Can Britain’s next govt handle tax rates?

By Reuters
June 15, 2024
People walk over London Bridge looking at a view of Tower Bridge in the City of London financial district in London, Britain, October 25, 2023. — Reuters

LONDON: Britain’s next government will find it near-impossible to stop tax levels approaching an all-time high, despite an election campaign in which both major parties have promised not to increase major tax rates.


Labour leader Keir Starmer, whose party has a 20-point lead in opinion polls, set out a manifesto on Thursday in which he matched a pledge by Prime Minister Rishi Sunak’s Conservatives not to raise income tax rates, employees’ national insurance contributions, value-added tax or corporation tax.

Together, these taxes account for more than 70 per cent of total government revenue.But economists -- including those at the International Monetary Fund, non-partisan think tanks and major banks -- think whoever forms Britain’s next government will soon be breaking the spirit, if not the letter, of these promises.

“I don’t think either of them has given the voting public a realistic picture,” Gemma Tetlow, chief economist at the Institute for Government, said.She said the pledges would “limit their scope for manoeuvre and does question the credibility of their commitments”.

Election pledges not to raise tax have been common since 1997, when Tony Blair promised not to raise income tax or VAT. His party had been defeated in 1992 when the Conservatives ran ads focused on ‘Labour’s Tax Bombshell’.

Despite this, tax revenues are now on course to reach their highest since 1949 at 36.5 per cent of national income this financial year, according to the government’s Office for Budget Responsibility, up sharply from 33.1 per cent at 2019’s election.

This represents a higher tax burden than the 30.5 per cent which the IMF estimates for the United States, but is far below the 46.3 per cent average in the euro zone, where the tax and benefit system covers retirement savings that Britons make privately.

Britain’s tax burden has risen much more since 2019 than in either the US or the euro zone, in part because thresholds for paying income tax and other taxes were frozen while surging inflation boosted the cash size of the economy, placing more of people's earnings within the tax net.

This dwarfed the impact of two cuts to national insurance -- to 8 per cent from 12 per cent -- which Sunak has made much of.

Britain’s tax burden is also forecast to keep rising. In March the OBR forecast 37.1 per cent by 2028/29, while the Institute for Fiscal Studies think tank estimated the Conservatives’ manifesto plans, which include another cut to national insurance, would still see the tax burden edge up to 36.8 per cent, the most since 1949.

Labour’s manifesto plans include VAT on private school fees, an extra levy on oil and gas companies and a crackdown on tax avoidance. These would raise 8.55 billion pounds ($11 billion) a year and take the tax burden to a record high 37.4 per cent.


However, the actual tax burden may be even higher as all these forecasts assume the next government will stick to March’s annual budget which limits growth in spending on public services over the coming years to 1.0 per cent on top of inflation.

Last month the IMF, in its annual review of Britain’s economy, said those plans “do not appear to sufficiently account for known pressures in public services” and that 2.0 per cent real-terms annual spending growth was more realistic.

British hospitals have had record waiting times for patients, and prisons are already so full that criminals are freed early. Prisons are slated for annual spending cuts of 6.0 per cent.

Overall, existing budget plans pencil in spending cuts of 10-20 billion pounds across areas which -- unlike health, schools or defence -- have not been exempted, roughly equivalent to the entire annual budget of the interior ministry.

Sanjay Raja, chief UK economist at Deutsche Bank, said cuts like this would be hard to square with Starmer’s public commitments that “we are not going to return to austerity”.

“You will inevitably get tax hikes,” Raja said.

Labour says its manifesto is fully costed and that it does not plan to raise taxes beyond what it has already publicly stated. The Conservatives dispute this and say Labour’s plans would lead to a further 500 pounds a year of higher taxes for the average working household -- an estimate Labour has dismissed as deliberately misleading.

The IMF said Britain’s next government should consider higher taxes on greenhouse gas emissions and road usage, widening the scope of VAT and inheritance tax, or increasing capital gains and property taxes.

Weak growth and high interest rates - which have led to a doubling in spending on debt interest since 2019 - are behind much of the fiscal impasse, and a turnaround in either of these would make the next government's life much easier.

But without that or higher taxes, the IMF forecasts Britain’s 2.5 trillion pounds of public debt, which surged in the Covid-19 pandemic, will keep climbing - something both Labour and the Conservatives have pledged to avoid.

Britain got a sharp lesson in 2022 when Prime Minister Liz Truss announced plans to cut taxes without seeking the OBR’s blessing.

Investors dumped British government bonds and the Bank of England had to intervene to stabilise the market.

Most British voters are already resigned to higher taxes whoever wins, polls show.

One option would be for Labour to use a review of government spending needs over the summer as a basis for shifting their position on taxation before an autumn budget, Raja said.

But IFS Director Paul Johnson said Britain’s would-be finance ministers should already be preparing the public for bad news. March’s OBR growth forecasts were stronger than most economists now thought likely and borrowing costs had risen.

“If the new government comes in and says: ‘Oh look, this is a terrible shock ... and that’s why we didn’t tell you about all these tax rises’ ... that would be fundamentally dishonest.”