Rachel Reeves will lay the groundwork for a tax-raising budget that could break Labour’s election promise on income tax, in a major speech in which she will be “candid” about the tough choices ahead.

The chancellor will give the speech as the markets open on Tuesday, when she will promise to make fair choices at this month’s budget but decline to repeat her manifesto pledge of no rise in income tax, VAT or national insurance.

Keir Starmer told MPs on Monday night it would be a “Labour budget built on Labour values” and promised it would protect the NHS, reduce debt and ease the cost of living.

The prime minister gave MPs a hint at how the government would frame its potential manifesto breach – saying it was “becoming clearer that the long-term impact of Tory austerity, their botched Brexit deal and the pandemic on Britain’s productivity is worse than even we feared”.

Starmer told the grim-faced crowd of MPs, many sceptical of the potential manifesto breach, that there would be “tough but fair decisions” – saying the choice of the Conservatives and Reform would be “to return us to austerity”.

MPs in the meeting repeatedly grilled Starmer on whether the budget would lift the two child benefit cap, in what one described as “coordinated” pressure on the prime minister.

While nobody raised concerns over a manifesto breach explicitly, at least one MP spoke about the necessity that the public “know what we stand for”. However, the absence of any direct confrontation over the manifesto may give Starmer and Reeves some confidence that they are not facing a major backlash from within the parliamentary Labour party.

Senior strategists are understood to be heavily invested in pitch-rolling the major changes before the budget, believing the key success of last year’s statement was that markets were not surprised by the changes to investment rules or the national insurance rise for employers, which although controversial were well trailed.

Though the fiscal landscape ahead of the budget is hard, the economic picture is said by some insiders to be less gloomy than predicted.

While they accept the Office for Budget Responsibility’s productivity downgrade has created a headache, they point out that a fall in debt financing costs and more people coming into the jobs market may help limit the damage. Interest rate cuts and stronger-than-expected retail sales could also help.

“It’s a tough backdrop but we’re going to be honest with people about the choices,” one ally of the chancellor said. “And there are some reasons for economic optimism.”

But the budget will still mean hard decisions, as Reeves seeks to potentially double her fiscal headroom, as well as find billions to scrap or ease the two-child benefits limit and protect capital spending in the NHS.

There will be a focus on easing the cost of living in the budget, with Reeves understood to be considering cutting VAT on domestic energy bills and some green levies.

The chancellor has been urged by an influential thinktank to raise income tax by 2p but to cut national insurance by the same amount, raising £6bn mostly from the added burden on those who do not pay NI – such as pensioners and landlords.

The move may allow the chancellor to argue that her budget will protect the incomes of working people – those paid with a monthly payslip.

The Resolution Foundation said that higher-than-expected pay could offset almost all the fiscal damage from the productivity downgrade and also reduce borrowing – predicting the gap would be £4bn, far smaller than expected.

Its former chief executive Torsten Bell, now a government minister, is a key figure who sits on the budget board of senior ministers and advisers in No 10 and No 11.

The thinktank also suggests further tax rises, including extending the freeze on income tax threshold, raising dividend tax and closing capital gains tax loopholes to raise a total of £26bn.

Reeves is also said to be considering an increased tax on higher earners – and has spoken about how those with the broadest shoulders should bear the burden. Reports have suggested that could target people with incomes over £46,000.

However, sources have told the Guardian that they believe the chancellor is convinced that raising the higher income tax threshold alone would not raise nearly enough.

At a speech in Downing Street, Reeves will promise to address the speculation about her budget, though she is not expected to make any specific policy announcements.

At last week’s prime minister’s questions, Starmer did not repeat his manifesto promises on tax, saying only that he would “lay out our plans” during the budget.

In a clear signal that Reeves intends to give herself more headroom and end the cycle of budget black holes, she will promise to “make the choices necessary to deliver strong foundations for our economy – for this year, and years to come.

“It will be a budget led by this government’s values, of fairness and opportunity and focused squarely on the priorities of the British people – protecting our NHS, reducing our national debt and improving the cost of living.”

The chancellor will say that there has been “a lot of speculation about the choices I will make … these are important choices that will shape our economy for years to come.

“But it is important that people understand the circumstances we are facing, the principles guiding my choices – and why I believe they will be the right choices for the country.”

Inside No 10, senior figures believe the biggest risk at the budget is the reaction of Labour MPs to a manifesto breach, given how MPs forced U-turns on winter fuel payments and welfare cuts.

“If we are going down this road we need to be absolutely clear where it leads us; we must have a plan that means ordinary people feel better off as a result, that we can deliver tangibly better public services or ease the cost of living,” one minister said.

Another government source said: “I fear that the communication around this will be that we need to take this action for economic stability or because of the economic situation. That will completely kill us. We need to show people we are delivering direct benefit to them as a result of their taxes going up.”

Another minister said: “Already we are hearing too much about bond markets and paying the debt down. We should care about those things quietly, and speak more loudly about what this money is paying for that our voters care about.”

One minister, a close ally of Starmer, said the prime minister had been clear with his team that he believed they were already in effect in a general election campaign, and they had to start making far more tangible offers and progress to the public on cost of living, tackling illegal migration and improving public services.