Why UK taxes should be higher

 

Discussion of taxation in the UK is bedevilled by two problems: one familiar and one less obvious. The familiar one is to imagine the level of taxation is separate from the level of public services and welfare. Most voters and much of the media understand the two are connected, which is why the Tory attack on Labour’s ‘tax bombshell’ is so misplaced. A majority want public services to improve, and know that requires higher taxes [1], so all the Conservatives are doing is reminding voters that Labour is more likely of the two parties to improve public services.

Yet this familiar point gets forgotten when we come to the less familiar problem, which is historical comparison. It is now well known that UK taxes as a share of GDP, as measured by the OBR, are currently higher than they have been since 1948 (see Ed Conway here for example). This sounds bad, until you remember the first problem, which is that it is pointless to discuss taxes without also discussing public services and welfare payments. The elephant in the room here is health spending. Below is OECD data on total health spending as a share of GDP in each of the G7 countries, with the UK in red.

Health spending as a share of GDP in the G7

Health spending as a share of GDP has been trending upwards in all the major economies since at least 1970, for familiar reasons like longer life expectancy and advances in what medicine can do. If health spending is mainly paid for through taxes, then unless some other large item of government spending is trending in the opposite direction, taxes are bound to be at historic highs. For some time in the UK there was such an item, defence spending, but once that peace dividend ended there has been nothing to take its place. Of course if health spending is not paid for by taxes citizens have to pay for it by some other means. The top line in the chart above is the US, where spending is so high in part because it is a very inefficient insurance based system.

I have heard journalists in the media say that UK taxes are at record levels countless times, but I have never heard them also say: ‘but of course this reflects the steady increase in health spending as a share of GDP’. The more general point is that talking about tax without discussing what it pays for is just uninformative. [2]

International comparisons of taxation are better, because advanced economies have similar structures to their public sectors. Here is the same chart as above for total tax as a share of GDP (source).

Total tax as a share of GDP in the G7

Note the definition used here is a little different from the national accounts total the OBR uses, so using this measure UK taxes in 2022 are similar as a share of GDP to taxes in the early 80s. France has the highest tax share in 2022, followed by Italy and then Germany. Indeed most major European countries have a higher tax share than the UK, as Ben Chu shows here. The UK share is similar to Canada and Japan, while the US has the lowest tax share. (Will Dunn shows an international comparison for taxes on wage income here.)

Although more informative than historical comparisons, looking at other countries has obvious pitfalls. The US tax share is so low mainly because most US citizens pay via their employers for health cover through insurance companies. It doesn’t mean that US citizens are better off because taxes are low, because their wages are lower so firms can afford to pay for health insurance. If we ignore the US for this reason, then the UK has amongst the lowest tax take among the G7, and also the lower than most major European countries.

While international comparisons of taxes are better than looking at historical trends, they are not ideal because - as the US shows - the structures of the public sectors are not identical. Partly for this reason, the OECD compiles an analysis of total public and private spending on what it calls “social expenditure”, which is mainly health and welfare. I discussed this data in this post. However, even if we restrict ourselves to total public spending on social expenditure, the OECD estimates that the UK has the lowest spending in the G7 (at 22% of GDP), even just below the US (at 23%). France tops the table at 32%, followed by Italy (30%), Germany (27%) with Japan and Canada both on 25%.

This suggests that public spending in the UK is unusually low compared to other major countries, and as a result taxes are unusually low. This should come as no surprise, because public spending excluding health has been cut back sharply since 2010, as this chart from the Resolution Foundation shows.

What international comparisons tell us is that these cuts in public spending have moved the UK to the bottom of the G7 in terms of spending and taxation. UK public services are in crisis not because they are unusually inefficient, but simply because the Conservative government has chosen to spend far too little on them in order to get taxes unusually low compared to other G7 and major European countries. The Conservatives are going to lose this election badly in part because they continue to prioritise tax cuts over improving public services.

Which means UK taxes are too low, and a Labour government is going to have to raise taxes to meet both its pledges and expectations about public spending. (The National Institute comes to similar conclusions here.) The question Rachel Reeves and the Treasury will have to answer is whether they can raise enough using the taxes left after you exclude those they have promised to keep at existing planned levels? If not, will they break these election pledges, or will the public sector remain underfunded and the UK remain under taxed?

Even if Labour can raise enough taxes without breaking its election pledges to get public spending to levels similar to other European countries, this may pose macroeconomic issues. Higher public spending matched by higher taxes on companies or the better off may end up increasing aggregate demand, because higher taxes will not be matched by lower private spending. Together with higher public investment, this will put upward pressure on interest rates. [3]

However this will be a price worth paying, in part because public spending at close to current levels is having a negative impact on economic performance. In particular ever growing NHS waiting lists are restricting labour supply and therefore UK output and incomes. If the Labour government is to be successful in ending a period of very weak growth in living standards, one of the things it will have to do is increase levels of public spending and taxes closer to other major European countries.

[1] To preempt the tweets from MMTers, even if you believe that the level of taxes is just what is required to keep inflation constant, that in turn will depend on the impact of the public sector on overall demand. For this to be roughly neutral over the medium term, what the public sector adds to demand with higher spending it needs to roughly subtract from demand with higher taxes, so spending and taxes will across countries and over time tend to move together.

[2] Discussing the composition of total tax, and how it has changed over time, is more interesting. The Resolution Foundation has an excellent account here.

[3] Whether this means higher interest rates, or just rates coming down more slowly than they otherwise would have done, will of course depend on other influences on aggregate demand.