During the election campaign, Chancellor Rachel Reeves made bold promises – no increases to Income Tax, National Insurance, or VAT. She also sought to echo the ‘prudence’ mantra of her predecessor as chancellor Gordon Brown, though his tenure was marked by significant spending increases rather than prudent restraint.
True to form, over the weekend Reeves indicated the government could accept recommendations for above-inflation pay increases, of about 5.5 per cent, for NHS workers and teachers. The Institute for Fiscal Studies (IFS) estimates that a similar pay hike across public sector professions would cost about £10 billion, requiring more taxation or borrowing. This comes amid other ambitious plans for restructuring and investment, which will all cost even more money.
Stealth taxes, such as failing to adjust income tax thresholds for inflation or tweaking capital and inheritance taxes, are Reeves’s most likely choice
But the public finances are in a precarious state. The tax burden is the highest it has been in seventy years. This year, Tax Freedom Day – the day of the year when the average person in the UK has earned enough to pay all the taxes demanded of them, and finally gets to earn for themselves – fell on 10 June, the latest since records began. Add on the burden of government borrowing and it is 20 July. On present projections of government spending plans and projections from the Office of Budget Responsibility, the Adam Smith Institute calculates that by the next election we will all be paying another two weeks’ worth of tax.
That is crippling, but there is little room for manoeuvre in the public finances. And government spending (even wasteful spending) is notoriously hard to cut, so further tax hikes are seen as inevitable. But if the government does decide to raise taxes to fund its plans, the challenge lies in what taxes they choose to raise. That is because all taxes have unintended consequences, usually bad ones, and taxes invariably damage one group of people or another – and the economy and growth in general.
Tax rises are unpopular, so governments naturally plump for ones that do not show so much. Stealth taxes, such as failing to adjust income tax thresholds for inflation or tweaking capital and inheritance taxes, are therefore Reeves’s most likely choice. But while stealth taxes may be politically easy, they can be extremely damaging. Gordon Brown’s stealth tweak of an obscure pensions tax, for example, ripped £2 billion a year out of people’s savings, made pensioners poorer and hit investment.
As I find in a timely new book, An Introduction to Taxation for Institute of Economic Affairs, some taxes are much more damaging than others. Higher taxes on struggling businesses, for example, like rises in employer national insurance, would be extremely harmful, because they are ultimately borne by consumers and workers, not just business owners. Higher capital gains taxes – another option Reeves has left open – would further distort saving and investment decisions, driving investment abroad and hitting UK productivity.
If the government is going to raise taxes, it should instead focus on shifting the tax burden away from productive activities like work, saving, and investment, and onto harmful things such as pollution and environmental degradation.
And more fundamentally, we need a comprehensive reassessment of the UK’s tax system: its purpose, level, the types of taxes, and their overall effects. Simplification and increased transparency should be key objectives, making the system easier (and cheaper) for individuals and businesses to understand and comply with.
Sadly, politicians rarely make bold, principled reforms until they have run out of other options. The political reality is that the new government’s tax policies will be a delicate balancing act. Reeves must navigate the competing demands of funding a ravenous public sector, maintaining her electoral promises, and trying not to do too much damage to future economic prosperity. But again, the reality is that she and her team will face intense pressure to eke out all possible revenue sources, even at the expense of squeezing the UK’s economic recovery.
But if tax rises are coming, they really must be carefully focused, on the things that are less damaging to growth, and not on the businesses, employment, saving and investment that are the only things that will get us out of the debt we are in.
Real fiscal success would require a clear-eyed assessment of the trade-offs involved, a willingness to make difficult choices, and a steadfast commitment to policies that prioritize economic recovery and growth. Anything less risks compromising the UK’s growth and competitiveness.
It is a challenge, but the opportunity to reform the fiscal landscape has never been greater. With realistic, principled leadership, Reeves could chart a course that takes the UK on its way to sustainable long-term growth, while still upholding the values of fairness and equity that her party has long stood for.
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