Hamish McRae: It's a tax by any other name, and so the bet is on a rise in national insurance

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Where is the money going to come from? Economists are not known for their unanimity of views but there is a rare degree of agreement in the profession that taxes will have to go up after the election, irrespective of who is the next Chancellor.

Where is the money going to come from? Economists are not known for their unanimity of views but there is a rare degree of agreement in the profession that taxes will have to go up after the election, irrespective of who is the next Chancellor.

The International Monetary Fund thinks so; the Institute for Fiscal Studies thinks so; even the Treasury thinks so, though there is a crucial difference between the Treasury and everyone else. The Treasury believes that tax revenues can rise as a percentage of national income without there being significant increases in tax rates, whereas the independent forecasters think rates will have to rise too.

For what it is worth, the latest figures ­ out yesterday ­ for public borrowing in the last financial year are even worse than the Treasury thought at the time of the Budget. There was public sector net cash requirement (PSNCR) of £13.6bn in March, which means that for the financial year 2004-05, there was a PSNCR of £38.6bn, £1.3bn higher than the Budget forecast of £37.3bn. According to Barclays, this is more the result of higher-than expected spending rather than lower tax receipts, but of course the overall picture is discouraging, to put it mildly.

So what is going to happen? The building blocks of the tax debate are set out below. On the left are the Treasury's figures for tax and national insurance revenues ­ there is, incidentally, no pretence in the way the figures are presented that national insurance is anything other than a tax, though the Chancellor has been known to suggest otherwise. As you can see, income tax and national insurance bring in nearly half the total, with VAT the other really big revenue stream.

Next to that table is the forecast for growth in revenues to 2007/8, done on an annual basis. So receipts are expected to grow in real terms (i.e. allowing for inflation) by 4.4 per cent a year, which is a lot when you consider that the Treasury assumption for the underlying growth of the economy is 2.75 per cent. Among the taxes the Treasury does not expect much more revenue are VAT (up only 2 per cent a year) and particularly excise duties (up only 0.5 per cent a year). But it thinks that revenues from corporation tax will shoot up by more than 13 per cent a year.

This expected growth in revenues is shown in the right-hand chart, with taxation rising from its trough in 2002/3 of just over 37 per cent of GDP to more than 40 per cent by 2006/7. The spending line is current spending, not total spending, and it is current spending that is supposed to be financed by taxation over the economic cycle under the golden rule. According to the Treasury, receipts will cover current spending in a couple of years, allowing it to claim that the golden rule will not be broken.

That graph, which comes from the IFS, shows another line, the expected growth in revenues as calculated by the IFS. It thinks the money will come in more slowly. Its dotted line, unlike the Treasury's, does not cross over current spending.

Let's assume the IFS is right, for its predictions certainly seem more plausible. What then?

The Government will either have to cut spending plans or raise more money from taxes. But it cannot decently increase the main income tax or VAT rates. Labour has given about as clear a commitment as any government can ahead of an election, while in the unlikely event of a Tory victory, such rises would be inconceivable. Indeed the next government cannot safely assume that these revenues will hold up as expected, given that revenues have been coming in a bit below Treasury expectations in recent years.

If you want big money you have to go for big taxes. You can pick up the odd billion by thinking up some new wheeze ­ the tax on airfares for example. And you can hit a known flow of funds that previously was exempt, such as pension fund dividend income, though that looks a little less clever than it did when Gordon Brown changed tax practice in 1997. But fiddling around would not change the big revenue shortfall that is in prospect. What else is there to boost tax?

Excise duties? Well, not really. Fuel duties might be squeezed up a bit, but we have about the highest duties on road fuel in the world. The main effect has been to encourage people to choose more efficient cars and push up distribution costs for industry. Besides, it is politically tricky. You could increase taxation on fuel for home heating but that is tricky, too. Booze and fags? Too much leakage here from people buying cheap in Calais. Indeed, we may be at the stage where an increase in tobacco duties actually cuts revenue rather than increasing it. The modest rises projected by the Treasury accept this reality.

So what is left? Well, of the biggies there is only corporation tax (projected at £44bn) and national insurance (projected at £83bn). You do not need to be a genius at maths to figure out that is where the hit will come.

But there are problems with both of these taxes. The Treasury thinks it can get a lot more out of corporation tax, and it may be right. But that is one area where international tax competition is most evident. Big companies are to some extent mobile. They are not completely mobile in the sense they cannot move their plants or their markets, and they cannot move their legal headquarters swiftly.

But governments are to watch it as power has shifted away from them. Just last week Sandoz, the drugs company, said it was considering relocating and it had approached the authorities in Germany, Austria and Switzerland to see what they could offer in terms of tax and other benefits. Several of the new EU members in Eastern Europe have introduced a flat tax on companies and individuals, and that is changing the whole game. Corporation tax revenues may be much more vulnerable than the Treasury realises.

That leaves national insurance contributions. Actually, NICs are two taxes for they are paid both by employers and employees. Of course, the money comes from the same pot, but it appears on different accounts. If tax on the company portion goes up, employers have to adjust in some way or other: put up prices, cut employment, negotiate lower pay rises, whatever. The big question is whether a further rise in their contribution would result in lower, private-sector employment. We just don't know, and last time the Treasury got away without damaging effects. But if, in the cooler climate of the next couple of years, the Treasury found it had cut employment it would have scored a catastrophic own goal.

On the other hand, the Government could argue that social security charges were still quite low by European standards and that since employers in Britain, unlike those in the US, were not saddled with healthcare costs, charges were low by US ones, too.

The other part of national insurance is the chunk paid by us, in effect a part of income tax. That looks the obvious candidate for another increase, perhaps by a further 1 per cent like the last rise. It would be presented as paying for "front line" services as opposed to the clipboard merchants and it might well be deemed politically acceptable.

But if you want an answer to the big question ­ how will they raise the extra revenues? ­ that is it. It will be national insurance. Clever idea to call it "insurance", wasn't it, when of course there is no pot of money being saved on our behalf and it is not insurance at all.

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