OBR challenges claims Reeves dropped income tax rise due to rosier forecasts | Office for Budget Responsibility

The Office for Budget Responsibility (OBR) has cast doubt on claims Rachel Reeves dropped plans to raise income tax in this week’s budget because of rosier forecasts, pointing out she knew about these well before the change of heart.

In a move likely to exacerbate tensions with the Treasury, the OBR chair, Richard Hughes, has taken what he acknowledged was the “unusual step” of writing to the Treasury select committee to explain how its forecast evolved, “given the circumstances in this case”.

Reeves’s budget was preceded by a flurry of speculation and briefing, even before the OBR accidentally made its documents available online earlier than intended on Wednesday.

The chancellor took the rare step of delivering an early morning “scene setter” speech, on 4 November. This was widely interpreted as an attempt to clear the way for breaching the letter of Labour’s manifesto pledge on income tax by raising rates. Reeves repeatedly refused to deny that she would do so.

Days later, however, when final policy decisions were being made, Reeves and Keir Starmer decided to ditch that idea – a development the Financial Times reported on 13 November.

The next morning, as bond markets reacted badly to the news, with yields – effectively interest rates – on government bonds rising, Treasury sources briefed journalists that the income tax plan was no longer necessary, because of improved OBR forecasts.

In particular, these sources suggested, higher than expected inflation and wage growth meant the adjustment needed to meet Reeves’s fiscal rules was smaller than expected.

A headline on the Bloomberg website – widely read in financial markets – said “Reeves’ Tax U-Turn Came After Better Forecasts from UK Watchdog”, citing “people familiar with the matter”.

However, Hughes’s letter includes a chart showing the evolution of the OBR’s forecasts through the autumn – information the watchdog would not usually release. It confirms that these did indeed improve; but that even by 3 October, the first forecast round, Reeves was set to breach her first fiscal rule by just £2.5bn.

That would have required an adjustment of £12.5bn to restore headroom of £10bn against the rules; or £22.5bn to give herself a £20bn margin of error – plus the £7bn costs of policy U-turns on the winter fuel allowance and disability cuts.

By round three of the forecasting process, delivered to Reeves on 31 October, she was set to meet her first rule, on balancing day-to-day spending and tax revenues, with £4.2bn to spare.

The OBR makes clear that after this date – more than 10 days before Reeves and Starmer apparently dropped the income tax plan – no significant alterations were made to its forecast, except to accommodate Treasury policy decisions.

In the OBR’s economic and fiscal outlook document, it said, “no further adjustments were made to our economy or fiscal forecasts” after 31 October.

In the event, Reeves chose to increase taxes by £26bn by the end of the forecast period, in order to raise her headroom to a more cautious £21.7bn and fund policy changes including the scrapping of the two-child limit.

Treasury sources flatly reject the idea that the OBR’s letter contradicts their account of pre-budget decision-making. They say it was not until the OBR had sent Reeves forecasts incorporating planned budget measures – including their impact on growth – that a final decision could be made.

The shadow chancellor, Mel Stride, said: “It appears the country has been deliberately misled. Rachel Reeves spent the months leading up to the budget claiming she would need to make difficult choices because of a downgrade in the economic forecasts that was not of her making.

“She even let it be known she was considering raising income tax rates. But it was all a smokescreen. Labour knew all along that they did not need to raise taxes and break their promises. It was an active choice to do so.”

Fraught relations between No 11 and the watchdog sometimes spilled into the open in the run-up to Reeves’s make-or-break second budget.

The chancellor was publicly critical of the timing of the OBR’s decision to reevaluate its productivity forecasts over the summer – the driver of the downgrade in its expectations for growth.

“I think that it would have been a lot better if they had adjusted their forecasts the year before the election, or even last summer, to enable the new government to really understand the economic position,” she said last month.

She has also complained about its failure to incorporate what the Treasury regards as pro-growth policies, such as the government’s reset with the EU and the prospect of a youth mobility scheme, into its forecasts.

Hughes is to appear before the Treasury select committee on Tuesday, with the issue of what Reeves knew when about the forecasts expected to be discussed – as well as the results of an inquiry into the inadvertent early release of the forecasts.