-raising measures. These include increasing taxes on gambling and revising pension schemes, which could collectively generate several billion pounds. Despite these efforts, Treasury sources indicate that further measures will be necessary to achieve the desired fiscal headroom.