Tax U-Turn

Reports of Tax U-Turn Hit Gilt Market

The UK government is expected to drop plans to raise income tax rates in the November 26 budget.

• Gilts hit hard: yields on longer maturities jumped as much as 14 basis points.
• Pound slipped: down 0.5%, touching 2.5-year lows against the euro
• UK stocks dipped: FTSE 100 index fell nearly 2%, led by banks

Markets had assumed Chancellor Rachel Reeves was preparing to raise rates after refusing to rule it out, warning “we must all contribute.” But on Friday, government sources briefed media that better‑than‑expected forecasts meant tax hikes were unnecessary — a message investors met with scepticism.

The Tax No One Dares Touch

Raising the basic rate of income tax has been avoided for half a century, because politicians see it as a fast track to a ballot box wipeout. Reeves was signaling readiness to break the taboo — before stepping back.

• Economists’ warning: Institute for Fiscal Studies and others argue higher income tax is needed to plug the fiscal gap.
• Political risk: Labour party pledged not to raise taxes on “working people”.
• Economy vs. electability: The toss‑up is now centre stage in the run‑up to the budget.

The latest U-turn left investors asking how the government plans to balance the public coffers.

Leak, Test, Retreat: A UK Fiscal Ritual

UK politicians frequently hint at difficult policy choices or leak proposals to the media, from tax hikes to spending cuts, only to retreat if the backlash is too strong.

Pre-budget signalling is a strategic tool: it lets ministers test public and market reactions without committing.

Income tax hikes, pension reforms, and fuel duty changes have all been floated and then dropped in past cycles.

This can backfire. U‑turns may briefly placate voters but spook markets and erode trust in the economy

What Are Gilts and Why Do They Matter?

Gilts are British sovereign bonds — the IOUs government sells to raise money. Investors buy them, and in return the government promises to pay interest and give the money back later.

• When gilt prices fall, yields (interest rates) go up, meaning it costs the government more to borrow
• Investors watch gilts like hawks: they’re a litmus test of whether the government’s budget looks solid
• Why you should care: if borrowing costs rise, governments often cut spending or raise other taxes, which can trickle down to everyday life

Quick fact: the word “gilt” comes from the golden edge on old UK bond certificates.

Lessons from 2022: Gilts Can Topple Governments

In September 2022, prime minister Liz Truss and Chancellor Kwasi Kwarteng promised the UK’s biggest tax cuts since the 1970s, funded by more borrowing. Markets judged this fiscally irresponsible.

• Gilts tanked: borrowing costs surged, forcing the Bank of England to step in.
• Sterling crashed: the pound fell to an all-time low against the dollar.
• Mortgage shock: lenders pulled products, and rates on two‑year fixes jumped above 6%.

This so-called mini-budget was quickly reversed, the Prime Minister forced out of office in record time, and some of the extreme market moves reversed. But borrowing costs stayed elevated long after. Since then, British politicians have been keen to keep investors onside.

If Not Income Tax, Then What?

With income tax rates apparently off the table, the UK government must find other ways to raise revenue.

• Income tax thresholds: Freezing or even cutting tax thresholds would pull more workers into higher tax bands. Could raise billions but hit lower earners hardest.
• Patchwork of levies: Smaller taxes can be easier to avoid and may have knock-off effects on businesses etc.
• Spending cuts: Reeves has hinted at deep reductions in capital investment to stay within fiscal rules.
• Business taxes: Labour’s previous budget targeted corporate levies; more could follow.