Gordon Brown is facing a £1 billion annual bill for the 1.1 million people who have yet to be compensated for the 10p tax fiasco.

The scale of liabilities piling up for the Government emerges today with a devastating critique of Mr Brown’s personal handling of the issue that has hobbled his Government.

As Chancellor, Mr Brown acted for the “perceived benefit of seeming to pull rabbits from the hat” when he cut 2p off the basic rate of income tax and paid for it by abolishing the 10p rate.

The criticism, from the Labour-dominated Treasury Select Committee, made deeply uncomfortable reading for Mr Brown the day after his first anniversary as Prime Minister and Labour’s humiliating fall to fifth place, behind the BNP, in the Henley by-election.

Mr Brown’s embarrassment was compounded when Lord Levy, Tony Blair’s chief fundraiser, said that Labour should “seriously consider” ditching the Prime Minister.

The committee report spelled out how new costs were rising fast for Alistair Darling, the Chancellor, even as his financial rules were being strained to the limit.

It highlighted that the vast majority of the Government’s 10p rescue package – £2 billion out of £2.7 billion – had gone to people who had not even lost out from the original tax change.

The committee also called on him to find £1 billion each year to compensate the more than one million losers who had yet to be compensated.

Mr Darling is also under pressure to find £410 million to compensate drivers for the shake-up of road tax. Without a promise of action, the Government faces another Commons rebellion next week.

The committee confirms that Mr Brown would have known when he made his 10p decision in 2007 that there would be losers. Ministers took decisions on the basis of a “thorough distributional analysis”, according to Nicholas Macpherson, Permanent Secretary to the Treasury.

But it was the report’s reference to “rabbits from the hat” – a clear reference to Mr Brown’s habit of making crowd-pleasing announcements at the end of his Budgets – that was seized upon by the opposition parties.

Vince Cable, the Liberal Democrat Treasury spokesman, said: “This report is a devastating criticism of the Government’s tax policy. The reference to the short-term benefits of ‘pulling rabbits from the hat’ is an accurate but cutting description of Gordon Brown’s abortive attempt to use his last Budget for political gain.”

The Conservatives called the report a damning indictment of Mr Brown’s first year. Philip Hammond, Shadow Chief Secretary, said: “It shows that his policies are driven not by conviction but by short-term political calculation, with the poorest in society paying the price.”

Mr Darling is facing fierce pressure from Labour MPs to drop his Budget plan to impose bigger road tax charges on high-emission cars bought since 2002. It is believed that some advisers within No 10 and other ministers are also pressing Mr Darling to do a U-turn. But the Chancellor has no money in the kitty to meet the £410 million cost of abolishing the plan now, and the most he can offer before the Commons debates the issue next week is that he will consider the matter in the run-up to his autumn Pre-Budget Report.

Today’s report points out that the £2.7 billion package unveiled in May was a one-off measure for this year and says that Mr Darling must include permanent compensation for all 5.3 million households who originally lost in the autumn Pre-Budget Report.

John McFall, Labour chairman of the committee, said: “The May 13 measures, whilst welcome, do not go far enough. There are still 1.1 million losing households, many of whom are on low incomes and who are being hit hard by rising food and fuel prices and the slowdown in the economy.

“The Government’s short-term priority must be to make every effort to compensate these people in full. The Government must not let this issue slide into the background and will need to produce fresh proposals to fully compensate these 1.1 million households by the time of the 2008 Pre-Budget Report.”

The May 13 measures did have merit in their “simplicity, transparency and greater incentives to work”, the report said. Future reforms should aim to keep low-paid people out of income tax while avoiding further complication of the system. Mr McFall said: “Raising personal allowances was clearly not a well-targeted way to compensate the losers from abolition, but had the merit of offering a quick solution.”

The MPs urged Mr Darling to use the Pre-Budget Report to launch consultations on any future changes to personal tax, rather than keeping them secret so as to be able to “pull a rabbit out of the hat” on Budget day.

Mr Brown reacted to the Henley by-election result — Labour trailed in behind the Tories, Lib Dems, Greens and BNP — by saying: “By-elections come and by-elections go. Of course, we have to listen to what people say.”

Lord Levy said that it was for Labour Party members to decide whether Mr Brown should be sacked. But in an interview with Newsnight he added: “I certainly, seeing the polls, would have to say that this is something that needs to be very seriously considered.”

The Prime Minister’s woes were compounded as a ComRes/Independent poll showed him 21 points behind David Cameron, with the Tories up two on 46 per cent, Labour down five points at 25 per cent and the Liberal Democrats up two on 18 per cent.

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