Brown gambles on £120 tax giveaway to woo back voters

The measure is designed to compensate victims of Mr Brown's decision to scrap the 10p lower tax bracket and so avert a mutiny of Labour MPs.

However, 1.1 million low- income households will still be worse off this year, gaining less from the tax break than they will lose from the ending of the 10p rate.

The level at which the higher 40p tax rate is paid will also be reduced, so higher earners will not gain from the change.

The government will have to borrow 2.7 billion to fund the tax change – endangering Mr Brown's own fiscal rules on debt being no more than 40 per cent of national income.

Pumping extra money into the economy is also set to raise inflation still further, after monthly figures released yesterday showed the fastest surge in the cost of living for six years, of half a percentage point, taking inflation to 3 per cent.

Labour MPs, who have been met with hostility from constituents over the abolition of the 10p rate – even from those who were not affected by the changes – were initially supportive of the move.

Frank Field, a former welfare minister who led a 50-strong back-bench rebellion, apologised for his personal attacks on the Prime Minister after witnessing the U-turn.

However, the Conservatives attacked what they called a "compensation con" and said it would still cost those earning between 6,635 and 13,355 up to 112 a year.

Announcing the changes, Alistair Darling, the Chancellor, said they were the "fairest and most effective way" to help those on low pay who had been set to suffer.

"At a cost of 2.7 billion, I will increase the individual personal tax allowance by 600 to 6,035 for this financial year, benefiting all basic-rate taxpayers under 65," he said.

"This will mean 22 million people on low and middle incomes will gain an additional 120 this year."

The changes will be backdated to the start of the financial year in April and come into force in September. That means basic-rate taxpayers will get an extra 60 in September and 10 a month thereafter.

Some 4.2 million middle-income households will receive at least the amount they originally lost. But 1.1 million households – those who were in the top half of the former 10p rate – will still miss out, by up to half the original amount.

Mr Darling also announced the threshold for the higher 40p rate of tax would be reduced by 600, cancelling out the 120 gain for those earning more than 40,835.

The changes have also been guaranteed for only one year, giving the government wriggle room if finances get even tighter.

Political opponents described the move as a cynical ploy to avert disaster in next week's Crewe and Nantwich by-election, which follows the death of Labour MP Gwyneth Dunwoody.

George Osborne, the shadow Chancellor, said: "This is a panic Budget from a divided, dithering and disintegrating government that has completely lost control of events.

"We support any help to compensate those hit by the government's tax increases on the low paid. But this is a one-off, one-year-only payment which could be reversed by a tax increase next year.

"They haven't addressed the root cause of the problem. They've followed the tax con with a compensation con."

He later said Scots would be worse off as they tended to be lower earners.

Vincent Cable, the Liberal Democrats' economic spokesman, told the Chancellor his changes might "for a few hours, get you out of the difficulties you created for yourself", adding: "I hope this is not just another short-term gimmick, but the beginning of a process by which the low-paid pay less tax."

Yesterday's changes are believed to have averted a rebellion by Labour MPs who were preparing to scupper the Finance Bill and force a reversal of the 10p tax abolition.

After Mr Darling's announcement, Mr Field apologised "without reservation" to the Prime Minister for allowing his campaign over the scrapping of the 10p rate to "become personal".

Mr Field infuriated Cabinet ministers at the weekend by saying he would be "very surprised" if Mr Brown lasted another two years in No10. He claimed the Prime Minister was visibly unhappy in his position, branding it a "tragedy". He has also held out the prospect of a Commons defeat for the government over the Budget without further reassurances on tax reforms.

Despite the approval of Labour back-benchers, the upping of personal tax allowances may not be enough to save Labour from defeat in the Crewe and Nantwich by-election. Tories are privately hopeful of overturning Labour's 7,000 majority, and

the bookmaker William Hill agrees with them. It has further slashed the odds of the Conservatives winning the seat from 1/6 to 1/8.

