Brown goes for broke

The battle lines for the next general election were dramatically redrawn yesterday when the Chancellor Alistair Darling announced plans to raise taxes for everyone earning more than £40,000 a year and to cut taxes for the millions of people earning lower salaries.

His landmark mini-Budget was a pivotal moment which will shape British politics for years ahead and presents voters with a stark choice between two very different futures: a European-style social democracy under Labour, in which the better off pay higher taxes to maintain public services, or a nation of lower taxes and state spending under the Tories.

The Chancellor took a huge economic and political gamble. As well as abandoning New Labour's pledge not to raise income tax rates, he announced a massive hike in government borrowing, which will soar to £118bn next year – even higher in real terms than during the Second World War.

Jubilant Labour MPs hailed what they called a "soak the rich" package. In private, ministers admitted the tax shake-up would redistribute wealth from the rich to the poor. In public, they described the changes as "fair".

The sweeping tax changes will not take effect until after the next election – figures issued by the Treasury pointed to a 2010 poll and income from the tax and national insurance changes is not pencilled in until April 2011.

To fund an immediate £20bn "fiscal stimulus" aimed at softening the impact of the recession, people earning between £40,000 and £100,000 would pay an average £156 a year extra in tax and national insurance if Labour wins a fourth term. A worker on £50,000 would pay an extra £125 a year; a worker on £70,000 would pay £250 more, while someone on £100,000 would pay an extra £375.

The tax rise for high earners will be bigger than what was leaked on Sunday, which was a 45p-in-the-pound top rate of income tax, on earnings of more than £150,000. A 0.5 per cent increase in national insurance contributions will hit about 800,000 people earning over £100,000. Someone earning £150,000 a year would face an extra tax and national insurance bill of £3,040 by 2011; someone earning £200,000 would pay £5,795 extra.

Mr Darling insisted his emergency measures would limit the recession to a short, sharp one. His forecasts – that the economy would contract by 1 per cent a year but then grow by 1.75 per cent in 2010 – were more optimistic than those of many independent analysts. If they do not materialise, the nation will plunge deeper into the red.

The Chancellor announced a £4bn increase in personal taxation and will raise another: £2.6bn by increasing national insurance for employers; £5bn from efficiency savings; and £12bn by reducing the rate of growth in public spending from 1.8 to 1.2 per cent on top of inflation from 2010.

The Tories have pledged to spend less than Labour, raising the prospect of a Cameron government having to make sweeping cuts in public spending to clear up the mess it inherited.

In an attempt to boost spending, VAT will be cut from 17.5 to 15 per cent from next Monday until December 2009. Similarly, rises in pensions and child benefits will be brought forward by three months to January.

Temporary tax cuts for 22 million basic-rate taxpayers, aimed at those who lost out as a result of the ill-fated decision to abolish the 10p tax rate, will be made permanent and increased to £145 a year from April, but 500,000 people will not be compensated.

And the starting date for £3bn worth of building projects will be brought forward by two years.

Mr Darling told the Commons: "These are exceptional times and require exceptional measures. It requires action now to help people – and action now to build a stable economy. We have made our choice."But George Osborne, the shadow Chancellor, attacked the package as "tax giveaways for Christmas, paid for by tax rises for life". He said: "This Budget is all about the political cycle and not the economic cycle." The Tories claimed a "£20bn temporary tax giveaway" would be followed by almost £40bn of permanent tax rises – almost £1,500 per family.

Senior Tories said last night that they were unlikely to reverse the tax increase for the rich if Labour introduced the necessary legislation before the election. They would not walk into a "trap" set by Gordon Brown where they appeared to oppose tax rises for the better off.

"Reversing this will not be a priority for a Conservative government," one Tory source said. "We do not support the increases in income tax, but our priority will be to reduce the tax burden on low-income families."

The Tories and Liberal Democrats claimed that people earning as little as £19,000 would be worse off from 2011. Labour disputed that, insisting that no one earning less than £40,000 would lose out as a result of the package.

Vince Cable, the Liberal Democrats' Treasury spokesman, said: "This is not a normal pre-Budget statement, this is a national economic emergency and what is required alongside radical cuts in interest rates, radical action on bank lending, is a serious tax cut concentrating on the low paid."

Mr Darling said his measures would bringing the year-on-year spending "back into balance" by 2015-16.

But analysts said Mr Brown's much-vaunted fiscal rules had been abandoned because the statement would do nothing to reduce the nation's mountain of debt. Maurice Fitzpatrick, a financial analyst at Grant Thornton, said the stock of government borrowing would rise to £1,047bn by 2014 – the equivalent of £40,000 per household.

The annual interest on this debt, which has to be raised from general taxation, would be £50bn a year – the equivalent of £2,000 per household.

"Effectively, the Government is providing a fiscal stimulus to the economy now and rolling the public finances impact of this into the overall government debt, on which significant government-debt interest will be payable, broadly in perpetuity," he said.

Lisa Harker, a co-director of the Institute for Public Policy Research think-tank, said: "In tax terms this was the most redistributive Budget statement of the past 30 years. By introducing a higher rate of tax, raising national insurance contributions, rebalancing and increasing personal tax allowances and enhancing child and pensioner benefits, the tax burden will be shifted away from those who can least afford to shoulder it."

The budget in numbers

£1 trillion

The amount that the UK's national debt will reach under the Government's budget proposals, according to the shadow Chancellor George Osborne.

55Minutes that Alistair Darling spoke for at the House of Commons yesterday.

4Times Michael Martin, the Speaker of the House of Commons, was forced to reprimand opposition MPs for excessive heckling.

372Points rise by the FTSE 100 index of leading shares yesterday, an increase of 9.8 per cent, the largest in its history.

£68.51The price of a pair of Levi's 501 jeans at John Lewis after the VAT cut yesterday. Previously, they would have been £70.

13Pence will be added to a bottle of wine after Mr Darling's surprise 8 per cent rise in alcohol duty, effectively cancelling out the price-drop effect of the VAT reduction.

Chris Green