Middle earners in the UK may face a new tax increase following a decline in gilt markets, which has created a £6 billion gap in Chancellor John Healey's Budget plans. The recent market turmoil has led to UK borrowing costs rising to their highest level since 1998, complicating funding for increased defense spending and other commitments made by Andy Burnham. This situation raises concerns about the financial burden on households and businesses, adding to the £75 billion in tax increases implemented by Healey's predecessor, Rachel Reeves.
Chancellor Healey has been cautioned that excessive spending could exacerbate the sell-off of UK bonds. A report from the Resolution Foundation suggests that UK taxpayers contribute less than those in other major economies and may need to pay more. Chief economist James Smith stated, 'There is a strong case that any benefits of increased defense spending will be broadly shared, so the tax rises needed to fund this should be too, including higher rates on middle earners.'
The analysis is expected to be closely examined by Labour ministers and officials, many of whom have ties to the Resolution Foundation. The UK is experiencing turmoil in global bond markets, driven by inflation concerns, interest rates, and public debt, with the ongoing conflict in Iran contributing to rising oil prices, which approached $93 per barrel.
As bond prices fall, yields rise, indicating that investors demand higher returns due to the increased risk of holding government debt. Yields on ten-year UK bonds, known as gilts, surpassed 5.25%, marking the highest level since the 2008 financial crisis, while 30-year gilt yields exceeded 5.9% for the first time since 1998, before slightly declining.
Simon French, chief economist at Panmure Gordon, noted that the spike in gilt yields could increase Britain's debt interest bill by £6 billion by the 2029/30 fiscal year. The bond market turmoil may also affect borrowing costs in financial markets, potentially impacting mortgage rates.
Chancellor Healey faces immediate challenges in his upcoming Budget, with a £5 billion gap to fund the defense investment plan announced by Sir Keir Starmer. Burnham has also committed to additional policies, including a council house building initiative and social care reforms. Sanjay Raja, UK economist at Deutsche Bank, indicated that the Budget could be a significant test for gilt markets, with potential spending measures ranging from £10 billion to £50 billion.
Raja stated, 'Market reaction will vastly differ depending on the type of Budget Burnham delivers. Getting the bond maths wrong at this juncture could risk a painful sell-off.'
Tory shadow chancellor Andrew Griffith criticized Labour's spending and tax policies, stating, 'Labour’s reckless spending and higher taxes are killing growth. Every time this rate goes up, so do mortgage rates and the burden for the next generation.' However, Labour may face pressure from the Left to increase spending further.
The Resolution Foundation's analysis supports the argument for higher taxes, noting that while taxes on UK jobs have risen since 2024, they remain the ninth lowest among 33 wealthy countries and are low by historical standards. The report concluded, 'The analysis strongly suggests that any politician promising a bigger state and lower taxes on middle earners is not being realistic.' It emphasized the need for broad-based tax increases, including higher contributions from middle earners, to fund increased defense spending.