Tough arithmetic of hitting the tax button

Click to follow
The Independent Online
HOW MUCH could they crank out of the tax system if they really had to? This brutally practical question is confronting both Tories and Labour, and each has but a few months to reach its answer.

It is beyond dispute that taxes will have to go up. The Government has just managed, amid cries that this is the most that can be saved, to cut pounds 1bn out of defence spending. But it knows, and Labour knows, that if present trends continue the social security budget could eat that up in a couple of years in additional spending on single parents. We spend the equivalent of a quarter of our defence budget on support for single parents.

All western democracies are in the same boat. Both France and Germany are cutting social security benefits, and the US is putting up taxes. The ageing of the population in every developed country will increase strains further. But for both Britain's main political parties this is a practical issue now.

The new Chancellor of the Exchequer will have to find yet more revenue and/or cuts in spending by the November Budget. The additional measures announced by Norman Lamont in the last Budget will help, but borrowing is still projected to be dangerously high. It leaves the Government vulnerable to a sudden loss of confidence on the world financial markets, and in any case piles an additional burden on to future generations of taxpayers.

For Labour to form a credible government it, too, must say what it will do about tax. To its credit, it is taking a long, hard look at the social security system and at taxation, through its Social Justice Commission. As reported last weekend, the commission is shying away from the idea of increasing income tax, as Labour proposed before the last election, and is looking instead at cutting income tax by increasing the thresholds at which people enter the tax net. It will suggest increasing consumer taxes to make up the difference.

But what in practice might this mean: which consumers, and how much more tax? What are Mr Clarke's options: how can he raise more of our money? Here are some crude calculations of what might be possible, comparing UK practice with other countries1 .

Start with income tax, the largest single source of revenue, raising pounds 57bn. We are the middle of the pack both in terms of the tax bite for middle-income earners and the proportion of total revenue that comes from this source. Our top marginal rate of 40 per cent is low, but Britons hit this top rate a long time before the taxpayers of most other nations.

That would suggest that if we followed other countries' practice we could raise more by increasing rates of tax at the very top. That has certainly been the instinct of the Labour Party, prior to the work of its justice commission, and of the unions. The trouble is that the reverse might be true. Britain gets proportionately more income tax out of its top 20 per cent of earners now than it did at the beginning of the Eighties, when top rates were much higher. It is counterintuitive, but quite possible, that increasing top tax rates might cut revenue.

The best indication of the extent to which high income tax encourages migration comes from Denmark. It has the highest overall taxes on income for the average family in the Organisation for Economic Co-operation and Development. Denmark happens also to be suffering dramatically rapid emigration. In 1990 it lost 0.42 per cent of its nationals2 . This may not sound much, until you consider that at that rate it would lose one- tenth of its population within a generation - an annual rate, proportionate to population, nearly as high as British deaths on the Western Front during the First World War.

Nevertheless, one might get something more out of income tax by squeezing up rates on the middle earners who are less mobile, maybe by trimming mortgage tax relief further. One could perhaps raise an extra 5 per cent, or pounds 3bn, without too disastrous an effect.

Next, national insurance payments. This, too, is a big puller, bringing in pounds 39bn a year. Britain is towards the bottom of the league, but there are very good reasons for wanting to keep it there. If social security contributions are paid by employees they are simply a form of income tax, and if by employers they discourage hiring - absolutely not what is wanted. One could nudge up the rates, but to take anything more would start showing in employment, and to take more than pounds 1bn would hit industry very hard.

The same objection applies to increases in company taxation, which brings in pounds 15bn. One could do something, but it would be unwise to do very much, particularly in view of the way companies can move their headquarters abroad.

This brings one back to the point that the Social Justice Commission has reached: it has to be taxes on consumers. Here one has to take a deep breath, because in British politics one hits the wild water. If Britain were France, it would have VAT on everything, including food, though maybe at lower rates on 'necessities'. VAT brings in pounds 40bn, so if one were prepared to do it, one could increase revenues by pounds 10bn a year. Put petrol up to pounds 3 a gallon, as in France, and that is another pounds 3bn. Reintroduce the car tax (setting aside squeals from manufacturers) and that could bring in another pounds 1bn. Doubling vehicle excise duties would add pounds 3bn more.

And that is about it. Increasing the duty on tobacco might be desirable on health grounds, but could reduce revenues as people smoked less. Increasing duties on drink would simply encourage day trips to Calais. Increasing business rates would encourage more voids; the council tax, however unpopular, raises only pounds 8bn, so not much more could be expected from that source. There are other taxes, such as capital gains tax or inheritance tax, but pushing them up would bring in a few hundred million, no more.

Add all these measures together, plus a couple of billion for new taxes associated with the environment, and what do we have? Additional revenues of less than pounds 25bn - roughly 10 per cent of total revenue. Hit the tax button as hard as one can in peacetime in a democracy, and one only halves the deficit. There is no more money for the NHS, or for social security, or for education. As the economy grows, the numbers should become a little better, for some of the deficit is simply a result of the recession. But this is tough arithmetic, none the less, for Chancellor Clarke and the Social Justice Commission alike.

1 Comparative data from 'Tax Policy in OECD Countries', Ken Messere, IBFD Publications, Amsterdam.

2 Source: 'The Future of International Labor Migration', John Salt, International Migration Review, vol xxvi, No 4.

Comments