Plans to increase National Insurance rates for self-employed people – announced in the Budget last week – have been dropped.
Chancellor Philip Hammond has said the government will not proceed with the increases which were criticised for breaking a 2015 manifesto pledge.
He told MPs in a Commons statement: “There will be no increases in National Insurance rates in this Parliament.”
Labour’s Jeremy Corbyn said the U-turn showed a government “in chaos”.
Mr Hammond had faced a backlash by Conservative backbenchers last week, who accused him of breaking a general election manifesto commitment not to put up National Insurance, income tax or VAT.
Explaining his change of heart to MPs, the chancellor said: “It is very important both to me and to the prime minister that we are compliant not just with the letter, but also the spirit of the commitments that were made.
“In the light of what has emerged as a clear view among colleagues and a significant section of the public, I have decided not to proceed with the Class 4 NIC measure set out in the Budget.”
Mr Hammond’s Budget announcement would have increased Class 4 NICs from 9% to 10% in April 2018, and to 11% in 2019, to bring it closer to the 12% currently paid by employees.
He said “most commentators” believed the “sharp increase” in self-employment over the last few years had in part been “driven by differences in tax treatment”.
He would use the Autumn Budget to set out further measures to “fund in full” the £2bn lost from NICs, he said.
But Tom McPhail, Hargreaves Lansdown’s head of retirement policy, argued the U-turn would increase pressure in other areas of fiscal policy – and “may increase the risk of further pension tax tinkering in the Autumn Budget”.
Labour’s shadow chancellor John McDonnell described the climb-down as “chaos – it’s shocking and humiliating that you have been forced to come here to reverse a key budget decision announced less than a week ago”.
He told him to spend less time writing “stale jokes” for his Budget speech, and turning on the prime minister sitting next to him, he added she should also have spent less time “guffawing like a feeding seal”.
Analysis: By BBC Political Editor Laura Kuenssberg
It undermines the credibility of the chancellor, an admission at the very least, that his political antennae have gone wonky.
Second, it questions the extent to which the prime minister is willing to back him.
Relations between the next door neighbours are businesslike and between their operations certainly frosty – and this will not have improved things at all.
It also tells us that although polling suggests the prime minister is strong in the country, she’s simply not that strong in Parliament.
A firm nudge from backbenchers, and they shifted.
Asked by former SNP leader Alex Salmond “who” had realised the Budget was in “flagrant breach” of a manifesto commitment, Mr Hammond replied: “I think it was Laura Kuenssberg on the BBC shortly after I said it in the Budget speech.”
Former Labour leadership contender Yvette Cooper rounded on the comment, saying she was “slightly astonished” to hear that – and asked why nobody at Number 10 or 11 Downing Street had checked the Conservative manifesto before he went on to write the Budget.
Mr Hammond clarified that he had meant Ms Kuenssberg “was the first person after I spoke to raise the issue outside”.
Theresa May had confirmed the U-turn at Prime Minister’s Questions, insisting that last week’s Budget announcements were consistent with the government commitment not to raise tax.
Stressing the need to “maintain fairness in the tax system”, she said she would await publication of the Taylor Report on the future of employment and consider the government’s overall approach to employment status, rights and entitlements before deciding what to do next.
But Mr Corbyn said the government should “apologise” for the stress the announcement had caused Britain’s 4.8m self-employed.
The SNP’s Westminster leader Angus Robertson accused ministers of a “screeching, embarrassing U-turn” – while Labour’s shadow chancellor John McDonnell tweeted that the chancellor’s authority had been “shredded”.
Liberal Democrat leader Tim Farron, an advocate of Britain remaining in the EU, questioned whether the chancellor would “now U-turn on another broken election commitment to keep us in the single market”.
Chris Bryce, CEO of the self-employed body IPSE, welcomed the U-turn, saying “hard working people will sleep easier tonight” – while Stephen Herring, the Institute of Directors’ head of taxation, said the National Insurance “saga can only be described as chaotic”.
Analysis: By Kamal Ahmed, BBC economics editor
Beyond the political ramifications of Philip Hammond’s U-turn on the Budget tax rise for the self-employed, the Treasury now has a new problem – the increase in the National Insurance rate was due to raise over £2bn by 2022.
Its reversal, with no prospect of any replacement direct tax increases this Parliament, makes the government pledge to “balance the books” even more difficult to honour.
And that makes the Autumn Budget a trickier prospect – it was heavily briefed last week that the National Insurance rise was to pay for spending commitments on social care and business rate support.
Income tax, National Insurance contributions and VAT raise 65% of the government’s tax income. If you pledge not to raise any of them, your room for manoeuvre is severely limited.