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Chancellor Rachel Reeves is to warn Labour MPs that the government’s shambolic £5bn welfare retreat means she cannot afford to axe the two-child benefit cap, as she faces an increasingly grim fiscal outlook.
Many Labour MPs hate the two-child benefit cap, introduced by the Conservatives, and Sir Keir Starmer said last month he would “look at” scrapping it, at a cost of £3.5bn.
But on Wednesday, hours after the government dropped its £5bn package of welfare savings in the face of a massive Labour rebellion, Reeves and her allies were warning MPs that their choices had consequences.
“There is a cost to the decision taken yesterday, there’s no denying that,” cabinet office minister Pat McFadden told the BBC.
“You can’t spend the same money twice,” he added. “So more money spent on [welfare] means less for some other purpose.”
While people within government admit that Reeves will be forced to raise taxes in her autumn Budget to close a growing fiscal hole, the chancellor will also tell MPs that they will have to forget some of their other favoured projects.
One ally of Reeves said: “Being chancellor is a tough job. But we are going to be the ones that are honest about the trade offs and choices.” The ally gave the £3.5bn cost of axing the two-child benefit cap as an example.
Reeves has already been forced by Labour MPs to abandon £6.25bn of planned benefit cuts: £1.25bn from a reversal of her winter fuel payment cuts, and £5bn after the welfare bill was gutted on Tuesday.
Scrapping the two child benefit cap — which means families can only claim child tax credit and universal credit for their first two children — would bring the total to £9.75bn, almost wiping out the chancellor’s slender £9.9bn of “headroom” against her borrowing rules.
The chancellor has been criticised by Labour MPs for trying to force through £5bn of welfare cuts, but Reeves is in turn frustrated by the reluctance of some of her colleagues to face tough economic reality.
One colleague of Reeves noted that Rachael Maskell, a leading opponent of welfare cuts, had been critical of the government’s decision to impose VAT on private schools.
Reeves’ team also noted a post quoted on social media, in which a Labour MP was heard saying after Tuesday’s welfare retreat: “I don’t understand why this means tax rises when it’s only a few billion pounds.”
Maskell said on Wednesday that Reeves “can’t afford not to lift the two-child limit” and suggested tax rises instead.
“This means that 360,000 children will be denied the opportunity to be lifted from poverty,” Maskell told the Financial Times. “Many mechanisms to raise additional funding were debated yesterday, which could take the pressure off the public purse, from equalising capital gains tax to a wealth tax.”
The Institute for Fiscal Studies has said that the last-minute changes to the welfare bill now mean the government will in effect save no money from the reforms, having originally intended to make cuts of almost £5bn.
If Reeves is to stick to her fiscal rules, given her limited headroom, she will either need to find cuts elsewhere or raise taxes at the autumn budget, the IFS said on Wednesday.
“The government has moved from saving some money to saving nothing, at least by the end of this parliament,” said Helen Miller, incoming director of the think-tank.
“It’s looking increasingly likely that if the government needs to do something they’ll turn to tax rises,” she added.
The UK’s borrowing costs ticked up in early trading on Wednesday, taking the 10-year yield up 0.04 percentage points to 4.50 per cent.
“Having boxed themselves in early with a lack of headroom to the fiscal rules, it was almost inevitable the walls would close in at some point,” said Gordon Shannon, a fund manager at TwentyFour Asset Management.
“Gilt investors wanted to see spending cuts,” he added. “Now the government’s only exit is tax rises, risking a death spiral of growth destruction.”
McFadden insisted the government would still push ahead with welfare reform and tried to deflect criticism that the U-turn on Wednesday had seriously undermined Starmer’s authority just one year into office.
He acknowledged, however, that little would happen on welfare reform ahead of November 2026, when the government’s review into disability benefits is expected to be completed.
Angela Rayner, deputy prime minister and a key negotiator with Labour rebels over welfare, said that the rising welfare bill “does have a cost to it” and that Reeves would address the issue in her autumn Budget.
Rayner also sought to downplay chaotic scenes in parliament on Tuesday during the welfare bill’s second reading, telling ITV that “the process of parliament can look like argie bargie and everyone’s falling out, but that’s the way you get a consensus”.
She added: “We’ve got to a better place now and we’ve got the bill through parliament at second reading and now we’ll get into the detail.”