Mr Darling's major announcement on income tax changes between Budgets is without precedent in modern British history.

Jonathan Loynes, chief economist at Capital Economics, said the move was a "pretty crude response" and risked breaching the government's fiscal rule of sustainable investment, which states net debt should not be more than 40 per cent of GDP.

And despite the government's intention of helping ordinary families, other experts warned boosting the amount of money in the economy could force inflation up.

Nice try – but quick fixes won't help

THE Chancellor, Alastair Darling, has announced that personal tax allowances will be raised by 600, backdated to April (the start of the fiscal year), at a cost of 2.7 billion.

Note that higher-rate taxpayers will not benefit, because the threshold at which an individual starts to pay higher-rate tax will be reduced by 600.

According to the Chancellor, this measure will fully compensate 80 per cent of those mainly low-income earners who lost out when the 10p tax rate was scrapped in Gordon Brown's last Budget in 2007.

The remaining 20 per cent of people will, on average, recoup half their losses. Other basic-rate taxpayers will benefit as well.

According to the Chancellor, the measure will "help all basic-rate taxpaying families at a time when oil and food prices have been rising in every part of the world… this family tax cut provides support this year for those on middle incomes at a time where they face increased bills, so supporting the economy".

The cost of this measure will be covered by higher government borrowing.

The timing of this announcement has clearly been brought forward to try to prop up the Labour vote in next week's by-election in Crewe and Nantwich in Cheshire.

Recent polls have suggested that Labour will lose this vote, in what normally has been a safe Labour seat. Such a by-election defeat would put further pressure on Mr Brown.

In our view, the announcement tends to confirm fears that, faced with the slowing economy and sliding opinion polls, the government will let the fiscal deficit rise further.

The UK already has the highest structural fiscal deficit among major European countries, and it is likely to rise above 3 per cent of gross domestic product this year.

The government might argue that this fiscal stimulus will give help to the economy in difficult times. The Bank of England's monetary policy committee (MPC) is unlikely to be grateful.

We do not regard any such stimulus as very significant. The bigger worry is that fiscal slippage will reinforce the MPC's worries about the rise in inflation expectations and possible slippage away from stability-oriented policies.

Faced with the difficult economic challenges of the credit crunch and rising inflation, it is all too tempting to look for "quick fixes" that can somehow avoid the need for UK consumers, businesses and fiscal policymakers to adjust to changed (and tougher) economic circumstances.

We doubt any such sustainable fix truly exists. The rise in global commodity prices implies a loss of real incomes for UK consumers, and this cannot be ducked. This is a message that the MPC will be keen to stress.

Michael Saunders is the chief UK economist at Citi European Economics.

Downing St transparency signals 10% housing slump

CONFIDENTIAL government papers exposing the true scale of the housing crisis were accidentally made public yesterday by a minister's blunder.

Caroline Flint, the housing minister, walked into Downing Street on her way to brief the Cabinet with a transparent file of papers revealing prices were expected to fall by up to 10 per cent this year, knocking 20,000 off the value of the average house.

Photographers were able to zoom in on the text – and the frank admission that "at best" prices are set to fall by 5 to 10 per cent.

There was an admission that "we can't know how bad it will get" – and a note that Ms Flint should remind her colleagues that the government was "on people's side."

The document pointed out that leading house-price indicators were predicting reductions for the first time in recent years. The figures are likely to relate only to England and Wales as housing is devolved to the Scottish Government.

Ms Flint also expressed concerns over housebuilding – indicating that the government could struggle to hit its target of building three million new homes by 2020.

Grant Shapps, the Tory shadow housing minister, said: "Rather than closed-door briefings to Cabinet, Caroline Flint must come out in public and make a full statement about what she thinks the future might be for hard-pressed home-owners."

Ms Flint accepted that she had been "caught out" but insisted that her briefing note contained only information that was already public.

Price-rise figures mask true hardship for families

IN THE past week I have had several disconcerting experiences while shopping. In each case, the cost of the goods was higher than the ample cash I had ready to offer. It is not that everyday life has moved to a new price level. It is moving to a higher level with almost every week.

