Just when you thought things were looking up ... er, they’re not

The economy may be recovering but tax revenues aren’t. This is a mystery, with no happy ending


The economy’s up; but government tax revenues are down. What’s going on? Well, something very big may be going on but we don’t know for sure. What we do know is this. The economy is growing by around 3 per cent a year, maybe rather more to judge by the rate of job creation. There are 800,000 more people at work than there were a year ago. Retail sales are well up, by 3.9 per cent year-on-year, and consumers are more optimistic than at any time in the past nine years. Given all this, you would expect tax revenues to be about 5 per cent higher – growth of 3 per cent plus inflation of 2 per cent – and the Office for Budget Responsibility projects that revenue this financial year will be up 5.3 per cent.

However, we learnt last week that revenues for the first two months of this financial year were down by 3.4 per cent on the same period in 2013. Total current receipts were £92.3bn, versus £95.4bn in April/May last year. VAT receipts are fine, up 5.7 per cent, and that would square with strong consumption, and corporation tax is up too. But income tax and capital gains tax are down 4.7 per cent and National Insurance Contributions (NICs) are down 2.2 per cent. This is not what is supposed to happen, particularly since tax revenues have in the past been particularly strong in the early and middle stages of an economic recovery.

There are three possible explanations, and I guess the answer will be a bit of all three. The first is that the figures are wrong. We may be undercounting income tax and NICs for some reason that is not yet clear. There have certainly been problems with PAYE assessments and these may be carrying through to this year. As for national insurance, it is pretty odd that this source of revenue is going into reverse if there are so many more people in work. We just have to hope that if there are serious distortions, these will unwind as we move through the year.

The second explanation is that there has been an even larger increase in the cash-in-hand economy than previously estimated. The best estimate I have seen on this comes from a paper by Charles Goodhart for Morgan Stanley, where he suggested that the grey economy might have added 4-5 per cent to gross domestic product (GDP) since 2008. That would explain the strong job growth and strong consumption over the past couple of years but unless you think that there has been a further surge in this grey economy since spring 2013, it is hard to explain quite why income and NIC revenues remain so weak.

The third explanation is that high-earners have become much more adept at running their tax affairs. The top 1 per cent of earners pay nearly 30 per cent of income tax and, as the Institute for Fiscal Studies has warned, it requires only a small shift in their financial planning to undermine the Government’s tax base. The surge in self-employment may be associated with this. Tax push-back would not, however, fully explain the fall in NIC receipts, which does seem a bit odd.

So, it may be that revenues will recover. We are, after all, only two months into the financial year. But there is a lot of ground to be made up and if revenues don’t recover, then we will be pushed to the harsh conclusion that rapid growth is not enough to repair the Government’s finances. This has profound political implications. It will be embarrassing for the coalition and George Osborne for obvious reasons. But it means that the next government, the one elected next May, will have an even larger fiscal mountain to climb than the present one faced when it came to power.

Think of it this way. The deficit the coalition inherited was 11 per cent of GDP. Roughly half of that was cyclical, roughly half structural – you can argue about the precise split but a 50/50 division won’t be that far out. The next government will inherit a deficit of around 6 per cent of GDP, so you could say that half the job has been done – but only half.

The present parliament has mostly been about dealing with the cyclical problem, the legacy of the financial crisis. The next one will be mostly about dealing with the structural deficit, the one we had (but did not fully understand we had) before the crisis hit. I think all three major parties have assumed that as the economy grows, tax revenues will climb enough to enable ourselves to dig our way gradually out of this. But if the present rapid growth is not increasing revenues, the second half of the job will be even harder than the first. Either taxes have to rise further; or there will have to be spending cuts over and above the pretty savage ones already projected; or, given the way the world works, most probably both. Keep your fingers crossed that revenues improve in the months ahead.

React Now

Latest stories from i100
Have you tried new the Independent Digital Edition apps?
iJobs Job Widget
iJobs General

IT Portfolio Analyst/ PMO

£40000 - £50000 Per Annum Excellent benefits: Clearwater People Solutions Ltd:...

Systems Analyst (Technical, UML, UI)

£30000 - £40000 Per Annum + excellent benefits: Clearwater People Solutions Lt...

Cost Reporting-MI Packs-Edinburgh-Bank-£350/day

£300 - £350 per day + competitive: Orgtel: Cost Reporting Manager - MI Packs -...

Senior Private Client Solicitor - Gloucestershire

Excellent Salary: Austen Lloyd: Senior Private Client Solicitor - We are makin...

Day In a Page

Read Next

I was a Woman Against Feminism too

Siobhan Norton
A screengrab taken on July 13, 2014 from a video released by the Nigerian Islamist extremist group Boko Haram, showing the leader of the Nigerian Islamist extremist group Boko Haram, Abubakar Shekau  

Boko Haram is a vicious sideshow - Nigeria's self-serving elite is the real culprit

Kevin Watkins
Noel Fielding's 'Luxury Comedy': A land of the outright bizarre

Noel Fielding's 'Luxury Comedy'

A land of the outright bizarre
What are the worst 'Word Crimes'?

What are the worst 'Word Crimes'?

‘Weird Al’ Yankovic's latest video is an ode to good grammar. But what do The Independent’s experts think he’s missed out?
Can Secret Cinema sell 80,000 'Back to the Future' tickets?

The worst kept secret in cinema

A cult movie event aims to immerse audiences of 80,000 in ‘Back to the Future’. But has it lost its magic?
Facebook: The new hatched, matched and dispatched

The new hatched, matched and dispatched

Family events used to be marked in the personal columns. But now Facebook has usurped the ‘Births, Deaths and Marriages’ announcements
Why do we have blood types?

Are you my type?

All of us have one but probably never wondered why. Yet even now, a century after blood types were discovered, it’s a matter of debate what they’re for
Honesty box hotels: You decide how much you pay

Honesty box hotels

Five hotels in Paris now allow guests to pay only what they think their stay was worth. It seems fraught with financial risk, but the honesty policy has its benefit
Commonwealth Games 2014: Why weight of pressure rests easy on Michael Jamieson’s shoulders

Michael Jamieson: Why weight of pressure rests easy on his shoulders

The Scottish swimmer is ready for ‘the biggest race of my life’ at the Commonwealth Games
Some are reformed drug addicts. Some are single mums. All are on benefits. But now these so-called 'scroungers’ are fighting back

The 'scroungers’ fight back

The welfare claimants battling to alter stereotypes
Amazing video shows Nasa 'flame extinguishment experiment' in action

Fireballs in space

Amazing video shows Nasa's 'flame extinguishment experiment' in action
A Bible for billionaires

A Bible for billionaires

Find out why America's richest men are reading John Brookes
Paranoid parenting is on the rise - and our children are suffering because of it

Paranoid parenting is on the rise

And our children are suffering because of it
For sale: Island where the Magna Carta was sealed

Magna Carta Island goes on sale

Yours for a cool £4m
Phone hacking scandal special report: The slide into crime at the 'News of the World'

The hacker's tale: the slide into crime at the 'News of the World'

Glenn Mulcaire was jailed for six months for intercepting phone messages. James Hanning tells his story in a new book. This is an extract
We flinch, but there are degrees of paedophilia

We flinch, but there are degrees of paedophilia

Child abusers are not all the same, yet the idea of treating them differently in relation to the severity of their crimes has somehow become controversial
The truth about conspiracy theories is that some require considering

The truth about conspiracy theories is that some require considering

For instance, did Isis kill the Israeli teenagers to trigger a war, asks Patrick Cockburn