Chancellor Alistair Darling has cut VAT from 17.5% to 15% for 13 months in his pre-Budget report – saying it would put about £12.5bn in consumers’ pockets.
But top rate tax will rise to 45% and all National Insurance contributions will go up 0.5% from 2011.
And he said he was increasing duties on alcohol, tobacco and petrol so they would remain at the price they are now.
Mr Darling said he wanted to soften the blow of a recession with the UK economy officially set to shrink next year.
He also announced that £15m would be made available to provide free debt advice to anyone regardless of their circumstances.
Mr Darling also slashed economic growth forecasts for next year from 2.75% to between minus 0.75% and minus 1.25% – the biggest downward revision on record.
But he said the government would inject an extra £20bn into the economy, or 1% of GDP, funded in part by an extra £5bn in efficiency savings and a big increase in government borrowing.
He said it would be “perverse and damaging” to stick to government borrowing rules in the current crisis so they would be temporarily suspended.
In other moves, Mr Darling speeded up the introduction of rises in child benefit and slowed down the introduction of increases in vehicle excise duty.
This year’s increase in the income tax personal allowance of £120 a year for basic rate taxpayers will be made permanent and increased to £145 in April, helping 22 million basic rate taxpayers – another 500,000 households not just this year but for good.
The 45% top rate will not come into effect until after the next general election, meaning Labour will not break its 2005 manifesto commitment on raising income tax.
The cut in VAT comes into effect on Monday in time for Christmas shopping.
Mr Darling’s Commons statement heralds the biggest shake-up of Labour’s economic policy since it came to power in 1997.
The announcements have had mix reviews with the opposition attacking Darling saying that they were skeptical of the plan. A full copy of the report can be down loaded here.