Chancellor needs £26bn and must break income tax pledge, says Labour's own favourite thinktank

Rachel Reeves must put up taxes by £26billion and break her pledge not to put up income taxes, Labour’s favourite think-tank has warned.

The Resolution Foundation said the scale of the hikes needed meant the Chancellor should ignore the election promise.

It suggested that, even though the financial black hole facing Ms Reeves may be ‘less daunting’ than some fear, she should break the pledge in order to fund the scrapping of the two-child benefit cap as well as Ed Miliband’s net zero plans.

Voters were told at last year’s general election that Labour would not put up income taxes, national insurance or VAT.

But speculation that the pledge will be abandoned has been growing especially after the PM refused to say recently whether he stood by it.

Earlier this year at the time of the spring statement, the Chancellor left herself with £10billion in ‘headroom’ to meet her fiscal rules – targets to bring down debt and borrowing.

Experts believe that has now been more than wiped out with many believing she now faces a ‘black hole’ in the tens of billions.

That is partly because of higher borrowing costs and U-turns on welfare reforms. A downgrade of Britain’s productivity outlook will also take its toll.

The Resolution Foundation found these would be partly balanced out by a stronger outlook for pay growth – which will mean more tax revenue.

That will leave Ms Reeves with a ‘black hole’ of just £4 billion, lower than many others forecast.

However, in addition to making up the shortfall, the Chancellor will want to give herself more ‘headroom’ against any future setbacks.

On top of that, scrapping the two-child limit on welfare support – a totemic issue among Labour backbenchers – would cost £3.5billion.

Another £3.5billion may also be spent shifting the burden of ‘social and net zero levies’ on electricity bills to taxpayers.

These charges are currently added to energy bills to pay for support to poorer households and fund renewable energy projects.

Added together, it will mean £26billion of tax hikes are needed, the Resolution Foundation said.

‘Delivering tax rises along these lines, and on the scale required, means prioritising sensible reforms over sticking dogmatically to manifesto commitments not to raise VAT, income tax or national insurance,’ it said.

Adhering to the manifesto pledge would risk ‘doing more harm than good’, the think-tank added.

A 2p income tax hike could come alongside a 2p cut in employee national insurance – meaning most workers see no change. But it would hit pensioners, landlords and the self-employed. Overall the measure would raise £6billion.

In addition, the report called for an extension of the freeze on income tax thresholds that will further punish low and middle earners by dragging into higher tax bands. That would raise £7.5billion but end up costing typical taxpayers £140 a year.

Raids on dividend tax, capital gains tax and salary sacrifice schemes could also be among the Chancellor’s options, as well as a hit to motorists by ending the freeze on fuel duty.

The Resolution Foundation’s findings are closely watched because a number of its former staff now occupy key positions as ministers or officials preparing the Budget – among them Torsten Bell, a former boss of the think-tank who is now pensions minister.

James Smith, research director at the Resolution Foundation, said: ‘Budget-watchers are braced for a major downgrade to Britain’s productivity outlook.

'But ironically, a major upgrade to the outlook for pay could mean that the Chancellor’s fiscal black hole is less daunting than feared.

‘However, reassuring the markets about the state of the public finances, paying for policy U-turns and providing fresh cost of living support won’t come cheap.

‘Tax rises of £26billion are likely to be needed.

‘The Chancellor should look to make sensible tax reforms to car taxes, dividends and capital gains.

‘Switching 2p of employee National Insurance onto Income Tax would raise £6billion while protecting workers’ wages.

‘Together, this will help to deliver a decisive Budget centred around prices, payslips and poverty reduction, and that shifts the focus away from black holes and back onto boosting growth.’