Sunday, September 12, 2021
After this dog's dinner. can we sustain record taxes?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

We have had some momentous announcements in the past week, dwarfing most budgets, though without the red box, the choreographed photo opportunities and the usual theatre. There are a couple of big questions I want to try to answer about these announcements, but first let me offer a quick assessment.

The policy package unveiled by the government to “fix” social care, and which included a big 2.5 percentage point in national insurance contributions – 1.25 points from employees, 1.25 from employers – was a dog’s dinner. So much of a dog’s dinner was it, in fact, that Pedigree, for years the manufacturers of Chum, could legitimately sue for breach of copyright. It may prolong this government’s active life, to recall a successful canine advertising slogan, but otherwise there was little to be said for it.

It was dog’s dinner because, even with a couple of minor tweaks, national insurance (NI) was the wrong tax to increase, as I pointed out a couple of weeks ago. The alternative to raising £12 billion a year (and we even had the triple counting horror of calling it £36 billion) would have been a two-percentage point increase in income tax.

The government chose not to do that, even though it would have been fairer, partly because all governments hate raising the highly visible income tax rate, preferring the more mysterious and widely misunderstood NI, which does not affect most pensioner incomes. Not only that, but as most taxpayers are probably unaware, income tax is already due to start going up from next year, through the stealthy route of freezing the personal allowance and higher rate threshold for four years. That will mean 1.3 million more taxpayers, and 1 million more on the higher rate, as well as higher taxes for all income taxpayers relative to indexing those allowances.

Even if NI was your chosen tax, there were better ways of doing it, as a useful London School of Economics/Warwick University report pointed out. It estimated that removing existing NI exemptions and earnings limits could raise considerably more than £12 billion a year, making room for a cut rather than an increase in the NI rate. As it is, last week’s announcement has further complicated our ludicrously complex tax system and introduced an even bigger discrepancy into the tax treatment of the employed and self-employed.

It was also a dog’s dinner because the extra money, overwhelmingly for the NHS, was not accompanied by any meaningful reform to ensure that the money is well spent, or even that it achieves its aim of eliminating the Covid backlog of treatments. Social care, the poor relation of the announcements, will remain a creaking and largely unreformed system, staffed by poorly paid but dedicated workers who are now in short supply. Anybody who thinks last week’s announcements have fixed social care has swallowed a lot of snake oil. When the elderly and infirm and their families get stung with the hotel costs of residential care, they will realise that the prime minister’s promises did not add up to very much.

It was a mess, and no way to make policy because, as we have seen quite often during the pandemic, we have a fiscal watchdog, the Office for Budget Responsibility (OBR), but it remains chained up at key moments. There has been some sterling work by the Institute for Fiscal Studies and Resolution Foundation, but the OBR has not been allowed a growl, and the package was nodded through the House of Commons without proper scrutiny.

I know why it happened like this. To introduce some more animals into the discussion, a camel is a horse designed by a committee, and this policy package was designed by a small committee with different aims. Boris Johnson wanted to be able to say he had fixed social care; Sajid Javid, the former chancellor turned health secretary needed many billions extra to try to clear the NHS backlog, and Rishi Sunak, overcoming the Treasury’s traditional objection to hypothecated taxes, wanted to make sure that the extra largesse would not be borne by government borrowing.

Now for those two big questions mentioned earlier. You will know that, under these plans, the tax burden will rise to around 35.5 per cent of gross domestic product by the end of this parliament. That is the highest since the immediate aftermath of the Second World War, when the wartime economy was being demobilised.

The overall tax burden does not represent the totality of government receipts. A broader measure, public sector current receipts, is set to rise to just under 40 per cent of GDP.

The interesting question that arises from this is whether the economy can sustain a tax burden of this size. The late time the tax burden was nearly as high as this, outside of wartime and its aftermath, was in 1969-70, when Roy Jenkins, Labour chancellor in the wake of sterling’s November 1967 devaluation, out up taxes in his “two years of hard slog” period.

The point about these peaks in the tax burden is that, unlike the one that is projected now, they are never sustained. There are a number of reasons for this. A change of government often brings a change in tax policy, though it is hard to see where the low tax alternative to the Tories might come from now.

More usually, the tax burden falls because the economy gets into difficulty. Most of the troughs in the tax burden over the years are associated with slowdowns or recessions. Often, chancellors have cut taxes, if only temporarily, to help the economy out of those recessions. Plans for increasing the tax burden, of the kind we have seen this year, are usually not achieved. A little bird told me that before he was chancellor, Sunak gave a speech on the limits of the tax burden in the UK, so he is familiar with the issue.

This brings me on to my second question. This year, as noted, has been a huge one for tax increases. The £12 billion a year NI rise is on top of the March budget announcements, which included the freezing of income tax allowances and the rise in corporation tax from 19 to 25 per cent. Those increases will build up to an annual £24 billion of extra tax, making £36 billion in all.

The tax rises are delayed, but they are still real. Increasing employers’ NI will mean fewer jobs and lower wages than otherwise. The taxes on individuals will reduce spending. Higher corporation tax makes the UK a less attractive location, and could affect employment, wages, investment and dividends.

How much will this damage the economy? Higher taxes will not cause a sudden stop, but the analogy of boiling the frog is a useful one. You can raise the temperature without any apparent adverse effects, but then they kick in dramatically. Poor frog. That is the tax experiment the government has embarked on, and it is a risky one.