What’s behind Rachel Reeves’s hokey cokey on income tax rises?

After weeks of wondering will she, won’t she, and recent heavy hints that she would indeed raise income taxes in the Budget, Chancellor Rachel Reeves has now decided against the manifesto-breaching move.

Amid the fog of Budget speculation, here is what we do know.

That plan, to raise income tax rates by 2p but compensate workers with a 2p National Insurance cut was sent to the OBR as an option earlier this month to be costed, to help fill what was then a £30bn gap in the public finances, mainly caused by a downgrade to productivity.

The so-called “2 up, 2 down” plan, pioneered by the Resolution Foundation think tank, would have raised several billion pounds, mainly from non-wage income such as landlords and savings.

Newer assessments from the OBR appear to have increased the projected strength of wages and tax receipts in the coming years and offset several billion pounds of that gap, taking it closer to £20bn in total.

As a consequence, the plan to raise income tax rates has not been advanced in the latest set of measures sent to the OBR to analyse.

While this “iterative” process is part of the normal forecasting round that precedes a Budget, on Monday of this week the chancellor suggested very strongly that tax rates would go up in a BBC interview.

Health Secretary Wes Streeting on Friday appeared to confirm the shift away from anything that could be seen to break election promises:

“It is really important that we keep our promises and we stand by our manifesto. The fact that there’s been speculation about income tax shows how difficult the situation is with public finances and secondly that the chancellor is determined to stick to her fiscal rules,” he said.

There is some irony in the health secretary making these comments, given suggestions from Downing St about leadership bids and claims about the unique power of the prime minister and chancellor over the bond markets.

By the end of the week the bond markets were more than nervous as a result of the hokey cokey over income tax.

It is always questionable to assume a singular motive behind the awesome financial power of the debt markets, but let me try to divine what happened over the past 24 hours.

After the Financial Times’ scoop about the dropping of the tax rate plan, there was a notable spike up in the effective borrowing cost for the Government. It was up 0.12% points for a 10-year gilt.

Markets had been reassured by the tough fiscal talk by the chancellor over the past month.

Much of this was driven by expectations of lower Bank of England interest rates amid a weakening jobs market. The willingness by the chancellor to take political pain, in the form of breaking tax rate manifesto promises, in order to restrain borrowing in a straightforward way, is a plus for the bond vigilantes.

But this week’s developments, including the dropping of other kites being flown – from extra tax on partnerships, and entrepreneurs leaving the UK – injected doubt about the appetite to trade political pain for lower bond yields.

Even when it was confirmed that better – or less bad – economic forecasts had helped reduce the budget gap, and create room to avoid the tax rate hike, the markets only calmed briefly, before they crept up to even higher effective rates by the end of the day. The jitters are back.

Insiders said that the chancellor’s Budget strategy “remains the same” to increase the buffer or “headroom” on meeting her borrowing rules significantly higher from the current £10bn a year, to tackle cost of living pressures, and to make “fair choices” on tax.

That would appear to mean an extension in the £40bn a year freeze on tax thresholds – which raises an extra £8bn a year as more worker’s salaries creep into the higher tax brackets .

Ministers point to how they are planning to raise tax, as well as the amount, suggesting a squeeze on wealth, capital and income from those sources, rather than long-suffering pay packets.

There are real questions about the loose lips around Whitehall, floating all sorts of significant tax reform, and the impact in markets.

It’s worth noting too that final decisions on the Budget have not yet been made, and the process continues. everyone will hope it is smoother from here until the big speech on November 26 .