We are now told that inflation on the official measure has "surged" to 3 per cent. Surge it may well have done. But there is not a household in the land that believes the rate of inflation to be this low. Everyday "real" inflation – the price of essentials such as fuel, fares and food – is rising by far more than the "official" 3 per cent.

Even the headline Retail Price Index rate, now at 4.2 per cent, fails to capture the scale of price rises households are now facing for basic necessities.

Food price inflation jumped to 7.2 per cent year-on-year last month. Dairy products – eggs, cheese and milk – are up 15.7 per cent. Electricity is up 8.3 per cent. Postal services are up by 6.7 per cent. Petrol is up almost 19 per cent.

Food inflation bears down all the harder on low-income families, as food accounts for a larger share of their weekly spending. Little wonder that the inflation rate facing people aged over 75 is reckoned to be 37 per cent higher than the official one.

All this is bad enough. But there is much worse in the pipeline. Latest figures on wholesale prices will have set off alarm bells at No 10 Downing Street and the Treasury. They show the prices of goods leaving the factory gate rising by 7.5 per cent year-on-year, while the cost of fuel and raw materials bought by industry is now surging at a staggering annual rate of more than 23 per cent.

Both output and input prices are rising at the fastest rate since the index started in 1986. Global price increases are being magnified here by the 12 per cent fall in sterling over the past year.

The problem with cost increases of this ferocity is that they have far wider effects. Consumers have less to spend on other items. Companies face a relentless squeeze on margins and profits. As if on cue, Scottish dairy giant Robert Wiseman, caught between the giant supermarkets and the soaring cost of raw materials, announced this week that its profits could take an 8.5 million hit. Its shares plunged.

It will be far from alone. Companies will be forced to cut costs and lay off staff. Businesses lose the confidence to invest. Tax revenues fall. And the government becomes increasingly unpopular and vulnerable to events.

It takes between three and six months for these increases to work through to retail prices in the high street. So unless there is a truly dramatic collapse in the oil and commodities markets, we are faced with further price rises in the autumn and winter.

So much for higher inflation being a short-lived "spike" that would not stand in the way of interest rate cuts. The Bank of England is now truly snookered. It cannot cut with credibility when the governor, Mervyn King, may soon be obliged to write a letter to the Chancellor explaining why inflation is way above the target level.

Bill Jamieson

'Horrible surprise' as inflation rate soars

A SHOCK spike in the cost of living during April hit hopes for interest rate cuts yesterday, as inflation soared at its highest pace for nearly six years.

The official Consumer Prices Index (CPI) benchmark of inflation jumped 0.5 per cent to 3 per cent – shattering City forecasts with its biggest monthly rise since July 2002.

The impact of surging gas and electricity bills, rising food prices and Budget tax hikes on alcohol and tobacco means Bank of England governor Mervyn King is on the brink of having to write his second letter to the Chancellor to explain the rise.

The Bank is charged with keeping CPI within 1 per cent of its 2 per cent target but Mr King will have to explain himself publicly if inflation moves any higher – as now seems certain. CPI last hit 3.1 per cent in March 2007.

Economists had been pencilling in a rate cut to 4.75 per cent from the Bank's monetary policy committee to help a slowing economy and ease pressure on borrowers next month, but yesterday's unexpected figures throw that into doubt.

Howard Archer, chief UK economist with research firm Global Insight, called the data "another horrible surprise on the inflation front" after figures on Monday showed factory-gate prices were rising at their fastest rate since records began more than 20 years ago.

"The chances of a June interest rate cut are rapidly diminishing," Mr Archer said.

The downbeat view was reflected in London's FTSE 100 index, which fell more than 1 per cent following the figures.

Other experts warned inflation could remain at elevated levels for months, as households braced themselves for another round of energy price hikes after heavy hints from British Gas parent company Centrica on Monday.

Russell Lynch