Why the government’s current budget will require tax increases
‘Read my lips: no new taxes’; ‘we will reduce net immigration to the tens of thousands’; ‘we pledge not to increase tuition fees’. Promises easily made in an election campaign. A source of endless regret in government.
There will be endless regret from Labour’s manifesto commitment not to raise tax rates on taxes accounting for three quarters of tax revenue. There is an urgent and compelling need to raise taxes in the coming budget for reasons of fiscal prudence and to stem the decline in public services. Yet, despite having an enormous parliamentary majority, the government has denied itself a mandate properly to address these fundamental problems.
We are now facing a budget on Wednesday which will in all probability fail to produce promised improvement in services and, by using several complicated tax devices, annoy almost everyone including businesses needed to restore the growth on which long term improvement depends.
The IFS estimates (within a wide margin of error) that around £20 billions of extra taxes will be needed over and above Labour’s already promised taxes if further erosion of public services is to be avoided and promised budget discipline maintained (balancing the government’s day-to-day, current, budget). Other estimates are of £40 billion or above. And that does not include measures to tackle child poverty (the ‘two child limit’), to sort out the near-bankruptcy of local government and of universities and to address social care.
£20 or £40 billion sounds a lot but a 1p rise in income tax on top of basic and higher rates would raise almost £10 billion. A 1% rise in VAT would raise £7 billion. Both could rise substantially and still be well below Scandinavian levels. There would, I suspect, be little resistance if there had been a grown-up conversation with the electorate, before the election, explaining that public services must be paid for and that Covid and the energy crisis left a bill which now needs to be settled.
So, if these major tax raises are to be ruled out, what can be done instead? In opposition Labour was able to rely on the magic money tree. It is possible that, in government, also, the fairies might help. The bizarre fiscal arithmetic around QE and the balance sheet of the Bank of England could be tweaked to relieve the government of some of the accounting costs of quantitative tightening -involving bond sales. But too much ‘tweaking’ will worry the bond buyers who don’t believe in magic, as Liz Truss discovered a few years ago.
This is especially so as one of the welcome, growth-enhancing, ideas for the budget is expanding government borrowing – bond sales – specifically for more public investment. As a veteran of -losing – battles with the Treasury over this issue I welcome Rachel Reeves’ determination to break out of the stranglehold of investment curbs. It is surely sensible if, as is proposed, public debt is offset against asset creation in a revised fiscal rule. But care is needed; the bond vigilantes will be suspicious that more public investment will simply disappear into a black hole like HS2.
It is balancing the government’s current budget which will require tax increases. If higher income tax rates are ruled out by manifesto commitments, the government may cut income tax thresholds instead by allowing the continued ‘drag’ of inflation. Apart from creating the impression of deviously breaking a pledge, this mechanism is less progressive than an increase in the rate (when people pay more the higher their income): an odd choice for a government embracing ‘fairness’. It will also antagonise many middle-income earners who will be paying the 40% rate for the first time.
It seems certain that the government will increase employers’ national insurance since it has pledged not to increase employees’ NI. Taxing employers might seem more popular: ‘the bosses can pay’. But, in practice, employers’ NIs are a tax on jobs and will be passed back to workers or passed forward to consumers. Not clever.
Economists and left-wing politicians tend to agree on the desirability of taxing dead people, especially those with large property assets. Inheritance Tax is in the sights of the Chancellor who wants to cut ‘loopholes’. Capital gains on death is another possible revenue source. IHT does no obvious economic harm and taxes people who became rich, unfairly, by sitting on appreciating property values. And why should the next generation of billionaires also become billionaires without working for it? Unfortunately, the tax is extremely unpopular: seen as a ‘double tax’ on earned income and an attack on property millionaires in semi-detached suburbs rather than billionaires in detached mansions (who can also afford the best tax accountants to find new loopholes).
The Chancellor is also reported to be looking at other taxes affecting the ‘rich’ who tend, in practice, to be ‘middle class’. Tax-free contributions to private pensions are apparently in the Chancellor’s sights. But pension planning is complex and long term and people get very angry when carefully calculated policies are turned upside down by cash-hungry Chancellors.
Capital gains tax is another can of worms. It covers unearned increases in asset wealth but also the returns from high risk, high reward entrepreneurship which is needed to get the economy growing again. Disentangling the effects isn’t easy.
Another mooted tax raid is on motorists who have ben protected from fuel duty increases for over a decade. There is a compelling environmental and revenue case for hiking petrol and diesel duties. But expect howls of outrage from rural and other areas badly served by public transport. And there is a growing worry that the more successful the policy in driving motorists towards electric vehicles, the fewer cars there will be to tax.
Not least there is a very unpopular tax which won’t be discussed in the budget, but which will be used to mop up some of the deepening pool of red ink in local government finance: council tax. There is a fundamental gulf in comprehension between those who see council tax as a basically sensible property tax, albeit needing reform of the banding structure and revaluation, and angry local residents who see it as a growing charge for deteriorating services like bin collection.
The Chancellor may produce some bold new ideas. The greater likelihood is a scattering of widely predicted and complicated measures with lots of unintended consequences and potential to create annoyance.
It would have been so much better to have told the public the truth about tax and prepare them for a few big, easily understood, increases.
Sir Vince Cable is a former Secretary of State for Business, and led the Liberal Democrats from 2017-19.
