Whichever way you cut it, taxes may need to rise

Published on 7 November 2014

Paul Johnson, IFS Director, writes in the Times.

This opinion piece was first published in The Times.

As we should all know by now, whoever forms the next government will still have a big deficit to deal with. Extra spending cuts have been planned for 2015-16. And despite what the prime minister wrote in last week’s Times, it is clear that the Conservatives are planning spending cuts over the next parliament at least as big as those they have implemented over this one. 

There are two routes out of that scale of cuts. One is to adopt a less ambitious target for deficit reduction - which is explicitly the policy of the Labour party and the Liberal Democrats. The other is to raise taxes. The main parties are not setting out measures to do that on any scale. Indeed the Conservatives are planning tax cuts.

But we should be talking about taxes, and not just because recent history suggests that, once the general election is out of the way, they will be raised to help to deal with the deficit. They may actually have to be increased just to stop things getting worse. 

Take what is happening this year. The Treasury has so far actually had to borrow £5 billion more than it did over the first six months of the previous financial year. That’s not the direction in which we are supposed to be moving. It’s always dangerous to draw strong conclusions too soon through the financial year, but so far growth in tax receipts has only been about half as fast as expected for the year as a whole. And that despite the fact that economic growth has been pretty good.

Some of the underlying trends are worrying too. Revenues from stamp duty land tax are not rising as fast as expected as the property market slows. Revenues from North Sea oil and gas have been hit by lower prices. Most worryingly, income tax revenues seem to have been hit by continued slow wage growth.

The shape of the recovery - jobs-rich, earnings-poor -  is bad for the government’s coffers. More tax gets paid if the same amount of economic growth is driven by higher earnings than if it’s driven by higher employment (and particularly self- employment). The chancellor can expect a good £4 billion less in income tax and national insurance contributions this year than he would have got if the rates of growth in earnings and employment was as he expected back in 2010. 

The big increase in the income tax personal allowance will have made this worse. People moving into work on low earnings won’t be paying much income tax.

The chancellor must also be bemoaning the lack of inflation. Low inflation means less tax revenue and it also means that the effective real cuts in public spending are smaller than expected. Limiting increases in social security benefits to 1 per cent a year doesn’t save much when inflation is running at only 1.2 per cent. 

The future may well hold more worries. Further tax cuts won’t help, of course. And official forecasts assume some bounce back in earnings, which may or may not happen. But there are at least three additional reasons to worry about the long-term stability of our tax receipts.

First, we have become increasingly dependent on a very small number of taxpayers. The top 1 per cent of income tax payers paid 28 per cent of all income tax in 2011-12 - up from just 11 per cent 30 years previously. The 1 per cent of transactions on properties worth more than

£1 million accounted for 30 per cent of revenues from stamp duty land tax. These figures reflect in part just how much richer than the rest of us are the very rich. They also illustrate just how dependent we are on them.

 Second, duties on petrol and diesel bring in a handy £27 billion or so a year. But as cars become more fuel-efficient and the level of duty is repeatedly frozen, the government has failed to bring in the amount of revenue the duties were intended to provide.

Third, the £40 billion of corporation tax that we raise every year is at risk from international competition. Even if OECD talks about corporation tax structures are concluded successfully, the UK could struggle to maintain these revenues.

The fiscal debate has been set over the size of the deficit and the scale of actual and planned spending cuts. But we are collectively failing to address the third part of the fiscal equation - taxes - other than through the slightly surreal lens of promises to cut them. In fact we may find that we need to raise the overall tax-take to deal with the deficit. Even if we don’t, it is quite possible that we will have to raise some taxes just to bring in the revenues forecast by the government. Ignoring the facts won’t make them go away.