By David Milliken, William Schomberg and Andy Bruce

LONDON (Reuters) – Finance minister Rishi Sunak gave more aid to Britain’s economy and offered companies a big incentive to start investing again, but also announced a future tax squeeze on people and businesses as he began to focus on the COVID-19 hit to the public finances.

Sunak said in an annual budget speech on Wednesday that the economy will return to its pre-pandemic size in mid-2022, six months earlier than previously forecast, helped by Europe’s fastest coronavirus vaccination programme.

But it will be 3% smaller in five years’ time than it would have been without the health shock and extra support was needed as the country gradually lifts restrictions over the next few months, he said.

Sunak’s early warning that he will demand more money from companies and individual taxpayers in the coming years makes him one of the first policymakers from rich countries to address the state of public finances.

Britain’s first rise in corporation tax since 1974 will see big, profitable companies pay 25% from 2023 compared to 19% now.

But Sunak first offered firms an immediate two-year “super-deduction” tax break in a bid to snap them out of their pandemic deep-freeze and invest to boost short-term growth.

The government’s budget watchdog said the move was more than 10 times more generous than an equivalent incentive in 2009.

Sunak repeated his plan to do “whatever it takes to support the British people and businesses”.

“Second, once we are on the way to recovery, we will need to begin fixing the public finances – and I want to be honest today about our plans to do that,” he told parliament. “And, third, in today’s budget we begin the work of building our future economy.”

Among the support measures were a five-month extension of Britain’s huge jobs rescue plan, wider help for the self-employed and the continuation of an emergency increase in welfare payments.

A business rates exemption for retail, hospitality and leisure businesses will now run until the end of June, by when Prime Minister Boris Johnson hopes to have lifted most COVID-19 restrictions.

An existing tax break for home-buyers was extended by three months until June 30 and then for cheaper homes until the end of September.

Shares in housebuilders gained on the news, with Persimmon one of the top risers in the FTSE 100, up about 5%.

Pub firms JD Wetherspoon and Premier Inn owner Whitbread also rose about 5%, helped by an extended VAT cut for the hospitality sector.

But British government bond prices fell sharply after Sunak said overall borrowing will be much bigger next financial year than thought just a few months ago – 234 billion pounds, or 10.3% of gross domestic product, compared with a previous estimate of 164 billion pounds, or 7.4% of GDP.

The Debt Management Office said it planned to sell 296 billion pounds of gilts in the coming year, well above the 247 billion pounds expected in a Reuters poll.

“The UK’s fiscal stance has become much looser, and more focused on investment, more in line with its U.S. and euro area counterparts,” Morgan Stanley economist Jacob Nell said.

“This shift changes our view of the UK. Near term, we see a stronger and more investment-focused recovery bringing forward the return to pre-COVID-19 levels of output.”

To show he will get a grip on borrowing, Sunak’s future hikes will increase the tax burden to its highest since the 1960s, rising from 34% to 35% of GDP by the mid-2020s.

“The UK is thus to become the first major economy to consider such measures,” Valentin Marinov, head of G10 foreign exchange research at Credit Agricole, said.

Britain has suffered the biggest COVID-19 death toll in Europe and its economy shrank by 10% last year, its worst slump in three centuries.

Many companies are also under strain from Brexit after Britain left the European Union’s single market on Jan. 1, and the government faces the challenge of huge investment to meet its promise to create a net zero carbon economy by 2050.

UK EARLY MOVER ON TAX HIKES

Britain’s Office for Budgetary Responsibility (OBR) said the economy was likely to grow 4% in 2021, slower than the 5.5% it had forecast in November, due largely to the current lockdown which began in January.

But the OBR raised its forecast for growth in 2022 to 7.3% from 6.6%.

Sunak has already racked up Britain’s highest borrowing since World War Two, with the deficit reaching an estimated 17% of GDP in the 2020/21 financial year that ends in April and set to fall to a still historically high 10.3% in 2021/22.

Announcing the corporation tax rise, he said: “Even after this change the UK will still have the lowest corporation tax rate in the G7 – lower than the United States, Canada, Italy, Japan, Germany and France.”

Rain Newton Smith, chief economist at the Confederation of British Industry, said the hike was “a huge jump” and that other G7 countries would be more competitive than Britain when state and federal level tax breaks were taken into account.

Businesses with profits of 50,000 pounds or less would pay a new Small Profits Rate at the current rate of 19%.

Sunak also said he would freeze the amount of money that people can earn tax-free and the threshold for the higher rate of income tax at the 2021/22 level until April 2026.

($1 = 0.7156 pounds)

(Additional reporting by Guy Faulconbridge, William James, Costas Pitas, James Davey, Estelle Shirbon, Elizabeth Piper, Paul Sandle, Alastair Smout and Sarah Young; Writing by William Schomberg; Editing by Catherine Evans)