October Budget 7: Soaking the rich?

 

This, my final post on the forthcoming budget, is designed to provide a guide to how to read what Reeves announces (or doesn’t announce) in a way that goes rather deeper than the normal media commentary. My perspective, along with a large part of the UK population, is how much does the budget get us on a path designed to end public service austerity. (See here for what I mean by that.) As I argued here, a budget that focuses on filling black holes rather than restoring public services will be a political failure. So I will start with current public spending, go on to talk about what taxes might be raised to match that spending, and finally talk about public investment.

Public spending

As I outlined in an earlier post, the share of public spending in GDP needs to rise substantially to get back to an acceptable level of provision. Below are the headline numbers for total current spending (excluding gross investment) and taxes from the OBR’s databank. We see the share of public spending in GDP rise under the last Labour government and fall under the Conservatives. The pandemic (with a little earlier help from the Johnson government) provided a sharp increase, but the plans Reeves inherited suggest a resumed decline.

A critical point that I made in that earlier post, which is routinely ignored in most analyses, is that this GDP share needs to rise over time because, in the UK and most other countries, the share of health spending in GDP has historically been on an upward trend for well known reasons. In that post I estimated that, compared to levels today, current public spending needed to rise by 3% of GDP to return to 2010 levels of public service. However a better point of focus is the end point of the OBR’s projections, and because of the decline in spending Reeves has inherited the increase in spending has to be over 4% of GDP by that date.

Although a spending review for that period is yet to take place, Reeves will have to give the OBR some indicative numbers, and these are what we need to focus on. I don’t expect to see the share of current spending rise from its 2023/4 level of 40% to 43% by the end of this decade, if only because restoring public services to 2010 levels is a ten rather than five year project. The key question is how far will Reeves go, which in turn will depend in part on how much she can raise in tax, and in part on the forecast the OBR gives her. As I noted in my first post on the budget, economic growth does not give you much in the way of additional resources for public spending as a share of GDP, unless it is accompanied by public sector productivity gains.

The OBR publishes revised numbers for current public spending immediately after the budget. There is always a risk that there will be an element of Treasury/Cabinet game playing in the numbers Reeves gives the OBR, However I would have thought anything less than a projected real term increase in departmental spending, after allowing for much more for the NHS, would be politically disastrous for the government. In addition it will be very difficult (and wrong!) for Reeves not to at least begin rolling back child poverty, and in particular abolishing the two child limit and benefits cap. (See this from the IFS on the impact of these policy options on poverty.)

Tax increases

For tax increases the numbers you will see in budget commentary will be in £ billion (or £ million), so to give you an idea of scale raising public spending by 1% of GDP in today’s prices will cost around £30 billion by the end of the decade, and after adding in inflation more than £33 billion.

The tax rises in Labour’s manifesto are small in comparison. VAT on private school fees, a higher windfall tax on energy, closing non-dom loopholes and ending the carried interest tax exemption raise about £4 billion. Labour also hopes to raise £6 billion by spending more on tax collection, but the OBR will need to make a judgement about how realistic that is.

There are some tax increases due to come in that were scheduled by the last government, most notably the freezing rather than indexing of tax allowances. In addition Covid business tax relief is due to end, fuel duty is due to rise (ending a temporary cut and adding in uprating which the last government routinely assumed but never did), and lowering the stamp duty threshold. Reeves could reverse any of these, but that would only add to the taxes she needs to find elsewhere.

So where are large tax increases going to come from? Reeves has pledged that they should not come from ‘working people’, but in practice that seems to mean not from income tax, personal NIC contributions and VAT. Labour has also pledged not to raise the rate of corporation tax. What is left that would yield large amounts of money?

