The question for Gordon Brown is: where have all the tax revenues gone?

A strong economy, a rather surprisingly strong one, like the UK ought to be pumping out more in tax than it is
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The Independent Online

So shares are back to a 14-month "high". Growth has just been revised upwards and may even be more than 2 per cent this year. Were it not for one disagreeable question, all would be well. That question is: if the economy is doing so well, why has the budget deficit widened so much that tax rises and/or cuts in public spending are in store?

So shares are back to a 14-month "high". Growth has just been revised upwards and may even be more than 2 per cent this year. Were it not for one disagreeable question, all would be well. That question is: if the economy is doing so well, why has the budget deficit widened so much that tax rises and/or cuts in public spending are in store?

The answer, I think, is both more complicated and more disturbing than the cyclical deterioration in public finances that you would expect when growth slows. We have a cyclical problem but that will fix itself. What won't fix itself is the structural one.

So where to begin? Start with the press, for surface rumblings reflected in the papers are the result of profound tensions, even alarm, in the bowels of Whitehall.

There has been a spate of stories about this spending round being the toughest ever. Yes, I know they often say that, but this time they are right. There has been the threat of sharp tax rises by sources close to the Chancellor, the usual softening-up process designed to make the less-sharp ones more palatable. There was the story, subsequently denied, that the Prime Minister has become worried about the extent to which the tax burden had risen already and had blocked the idea of still more tax rises. And there have been the various think-tank ideas of increasing taxes on motorists, applying a nationwide congestion charge and the like.

Some of us have been warning of this for several months. We could not believe that the Treasury had done its sums right, when it was so much more optimistic about growth than the consensus of other economic forecasts. There had to be tax rises or spending cuts.

But it looks as though we have been right, to some extent at least, for the wrong reasons. Sure, government spending has been racing upwards with, so far, very little evident improvement in the quality of services. Spending, however, is only half the problem. More disturbing is the slow growth of revenues, despite the rise in taxation. Those of us who predicted this did so on the basis that growth would falter. For example, as national insurance and other taxes went up, employers would trim their workforces and individuals would trim their spending. That does not seem to have happened. Employment is at an all-time high; car sales are also at record levels; retail sales are still quite strong; house prices are still creeping up; and as for consumer borrowing - we, like the Government, are carrying on as though there were no tomorrow.

Tax receipts, by contrast, are not strong at all. Income-tax revenues are now running down year-on-year. Corporation tax revenues are down, too. VAT is OK, but had it not been for the rise in national insurance, tax receipts would hardly be up at all. Something has gone wrong. But what?

Taxes have been hard hit over the past couple of years. In 2001/2 the top 10 per cent of earners paid more than half of all income tax revenues and the top 1 per cent paid nearly a quarter. So if the top 1 per cent, about 200,000 people, are having to tighten their belts, there is a huge knock-on impact on government revenues. The remaining 99 per cent of income-tax payers need the fat cats to do well, if their own tax burdens are not to soar - not a fact that is generally acknowledged.

If that were the only problem then as City bonuses and executive salaries rise again, that would start to correct the shortfall. But there may be something more deep-rooted: a more general effort by a wide variety of taxpayers to trim their payments. There is only anecdotal evidence for this but there does seem to have been some further rise in the cash economy over the past three years. A higher proportion of people may be buying their drink and tobacco in Calais. Maybe more small businesses are trying harder to use the legal loopholes available to control their tax costs. Tax payments you did not worry about during the boom years may be scrutinised more thoroughly now.

In short, the economy is a tougher place than it was during the boom. If a business is cutting, say, air travel costs by flying easyJet, why not also try and trim the tax bill by applying a similar sense of discipline.

Some support for this view comes from America. Every government in the world is facing a shortfall of revenues. The result is that budget deficits next year are expected to range from nearly 8 per cent of GDP in Japan, through more than 5 per cent in the US, 4 per cent in Germany and France and a little over 3 per cent here. But you would expect this in slow-growing Japan and recession-bound continental Europe. What has gone wrong in the US?

The deterioration in public finances is partly the result of tax cuts and partly higher spending, including spending on defence. But, as in Britain, there is an unexplained shortfall in tax revenue. A strong economy, a rather surprisingly strong one, ought to be pumping out more in tax than it is. And in the US, unlike in Britain, you cannot blame public resistance to higher tax rates for the shortfall. I have seen no good explanation for this from US economists - it all seems a bit of a puzzle - so the best I can offer is this. When you put extreme pressure on an economy to cut its costs, one of those costs that gets squeezed is tax.

A side-effect of the drive for more efficiency in the US, efficiency that is increasing productivity, is that everybody gets more efficient at managing what is paid to the government.

I can advance afurther bit of evidence from the UK. One of the big surprises in London has been the "success" of the congestion charge. But while it has been hugely successful in keeping cars out of central London, it has been hugely unsuccessful as a revenue raiser. Indeed, once the loss of council parking charges is taken into account and business rates have to be trimmed to allow for the cuts in commercial activity, it may not raise any net revenue at all. It may turn out to cost the public sector money, rather than bringing it in.

But why did they get their sums so wrong? There are two decent explanations. One is the administrative hassle of paying the charge - it is one more damn thing to have to worry about. That does have some resonance to it. The other is that the charge hit a tipping point. Motorists did not feel it was fair and so a lot of them have simply changed their habits. They were pondering whether to carry on driving in central London after Ken Livingstone had mucked up the traffic and this tipped them over.

If this line of argument has any merit, then there is a huge and looming problem. In the case of the US, the pressure to shave costs encourages people to adjust their habits to shave tax. In Britain the threat of higher tax rates is having the same effect. Either way, those great days of the late 1990s when the money rolled into government coffers are long past. Even if overall growth is maintained, governments will increasingly struggle to make ends meet.

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