The politics of UK tax rises are as complex as the system
This piece was first published in the FT.
The case for tax rises to fund creaking public services in the UK, an ageing and indebted nation, will only grow as an issue in the year ahead. Public attitudes towards higher taxes are softening as opposition to further austerity hardens.
Many taxpayers in the UK already face dramatically higher marginal rates of tax than the headline income tax rates of 20p and 40p suggest. That is partly due to overlooked national insurance contributions but also, crucially, because at different points on the income spectrum benefits and tax allowances get withdrawn and tax-like contributions rise. This means that less of an extra pound of earnings is retained by households after all the deductions.
This point may sound like fodder for tax anoraks rather than a matter of high politics. But that would be to misread the new reality. As the tax system has become more complicated so, too, have the politics of tax rises.
To survey those most affected is to go on a virtual tour of some of Britain’s most consequential electoral groups. Start with the seven million low and modest income families — including half of all households with dependent children — who are eligible for the new universal credit. Those paying income tax face losing 75p of every extra pound earned.
Consider, too, the almost half a million better-off families, with a parent earning between £50,000-£60,000, whose child benefit is withdrawn as their income rises. This creates effective marginal tax rates of 60 per cent for those with two children, rising to 74 per cent for those with four.
Then contemplate the position of graduates. Each year hundreds of thousands start repaying their student loans via a 9 per cent charge on income above £25,000 — creating long-term marginal tax rates of 41 per cent for those on the basic rate and 51 per cent for higher rate payers. Whether you are friend or foe of the current university finance system, there is no denying that this squeezes the space for income tax hikes.
Nor should we forget the more than half a million highly paid professionals earning between £100,000-£123,700, whose marginal tax rate hits 62 per cent as their income tax allowance is withdrawn. Weigh in “auto-enrolled” pension contributions and some of these marginal rates climb higher still. None of which is to decry the principle of tax credits, graduate contributions or workplace pensions. It is simply to recognise their cumulative effect.
Politics has also played its role. Today’s perverse schedule of marginal tax rates arises in no small part from this Conservative government’s determination to find ever more ways of cutting working-age welfare. Its Labour predecessor had a soft spot for stealthy ways of taxing the affluent.
No rational person would ever have designed the system that has resulted: large swaths of working Britain retain less of an extra pound earned than Britain’s corporate titans.
The options for government and opposition boil down to a choice between ducking, dodging or re-designing. The first of these assumes that punishing marginal rates are a binding constraint: tax rises must, therefore, largely be ducked. The most that can be attempted from this perspective might be to freeze tax thresholds and to make regular, ritual commitments to cracking down on evasion. Necessary tax revenues will not be raised this way.
The second approach is to selectively raise more revenue while avoiding the groups most affected by punishing marginal rates. Tax raids could be launched on wealth rather than income, and on popular targets like big tech and, perhaps, on those with the very highest incomes. This would bring in new funds, though less than many like to think. But it is a piecemeal approach that dodges, rather than deals with, existing problems.
Lastly, there is tax re-design. This would iron out kinks and reliefs in the tax system while broadening the revenue base and raising some headline rates. It is an eminently rational approach: serious funds could be raised and distortions removed. Yet it would meet a wall of resistance. Only a government with a thumping majority, a zeal for reform and a taste for battle will contemplate it.
It is often said that good politics makes for bad policy — a dictum that applies in spades on tax. A generation of choices and bodges weighs down on today’s system, aggravating the always vexed question of how to raise more revenue.
Today’s advocates of the principle of higher taxes have a good case to make. They need to combine it with practical proposals that navigate the reality of this treacherous terrain.
