by This week economists at the National Institute for Economic and Social Research (NIESR) said that the UK’s poor fiscal position, with high levels of debt and no scope to cut public spending, means that after the election taxes will have to rise regardless on who won. – or alternatively, that Jeremy Hunt’s fiscal rules must be abandoned.
Total government revenue from taxes and other sources is currently scheduled to reach 41pc of GDP this year. That compares to 37 computers as recently as 2019-2020 and 32 computers if we go back to the mid-1990s.
The last time government revenue was above 41pc was 1969-70, for one year. The last time they were over 41 PCs for several years in a row was in the late 1940s and early 1950s.
Could taxes be raised materially even higher than currently scheduled?
I don’t doubt it. In fact, I doubt even Hunt’s plans will be deliverable.
A key reason why taxes have not been held at these levels for several years in a row since the late 1940s/1950s, let alone increased, is that the UK economy is unable to generate that much revenue.
And he won’t be able to generate it anytime soon, either.
It is often noted that tax levels in the UK have, over time, been several percentage points lower than rates in some of our continental European peers.
What is less well known is that there is an important relationship between tax levels and the structure of a country’s economy and society.
Partly because our tax rates have historically been lower, but also because of aspects such as our tradition of a strong rule of law; confidence that UK governments (regardless of their political colour) will not introduce arbitrary wealth confiscation; our welcoming attitude towards foreign immigrants and foreign investments; the UK tends to attract a disproportionate amount of the world’s most mobile capital and high-income workforce.
Consider financial professionals, lawyers, highly skilled management consultants, highly skilled design professionals and those in similar professions.
The UK creates and trains its own citizens in these roles, disproportionately to our share of the global population, and we also attract these kinds of foreign-born workers.
We also attract foreign investors and manage the assets of wealthy individuals and institutions.
The ability to attract this globally mobile capital and high-value labor is called “competitiveness”. Other economies envy our ability to do it.
But one side effect of having high shares of such mobile factors is that if we tried to raise taxes on them they would tend to leave.
In any country there is a risk that the attempt to raise taxes beyond a certain point will fail, because the attempt to raise taxes damages the economy enough that taxes fall instead of rising.
But in the UK, because such a high proportion of our economy involves highly globally mobile capital and labour, the issue is more acute than elsewhere.
In our current situation, apart from further tax increases that increase the tax share of GDP closer to the normal levels of our continental competitors, the attempt to raise taxes is more likely to fail because firstly, it induces a recession, which causes the amount of tax to fall; secondly, it causes capital flight, reducing the tax base; and thirdly, high-income and high-wealth people emigrate, reducing the tax base again.
Maybe eventually, after many years of adjustment, our economy will change and settle down to higher percentages of GDP than before.
But that would involve significant structural changes in our economy. Losing our unusually high share of internationally mobile capital and high-income and high-wealth individuals would change our economy in ways that are difficult to predict precisely, but we can get some idea.
It would probably mean that financial and legal professionals, business consultants, software developers and manufacturing design experts would take a lower share of GDP than today.
We could have had lower house prices in London because that was not a safe haven for international assets. There would be less venture capital for start-ups and fewer of our businesses would be owned by foreign firms and individuals.
“Sounds good!” I hear some readers cry. Maybe. But the main relevant point for now is that it would take decades to get there, and for most of that time our economy would be producing less tax, relative to GDP, than it does now.
Therefore, whether or not such a structural change would be desirable in the medium term, it would do nothing to address the impending fiscal crisis that will greet whichever party wins the election.
So it is unlikely that taxes can rise. What else is there? Spending should be cut, but that means cutting NHS spending and no government will do that unless international lenders force it to. The last time it actually happened was under the IMF’s austerity program in the 1970s.
We could use structural reforms to grow the economy faster, so debt falls relative to GDP.
Both parties say they want to do that – Labor in particular say they want to “Get Britain Building Again”. But will it work, and if it does will it be fast enough? I do not think so.
The only thing left is to increase the debt, probably by allowing UK inflation to be continuously higher over several years (although the 1970s route of a few years of 10-20pc inflation would also work ). My guess is that the inflation target will be raised to 3pc soon. But even that may not be enough.
We will soon have to face a fiscal reckoning.