1. Employers National Insurance Contributions

Raising the contribution rate by 1% for employers would raise about £5 billion net. (Beware larger numbers quoted in the media that include contributions paid by the public sector.) Another possibility is to extend national insurance payments to employers’ pension contributions, which could raise £12 billion (net of the public sector). Finally she could remove the NIC higher earnings cap, which could raise over £12 billion. Strangely (not really!) this possibility is hardly ever discussed in the media. It is one of the steps needed to make national insurance contributions more like income tax, with perhaps the eventual integration of the two taxes on income from employment, but Reeves may feel it is precluded by Labour’s pre-election promises.

2. Capital Gains Tax (CGT)

At present, capital gains are taxed at a much lower rate than incomes, which if nothing else leads to a lot of tax avoidance. The details of what Reeves could do quickly get quite complex, as are estimates of how much the tax increase would raise. The key uncertainty is how much owners will (initially at least) hold on to assets to avoid paying the higher tax, hoping for a change of government. The OBR will have to take a view on this. Equalisation is also not straightforward, because it could involve just income tax, or it could involve all taxes on income from employment including National Insurance. A recent study suggested that equalisation with income tax (with rates of 20%, 40% and 45%) plus a system of allowances and other changes could raise £14 billion. Leaks to the Guardian suggest Reeves is looking at increases in the CGT rate from 20% (for most) to between 33% to 39%.

3. Investment income

Reeves could raise the tax rate on rental and dividend income. These are currently taxed at similar rates to earned income, but they could be taxed at higher rates. More radically, she could extend National Insurance Contributions to investment income, which Advani estimates could raise £11 billion.

4. Inheritance tax

Raising this from 40% to 45% would only raise a billion according to the IFS ready reckoner. (I would advocate a much bigger rise - sorry kids! - on equity grounds.) There is probably more scope to raise money by removing various exemptions (e.g. business and agricultural reliefs are worth 2 billion), and Reeves could be more radical still and replace it with a gifts tax. I don’t expect it, but Reeves could also introduce a wealth tax. Advani suggests a 1% annual tax would raise £13 billion.

5. Extending the freeze on tax thresholds

These are currently frozen until April 2028. Reeves could extend these over the full OBR forecast period, raising around £8 billion, but this really is an income tax increase. Budget leaks suggest she intends to do this, and perhaps she thinks this is politically safe as the Conservatives will find it difficult to condemn her for continuing what they started.

There are a lot of detailed changes that Reeves could make, which tend to be small in revenue terms but can add up. For those who want to get into the nitty gritty of all that and the above, there are plenty of good resources around from, among others, the IFS (their ready reckoner and Green Budget), the Resolution Foundation, Centax, the Financial Times and Dan Neidle.

The numbers above indicate that there is clear scope for substantial increases in taxes, even within the limits Labour has imposed on itself (with help from the Conservatives). Whether they amount to enough to bring public services back to 2010 levels is more doubtful. Most, but not all, of the proposals mentioned above will mainly hit individuals who are well off. Unfortunately the obvious redistributive tax change, raising taxes on very high earned income, is probably ruled out by Labour's pre-election pledges.  

Two final points. The first is to look out for tax increases that could be extended further in later years. In many cases gradualism makes economic and/or political sense, and also see the point about Cabinet game playing above. The second is to see if Reeves makes any initial moves to introduce new taxes, such as road pricing for example.

Public investment

There has been plenty of discussion in the media of how she could amend the ‘falling debt to GDP’ fiscal rule to allow more borrowing for investment, and almost no discussion of my own preferred option of getting rid of the rule completely. This makes perfect sense as the rule is designed to appease mediamacro rather than economists or the markets!

Whatever she decides to do, the key issue is how much extra public investment she plans for by the end of the OBR’s forecast period. On present plans net public investment is set to fall from 2.5% of GDP currently to 1.7% by 2028/9. In my view this decline needs to be turned into a substantial rise if we are going to catch up with all the investment lost under the Conservatives.

As the budget is on Wednesday next week, I will not do the usual post of Tuesday, but instead delay it until Thursday or Friday to give my own reactions to the budget.