by Mike Denham, former chairman
It now looks inevitable that Rachel Reeves will hike taxes yet again in her autumn budget. Labour’s chronic inability to cut or even restrain the growth of public spending, combined with a weakening economy and the bond market’s unwillingness to fund ever larger deficits, leaves her with no other option.
How much she raises them will depend on how far the OBR’s budget forecasts have deteriorated since March; independent forecasters are suggesting it could be of the order of £20bn annually. The question is who will be slammed for the higher tax?
As always, Labour’s instinct is to squeeze the rich. There’s much talk of a wealth tax, or perhaps the reimposition of the 50p top rate of income tax imposed under Gordon Brown. The argument is that the rich have far more than their fair share, and they should be forced to carry more of the tax burden. “Working people” should be protected from the consequences of ever higher government spending.
However, as anyone who’s ever seriously examined the question knows, a wealth tax has highly damaging economic and other consequences, described at length in a recent TPA research report. Which is why even countries that have tried them have now mainly abandoned such taxes.
As for our existing taxes, an under-appreciated fact is that the rich are already paying considerably more than their proportionate share.
In the most recent year for which we have data (2022-23), the top one per cent paid 28.5 per cent of all income tax. And the top ten per cent paid 60.3 per cent.
Taking other taxes into account reduces these proportions somewhat, but according to the latest official analysis, the top ten per cent of households still pay 34 per cent of all household taxes. And that’s almost certainly an underestimate because the analysis excludes various capital taxes, such as Inheritance Tax and Capital Gains Tax, which impinge more on higher income groups.
It’s also not widely known that the tax share of the rich has already increased considerably over recent decades.
Back at the turn of the millennium, the top one per cent paid 21 per cent of income tax, against their current 28.5 per cent, while the top ten per cent paid 40 per cent, against 60 per cent now. And the top ten per cent of households were paying around 27 per cent of all household taxes against 34 per cent now.
Note too, that to be in the top ten per cent today, is not necessarily to be fabulously rich. For an individual taxpayer it’s a pre-tax income of around £70,000.
Another widespread misperception is that our rich are under-taxed relative to their counterparts in comparable countries elsewhere. But even if that was once true, it is true no longer.
A recent OECD report on taxation and inequality shows clearly that after taxes, the share of total income received by our top ten per cent is broadly in line with France and Germany, and significantly less than in the US. Moreover, our top ten per cent’s share has fallen over the last three decades, whereas it’s increased across much of Western Europe, including in Scandinavia.
Such cross-country comparisons are always revealing, and they point to a big difference between the UK and our European neighbours in terms of sharing the tax burden.
For years we’ve known that funding an expensive European style social welfare system requires higher taxes than we’ve ever sustained outside of wartime. Yet successive governments have avoided spelling it out to the electorate. Instead, there’s been a fiction that we can somehow enjoy European levels of state funded social provision while getting someone else to pay for it – either the rich through tax, or future generations through debt financing.
The problem is that the rich, or more specifically high earners, are getting fed up with ever higher taxes and are increasingly looking for ways out, including emigration. And the debt markets are charging ever more for filing the gap.
What happens among our neighbours is that the cost of their social welfare systems is borne much more by those on middle incomes – the people who largely benefit from the provision.
According to the OECD, a single person on the average wage in the UK pays 29.4 per cent of his/her earnings in income tax and social security contributions (the so-called “tax wedge”, including both employee and employer National Insurance Contributions, NICs). But in Germany it’s 47.9 per cent, and in France 47.2 per cent – a huge difference.
We’re close to the crunch point. Having failed to push through even her own inadequate cuts to welfare spending, and with the bond markets increasingly leery of yet more debt, Reeves is boxed in. Our total tax burden is already at the highest level since the Second World War, the rich are starting to bail out, and the business sector is buckling under the onslaught of previous tax rises. She’s going to have to increase taxes on middle income groups.
Her most likely move will be to extend the freeze on the personal tax allowance and tax thresholds, currently slated to end in April 2028.
Threshold freezes are of course a classic stealth tax, widely deployed by Chancellors before 1977, when they were stopped by the Rooker-Wise amendment to the Finance Bill. Thereafter thresholds were to be increased annually for inflation, which they generally were, right up until 2022 when Chancellor Rishi Sunak froze them, supposedly as a temporary measure.
The current freeze means more and more people are being dragged into income tax for the first time, with many others pushed into the higher rate bands. According to HMRC, the number paying the higher rate (40 per cent) has already increased from 4.4 million in 2021-22 to 7.1 million now, while those paying the additional rate (45 per cent) has more than doubled, from 0.5 million to 1.2 million.
In its March forecast, the OBR projected that in 2029-30, the combined effect of freezing the personal allowance, income tax and NICs thresholds will generate an additional £51 billion of tax revenue compared to the amount that would have been raised had there been no freeze. It’s a huge additional amount – four per cent of all tax revenue in that year – and the OBR assumed the freeze ends in April 2028.
If Reeves extends the freeze for a further two years, then March’s OBR forecasts suggest it could increase 2029-30 revenue by a further £8 – 10 billion.
By 2029-30 that would have at least 25 per cent of taxpayers paying the higher or additional income tax rate. And adding in both employee and employer National Insurance payments, all employees in that top 25 per cent will be taxed at a marginal rate of at least 57 per cent.
And note those people are by no means all rich in any normal sense of the word. Today it includes anyone earning £47,400 or more – in other words, middle income earners.
It’s not being publicly acknowledged, still less voted for, but step by stealthy step the government is already moving middle income groups onto a much higher European level of taxation. And unless somehow there’s a growth miracle, or somehow this chronically weak government gets a grip on spending, there’s much more to come.