Labour makes tax the election battleground

Alistair Darling yesterday drew the battle lines for a general election in a year's time by announcing a tax increase for the rich to help fund a record £700bn rise in public borrowing over the next five years.

In what was called a "going for broke" Budget, the Chancellor breached New Labour's election manifesto pledges since 1997 not to raise the 40p top rate of income tax. A new 50p rate will apply on earnings above £150,000 a year from next April – a year earlier than the abandoned 45p rate announced last November. The same group of high earners will also see the 40 per cent tax relief on their pension contributions pared back. Personal tax allowances for people earning more than £100,000 a year will be abolished.

Mr Darling told the Commons that borrowing would rise to an unprecedented £175bn in the current financial year because of a worse than expected global recession. It is the highest level of borrowing since the Second World War and a huge increase on the £38bn he forecast a year ago and the £118bn he predicted in November. It will be £173bn next year, he added.

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But experts predicted the actual figures would be even worse, accusing him of being wildly over-optimistic in predicting a rapid bounce back to 3.5 per cent growth from 2011. Only minutes after the Chancellor finished speaking, the International Monetary Fund contradicted his forecasts. It said the British economy would contract by 0.4 per cent next year, challenging his prediction of 1.25 per cent growth.

Mr Darling rejected pressure from some cabinet colleagues and Labour MPs for an even tougher squeeze on the rich. They wanted a 50p top rate on incomes of £100,000 a year. In his discussions with Gordon Brown on the Budget, the Chancellor insisted on spelling out clearly how the nation's books would be balanced to try to reassure the financial markets. The rebalancing will not be achieved under his plans until 2015-16, two years later than planned in November.

City analysts warned that the tax rise for top earners could provoke a 1970s-style "brain drain" from Britain. But cabinet ministers denied the "soak the rich" strategy marked the end of New Labour, even though Tony Blair blocked Mr Brown's plans for a 50p top rate ahead of the 1997 election.

Lord Mandelson, who in 1998 said New Labour was "intensely relaxed about people getting filthy rich as long as they pay their taxes", said last night: "This a serious economic shock and we have to respond to it in a tough, responsible and fair way." Pointing out that President Barack Obama was raising taxes on the rich, the Business Secretary asked: "Does Britain really want to be the odd one out?" He added: "Fairness is not only popular – it is right."

Labour sources insisted the tax hike would affect "the few, not the many". Only 1 per cent of taxpayers would be hit by the 50p rate and 2 per cent by the squeeze on those earning above £100,000. From next April, someone earning between £150,000 and £200,000 annually will be £80 a week or £4,000 a year worse off. Someone earning between £100,000 and £150,000 a year will be £40 a week or £2,000 a year worse off. For those earning more than £150,000, the 40 per cent tax relief on pension contributions will be gradually withdrawn, falling to the 20 per cent basic rate when they earn £180,000. The Treasury said a quarter of tax relief on pensions currently goes to people on more than £150,000.

The Tories will hope to turn the tables on Labour by pledging at the election to "protect the many, not the few". They will not reverse the tax increases affecting people earning more than £100,000, fearing that Labour would brand them "the party of the rich".

But if they win power, they will seek bigger spending cuts to head off the 0.5 per cent rise in national insurance payments due in 2011, which will affect workers paid more than £20,000 a year. Mr Darling, who announced the move last November, remained silent about it yesterday.

"These are tax rises for the many, not the few," a senior Tory source said. "We will make sure the election battleground is all about these national insurance rises." Calling it a "dishonest Budget", the Tories said Mr Darling's growth assumptions were "fantasy forecasts". They said debt repayments would equal the £43bn education budget, while national debt would double to £1.4 trillion.

Treasury officials said only one-third of the rebalancing to repay the extra borrowing would come from higher tax, with the rest coming from a big squeeze on public spending. It will grow by only 0.7 per cent in real terms from 2011, instead of 1.2 per cent. But the Government refused to disclose yesterday where the axe would fall.

Kickstarting a year-long election run-in, Lord Mandelson challenged the Tories to say how they would cut spending deeper to avert the national insurance rises. "The Tories' real plan is for big cuts today and even bigger cuts later," he claimed. "They are playing hide-and-seek with the public. They don't support our invest-and-growth strategy but won't say how they would reduce spending. Not declaring their hand on anything is not going to win them the election."

Mr Darling, who added 2p on a litre of fuel, 1p on a pint of beer and 7p on a pack of 20 cigarettes, used what little money he had at his disposal to announce a £3.1bn plan which he hopes will help the unemployed back into work. He also announced a scrappage scheme under which people with cars at least 10 years old will qualify for a £2,000 discount in a new vehicle from mid-May.

Despite presenting an "austerity Budget", the Chancellor argued that his package was preparing Britain for the recovery and announced plans to boost the industries of the future, such as wind power and "clean coal". In a sideswipe at the Tory Opposition, he said: "You can grow your way out of recession. You cannot cut your way out."

But David Cameron said Mr Darling had written himself into the history books with "a whole chapter in red ink" and landed Britain with a "decade of debt". The Tory leader said the Government was "running out of money, moral authority and time". "As of today, any claim they have ever made to economic competence is dead, over, finished."

Nick Clegg, the Liberal Democrat leader, said Labour had "condemned us to years of unemployment and decades of debt" and had been "desperately rushing around picking up half-baked ideas to save the skin of this failing government". Alex Henderson, a tax partner at PricewaterhouseCoopers, warned that the tax hike could see the City's high-earners move to lower-tax countries such as Ireland and Switzerland. He said a reduction in tax relief on pension contributions would hit the self-employed.

Richard Lambert, the Confederation of British Industry's director general, said: "The key question for this Budget was whether it set out a credible and rigorous path for restoring the public finances to health. The CBI's preliminary judgement must be that it does not."

Budget at a glance

Top earners

New 50 per cent top rate tax from next April for those earning over £150,000, and their pension tax relief slashed in April 2011.

Pensioners

State pensions to rise by 2.5 per cent. Winter fuel allowance maintained at £250 for over-60s and £400 for over-80s.

Alcohol and tobacco

Taxes up 2 per cent, putting 1p on a pint of beer; 4p on a bottle of wine; and 7p on a packet of 20 cigarettes.

Petrol

Fuel duty up 2p a litre in September, then by 1p a litre each April for four years.

Car scrappage

From May, motorists with cars over 10 years old will get £2,000 off a new car.

Savings

ISA tax-free limit rises to £10,200 (£5,100 cash) for over-50s this year; for everyone next year.

Redundancy pay

Rises from £350 a week to £380, from October.

Unemployed under-25s

After a year, will get a subsidised job or training place.

House buying

Stamp duty holiday for homes up to £175,000 extended to the end of this year.

Grandparents

Those of working age who care for grandchildren will see that work count towards entitlement for basic state pension.

Whitehall spending cuts

£9bn in unspecified "efficiency savings".

Environment

Carbon emissions to be cut by 34 per cent by 2020.

UK economy

To shrink 3.5 per cent this year; then expand by 1.25 per cent next year; and, from 2011, grow annually by 3.5 per cent. Inflation to fall sharply to 1 per cent by the end of 2009.

Public finances

Public borrowing to increase to £175bn this year; £173bn next year; then £130bn, £118bn and £97bn each of the following years. Public debt to rise to 68 per cent of GDP for 2010-11 and peak at 79 per cent in 2013-14.