Government borrowing has soared as a result of the pandemic. Longer-term pressures on public spending were already building. Can the spectre of tax rises be far behind?
The Treasury has made no secret of its desire to “repair” the public finances, perhaps starting as soon as the autumn Budget. Some have already been spooked by the Chancellor’s decision to ask the Office of Tax Simplification to conduct a review of capital gains tax (CGT) for individuals and smaller businesses.
Of course, this review could just be an exercise in tidying up the various allowances and exemptions. However, there is plenty of scope to raise money by taxing capital gains in the same way as other types of income, even if charging CGT on the sale of your home would probably be a step too far.
We had a taste of this in the March Budget which restricted Entrepreneurs’ Relief (or Business Asset Disposal Relief as it is now known). The Chancellor has also hinted that he would like to look again at the lower rates of National Insurance Contributions paid by the self-employed, in return for the attempts to provide them with the same financial support as that available to employees during the pandemic.
This would be hard to square with the manifesto commitments not to raise the rates of income tax, VAT or National Insurance, but not impossible.
For its part, Labour’s approach here is best described as “constructive ambiguity”. Anneliese Dodds, the shadow chancellor, has stressed that she does not see a need for tax increases now. However, she has also said that if tax increases are needed in the future, they should land on those with the “broadest shoulders” and address “rising” inequalities, including in wealth.
As it happens, there is little evidence that either income or wealth inequality has risen significantly over the last decade, or that the UK is the outlier here that many seem to think. But the idea of taxing “wealth” more equitably is obviously popular.
For now, there does at least seem to be a broad consensus that taxes will not have to rise to pay for the costs of the pandemic itself. The Treasury will probably have to borrow £300bn more this year than originally expected – and find buyers for well over £500bn of government bonds to finance both this additional borrowing and replace bonds that are maturing.
Nonetheless, few are seriously questioning the creditworthiness of the UK, and there is plenty of safe-haven demand for government bonds from private investors. If necessary, the Bank of England could still pick up whatever is left.
What’s more, the surge in borrowing is expected to be temporary. The budget deficit should narrow sharply next year as the economy recovers and the emergency fiscal support can be withdrawn. The stock of debt will remain higher, but the burden of this debt as a share of national income will also start to come down. In the meantime, it should be readily financeable at historically low interest rates.
But even once this crisis is past, there will be still be huge challenges ahead, especially given the demographic time bomb. The Office for Budget Responsibility has again warned this week of the need to take longer-term measures to return public debt to a sustainable path.
In particular, as the population ages, the number of older people who will require potentially expensive health and social care will increase, at the same time as there will be fewer younger people in work to contribute towards the costs.
The Chancellor is therefore right to review the options on the tax side. Indeed, this should go further than just a rethink of capital gains tax. There are lots of anomalies where income is taxed at different rates depending on whether it is from employment or self-employment, or capital gains, or dividends. High-earning taxpayers receive bigger breaks on their pension contributions than others.
Correcting these anomalies would simplify the tax system and reduce distortions.
If there is a need to raise more revenue, this can be done by levelling taxes up rather than down. This would also make more sense than introducing brand new taxes. New taxes on wealth in particular are likely to run the risk of double or even triple taxation. They are also only likely to raise significant amounts of money any time soon if they are applied retrospectively, which would – or should – be a non-starter.
This is in addition to the practical problems of wealth taxes. For example, it is hard to work out the appropriate tax on a property without a transaction to determine a market price, and without a recent sale it may be hard for the homeowner to find the cash to pay the bill.
It therefore seems likely that any wealth tax would focus on financial assets. But an additional tax raid on people’s savings – on top of existing taxes on any capital gains or income earned – would not obviously be either fairer or more efficient. The richest would probably still find some way to avoid it anyway, including by moving their assets overseas.
Nonetheless, it would also be a failure of imagination to assume that the only way to increase tax revenues is to increase tax rates or to introduce new taxes, or even that raising more in tax is the only way to keep public borrowing under control.
Instead, there needs to be a relentless focus on economic growth or more precisely, boosting productivity. This will not avoid the need for difficult decisions – for example on planning reform to allow more building on the green belt, or the case for a more flexible immigration policy, or market-led reforms of how health and social care are funded and delivered.
The good news is that there is time to get all this right, despite the pandemic. But the sooner we start these conversations, the better.
Julian Jessop is an independent economist