Growing tax hike rumours overshadow interest rate cut

There is a rather uneasy sense of déjà vu simmering.

Before last year’s Autumn Budget, rumours about tax rises spun into a frenzy, after the government warned “painful” measures were needed at its first fiscal event since gaining power to shore up the nation’s finances.

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Things were meant to be different this time around. Labour’s £40 billion package of hikes last year filled the “black hole” and would not need to be repeated, we were informed. The pain had been administered. The tax system had been given the shake-up required to begin to fix the country’s finances.

But here we, a few months away from the 2025 Budget, although the exact date is yet to be set, and the tax-hiking rumour mill is gearing up for round two.

Fiscal rules under threat

Economists have warned the government is under mounting pressure to meet its self-imposed fiscal rules. The Bank of England’s decision today to cut interest rates to their lowest level for two and a half years will offer some reprieve to Keir Starmer, but not a great deal.

The Bank’s Monetary Policy Committee (MPC) chose to reduce the Bank Rate to 4%, but the vote proved a lot tighter than anticipated. Five members preferred a 0.25 percentage point cut, with one member, Alan Taylor, initially voting to reduce rates to 3.75%, while four felt interest rates should remain at 4.25%.

This division underlines the dilemma facing policymakers right now, as they strive to stimulate the UK’s stuttering economy without aggravating inflation.

The Bank has stuck with its cautious approach to lower rates at every other meeting, and markets expect this to continue over the near term, forecasting a further 0.25 percentage point reduction in November and another early in 2026, ahead of today’s decision.

However, in the past 48 hours, interest rate changes have been overshadowed by talk of tax hikes, after the National Institute of Economic and Social Research (NIESR) warned that Rachel Reeves may overshoot her self-imposed “stability rule” by a whopping £41.2 billion by 2029-30. This rule stipulates that tax revenues must cover day-to-day spending.

The think tank says the stark shortfall is due to a combination of weak economic growth, higher than anticipated borrowing costs and the move to row back on welfare cuts. It suggests significant tightening of the tax system is required to solve the problem.

When quizzed on the matter yesterday, Prime Minister Keir Starmer replied: “Some of the figures being put out are not figures that I recognise.”

Sir Keir went further: “What’s really important is that I’m clear about our focus which will be on living standards and making sure that people feel better off, partly because more money is coming into their pockets in the first place through better wages, and partly because we’re bearing down on costs like mortgages and other costs to everyday families.”

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Many households will indeed receive a financial boost after today’s rate cut. Those on variable rates will see monthly repayments fall immediately, while borrowers on fixed rates may have access to better deals once their current one expires, particularly if further interest rate cuts arrive. First-time buyers stand to benefit, too.

On the flip side, savings rates will become less attractive over the coming weeks and months – something to strongly bear in mind given the Bank expects inflation to accelerate to 4% in September. If the rate you receive on your cash savings is lower than the pace of price rises, your money will erode in “real terms”.

The Bank Rate has now been cut five times since Labour won power, which is due to the government stabilising the economy, according to Starmer. However, today’s rate cut will do little to assuage pressure on the prime minister.

While our borrowings are gradually becoming cheaper, our HMRC bills will continue to rise no matter what happens in autumn, thanks to tax thresholds being frozen until 2028-29.

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Rumours about tax reforms had begun to swirl weeks before NIESR shared its calculations. The Institute for Fiscal Studies (IFS) has repeatedly warned that taxes might continue to rise during this parliament to keep the books in check.

Should these assertions prove accurate, and Reeves does need to jack up tax revenues at her second fiscal event, the chancellor isn’t blessed with an array of levers to pull. UK tax receipts were already at a 70-year high before the £40 billion package of hikes were announced last year.

A further raid on businesses, which saw corporation tax rates increase in 2023 and an employer national insurance hike earlier this year, must surely be avoided at all costs.

While the government hasn’t ruled out tax rises, Downing Street reiterated Labour’s election manifesto pledge not to raise taxes on working people, which leaves reforms to income tax, employee NI and VAT off the table.

Pension reform rumours prompt concern

Rumoured tax reforms to pensions have once again been grabbing the headlines. Cuts to pension tax-free cash is a particularly sensitive area as last year emphatically underlined. Given that anything above this figure - which is typically 25% of your total pension savings, capped at £268,275 – is taxable, people understandably want to make the most of this feature. If it were reduced, many retirees would face higher tax bills.

Last year’s proposal to bring pensions into the inheritance tax (IHT) net, which minus a few tweaks progressed into draft legislation last week, has already altered saver behaviour. Anyone who inherits a pension faces the very real prospect of facing exorbitant tax rates and could be tasked with an administrative maelstrom.

Understandably, families want to get ahead of the game, with some already draining pension savings before other assets and either spending the cash or passing it to younger loved ones. According to the government’s annual pension statistics, savers hooked out £5 billion from their pensions in Q1 2025, a 24% uptick compared to the same period last year. The number of individuals making withdrawals increased a notable 13%.

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Depleting pension savings might not be a problem for those who have sufficient other assets to live comfortably in retirement. But a spanner in the gears here is there are multiple future variables that can impact whether your wealth lasts the distant. Future stock market performance, inflation, need for long-term care and longevity are all unknown.

Among the other pension tax rumours doing the rounds is one about replacing the current marginal relief at source system with a single rate of upfront tax relief at either 25% or 30%. This would benefit anyone less earning than £50,270 a year but penalise those who earn more. Given 68% of the £50 billion dished out in pension tax relief every year is claimed by those paying higher and additional rates of tax, it may appear a juicy target for the government.

However, such a move would create a rather large mess, notably for defined benefit (DB) schemes, and with more workers tripping into higher-rate tax over time due to frozen tax thresholds, this would not only impact wealthy savers. Even middle earners would see pension tax breaks erode, making it harder to save for later life. I appreciate that lower-paid workers need considerable support but there are other ways to improve the retirement outcomes for this group, which the government will hopefully unearth in its newly launched pension adequacy review.

We should note the headlines about tax rises are no more than speculation – it’s important to bear this in mind before making any key decisions with your wealth. While governments usually resist commentating on pre-Budget rumours, in light of the panic and alarm that ensued 12 months ago, especially with regards to pension tax-free cash, it might be time to break the mould and offer some much-needed reassurance to savers.