The Tax Conundrum
Britain is ‘living beyond its means’: a slow growing economy, a burgeoning population of elderly dependents, and a seemingly unbridgeable gap between budget receipts and government spending.
The Coalition was the last government to address the issue systematically, if painfully, in the wake of the deficits and debt generated by the global financial crisis. Since then, Brexit, Covid, the ‘cost of living crisis’ and Trussonomics have made the problems worse. Britain increasingly resembles Italy: an economically stagnant, ageing, highly indebted, crumbling relic with a great history.
The Labour government has refused to face reality. All inherited problems were the fault of the wicked Tories. And a Growth Fairy would magically appear to wish away any underlying problems. Painful trade-offs involving spending and tax were to be avoided wherever possible. And, now, no-one is to be upset, ever. After the political fall-out over the Winter Fuel Allowance and failed, modest welfare reform, ministers are once bitten, twice shy.
But this Alice in Wonderland approach does not detract from the hard facts. Rachel Reeves claimed in her Mansion House speech this week that debt is ‘on a downward path’. Yet the Office for Budget Responsibility has made it clear that current budget deficits and debt are unsustainable. In addition, there are major uncertainties facing the economy – such as the global impact of Trump tariffs; interest rates; defence needs.
The government will simply have to raise an additional £20 to £30 billion in tax revenue in the autumn budget. There is no alternative if Britain is to retain the confidence of international lenders on which it still heavily relies.
The Chancellor now has the unenviable task of explaining why, after seeking to fill the £20 billion ‘Tory black hole’ with higher taxes last year, there now must be a repeat.
There are two approaches. One is to resort to the usual box of tricks by which Chancellors try to conceal taxes: allowing inflation to erode tax allowances; taxing companies rather than people; ‘cracking down’ on elusive tax ‘avoidance’; and other clever wheezes to get around the – foolish and unnecessary - pre-election commitment not to raise the basic rate of VAT, income tax or employee NICs.
Labour activists have their eyes on taxing ‘the rich’: a tiny group of undesirables who, supposedly, can’t fight back through the ballot box. But, as we have seen, even small numbers of country landowners threatened by IHT can make a lot of political noise. And, as with the non-doms, rich people are not idiots: they will move to minimise their tax liabilities. Withdrawal of tax reliefs on large pension contributions sounds like an easy hit, but will have unintended consequences for national savings. There are no easy options.
A better place to start would be to ask how any government with progressive intent can pay for the kind of state which the public demands.
The answer would start from the proposition that Britain wants, ideally, to be a bigger version of Scandinavia: well-funded services and welfare provision; a generous and civilised approach to poverty and distress at home and abroad; an innovative pro-business, open economic environment; and high standards of living measured not just in GDP but wider indicators of wellbeing and ‘happiness’.
The five Scandinavian countries all have flaws (as a devotee of Scandi thrillers, I recognise the unwholesome side of ‘happy’ countries). But, by UK standards, they are in an enviable place. Both Sweden and Denmark have falling debt levels, between 30% and 35% of GDP. Britain’s is at 96%.
Several things are immediately obvious about the Scandinavian ‘model’. All have a significantly higher tax share in the economy than we do. On OECD comparisons, the UK share of tax in GDP was 35.3% in 2023, slightly below the OECD average. It is forecast to rise to 37.7% in 2027-28 following recent tax increases: as high as it has been since the war but some way below the Scandinavian level. Denmark is at 43.4%; the others all over 40% except Iceland.
A second common feature is that all have VAT rates around 25% as against the UK’s 20% (albeit with some exemptions and tiering). The Scandinavians see merit in a broadly based tax through which almost everyone contributes depending on how much they consume, adding to a sense of solidarity. In the UK, VAT is wrongly seen as highly regressive, despite exemptions or zero-rating for the necessities of life.
Third, there are also generally higher rates of income tax and higher marginal rates on top earners, as well as high capital gains tax. And enforcement is made easier by transparency. In Denmark, tax returns are published. But there is also an understanding that risk, innovation and entrepreneurship need to be rewarded, and that penal taxation of company profits makes no sense if the aim is to promote investment.
The latter point is crucial if Britain is to have any hope of moving beyond the near stagnation of the economy which makes all the trade-offs so much more difficult. The underwhelming ‘Leeds reforms’ add little.
Ed Davey was dead right last week to point to unrealised benefits which could be gained from the green energy sector and breaking the link between electricity and gas prices. And Liberal Democrats remain Britain’s principal advocates for tearing down post-Brexit trade barriers with the EU. Doing so would generate another £22bn or so of GDP each year and cost us nothing.
There is nonetheless an emerging vacancy in British politics for a party or individuals willing to pose the question: do we want our country to be a colder, wetter version of Italy or a warmer version of Scandinavia? And, if the latter, to make the case for making Britain a bit more like Scandinavia – and paying for it.
Sir Vince Cable is a former Secretary of State for Business, and led the Liberal Democrats from 2017-19.
