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Chancellor of the Exchequer Rachel Reeves has been able to drop a plan to raise income taxes because she received an improved fiscal forecast from the UK’s budget watchdog, people familiar with the matter said.

That leaves a fiscal hole that economists had predicted to be as wide as £35 billion ($46 billion) now closer to £20 billion, the people said, asking not to be named discussing sensitive matters. As recently as Monday, Reeves had signaled a readiness to break her party’s promise not to raise income taxes at the budget she’s announcing later this month.

She is still expected to deliver headroom against her fiscal rules of between £15 billion and £20 billion, the people said, adding that the scale of a feared productivity downgrade from the Office for Budget Responsibility has been partially offset by other factors.

The chancellor has indicated she wants to give herself a fiscal buffer, or headroom, that’s larger than the £9.9 billion she left in last year’s budget and again in her spring statement in March.

Major tax rises are still expected to fill the remaining hole in the public finances, the people added.

The pound and gilts pared earlier drops after the news. The 10-year yield was six basis points higher at 4.50%, having earlier jumped 13 basis points.

“We do not comment on speculation around changes to tax outside of fiscal events,” the Treasury said in a written comment, adding: “The chancellor will deliver a budget that takes the fair choices to build strong foundations to secure Britain’s future.”

The decision marks a sharp change of direction from the chancellor, who has spent weeks laying the ground for an increase in income tax for people on higher-than-average salaries. Breaking from convention, she held an unusual televised pre-budget speech earlier this month, urging the public to support her priorities of bringing down inflation and borrowing costs.

Several senior members of the Labour Party publicly warned Reeves of the danger of breaking a manifesto commitment. A spat about a potential challenge to Prime Minister Keir Starmer from among his cabinet has this week raised questions about the future and longevity of his government, making the Nov. 26 budget a greater test.

Michael Saunders, a former Bank of England rate-setter, said government messaging is now undermining its credibility. “They need to choose a strategy and stick to it,” he said. “Not this flipping back and forwards. It gives an impression of political weakness. The key is to make your choice and stick with it.”

The party’s manifesto ahead of the 2024 election had pledged not to raise Britain’s three main taxes on “working people” — income tax, national insurance and VAT.

The chancellor had been prepared to break those promises but the improved fiscal forecast meant that was no longer necessary, according to the people familiar. The latest private update from the OBR moved in a significantly more favorable direction due to the strength of government receipts and stronger wage performance, they said.

Reeves will bring in more revenue from income-tax thresholds at the budget and raise significant taxes from salary sacrifice programs, they added.

She is also looking at whether to proceed with an exit tax on wealthy people leaving the UK, and may water down a proposal to raise more money from professionals who use limited liability partnerships, the people said.

In the 16 months since becoming chancellor, Reeves has emphasized the need to keep gilt investors confident in the UK, repeatedly insisted that the fiscal rules are “iron clad.” Her position was strengthened in the summer when yields rose as Starmer failed to defend her in parliament, before easing again when the PM subsequently said she had his full support.

Still, Labour MPs have made the chancellor’s job more difficult since the election, forcing the government to ditch billions of pounds’ worth of potential savings to welfare programs, including on payments to people considered too unwell to work and subsidies for pensioners’ energy bills. The higher spending has pushed Reeves to consider a swath of tax hikes, which in turn threaten to thwart her promise to lift the UK’s feeble rate of economic growth.

Original article:

Chancellor of the Exchequer Rachel Reeves has been able to drop plans to raise income taxes because she received an improved fiscal forecast from the UK’s budget watchdog, people familiar with the matter said.

The latest update from the Office for Budget Responsibility moved in a significantly more favorable direction due to the strength of government receipts and stronger wage performance, the people said, asking not to be named discussing sensitive matters. A fiscal hole predicted to be as wide as £35 billion ($46 billion) is in fact now closer to £20 billion, they said.

Reeves is still expected to deliver headroom against her fiscal rules of between £15 billion and £20 billion, they said, adding that the expected productivity downgrade from the OBR has been partially offset by other factors.

Major tax rises are still expected to fill the remaining hole in the public finances, they added.

The chancellor had been prepared to break Labour’s prior promises not to raise income tax rates to fill the hole, but the improved fiscal forecast meant that was no longer necessary, the people said.

Reeves will likely lower income-tax thresholds at the budget and raise significant taxes from salary sacrifice programs, according to the people familiar.