Theme: Political Economy | Content Type: Blog

Tax and Spending (Again)

Michael Jacobs


Lubo Minar

| 15 mins read

The depth of the spending cuts now being implemented by Whitehall departments and local authorities across the UK is unprecedented in postwar Britain. With health, education and overseas aid protected, most departments’ budgets are being reduced by around a fifth between 2010 and 2015-16. Local councils will see spending fall by over a third. A significant slice of the cuts is being borne by the non-pensions social security budget. Inevitably, this means that the poorest and most vulnerable are being dealt most of the pain. The 4% real terms cut in all benefits and tax credits over the next three years; the cap on individual benefits; the housing benefit penalty being applied to those with a spare room; the localisation of council tax benefit; the abolition of the social fund; the conversion of disability living allowance into personal independence payments with more restrictive eligibility criteria; the removal of legal aid for welfare benefits advice; the paring back by most councils of basic social care services – the impact on the lives of those who already have least is desperately severe, and will only grow harsher over the next three years.

The reason for all this is well known: the Government is determined to reduce the budget deficit and pay down the public debt. But while Labour has focused its criticism on the overall speed with which this being done, and the now evident truth that austerity is economically self-defeating (the deficit is not being reduced, and the debt continues to rise), the proximate cause has been largely overlooked. It is not just the overall speed of deficit reduction, it is the method the Coalition has chosen. In any such austerity plan a division must be made between spending cuts and tax rises. The Government has chosen to fund around three quarters of its deficit reduction plan from spending cuts, and only a quarter through tax rises. This is a greater bias towards spending cuts than it originally announced in 2010, when the planned split was 70% / 30%, and considerably greater than that proposed by Alistair Darling (67% / 33%) in Labour’s pre-election plans.

This distribution of deficit reduction makes it inevitable that the poor will bear the greatest burden: most spending goes on those on lower incomes, while most taxes are paid on higher incomes. But the situation is in fact even more acute than this, since the Government has actually been cutting key taxes. Fully £24bn will be spent by 2016-17 on the raising of the personal income tax threshold, the reduction in corporation tax and the real terms cut in fuel duty. This is almost twice the revenue gained from the 2011 increase in VAT. The Liberal Democrats trumpet the £10,000 personal income tax threshold as a redistributive measure, but that is disingenuous: most of the benefit goes to people paying higher rate tax, while those at the bottom of the income distribution gain little or nothing because they don’t earn enough to use the tax-free allowance. For such people, rather, the effective marginal tax rate can be up to 85% through the clawback of tax credits and housing benefit as their earned incomes rise. It is no surprise that the Government’s own analysis shows that by 2016 600,000 children will have been pushed into poverty since 2010: the Government’s welfare reforms are projected to result in the poorest tenth of households losing the equivalent of around 38% of their income.

The choice to focus most of the deficit reduction plan on spending cuts has had another effect, also inadequately noticed. By 2018 the proportion of discretionary departmental spending is set to drop to its lowest level since 1998. The Coalition, in other words, is doing what the Conservative Party has long wanted: it is shrinking the state. Coupled with the step-change now under way in the marketisation of the NHS and other public services, it suggests that, so far from being the compromise many anticipated, the Coalition Government is proving as ideologically radical as those of Thatcher and Attlee.

That this has caused so little reaction from the Labour Party is regrettable, though understandable. Cowed by the constant charge levelled by the Coalition that its own leaders were responsible for causing the economic crisis, and the relentless demonisation of welfare claimants by Conservative-supporting newspapers, the Opposition has felt unable, or at least unwilling, to fight any kind of ideological corner. It remains to be seen whether a combination of trade unions and civil society organisations will mobilise enough protest to render the human impact of austerity publicly visible.

For this is by no means the end of it. In its analysis of the Budget, the Institute of Fiscal Studies pointed out that the Government’s overall planned spending cuts to 2018 are still unfunded: to achieve the plans, around £23bn still has to be found, either from yet larger spending reductions, or from tax rises. Even if departmental spending continues to be cut at around 2.4% a year, that will still leave £9bn in welfare spending cuts or tax rises. It is not hard to see what the Chancellor is planning for the next election: a campaign in which the Conservatives promise to cut welfare spending even further, while forcing Labour either to back them, or to admit that they will have to raise taxes in the next Parliament. ‘Labour’s tax bombshell’, in other words, is the goal. As with gags, so with election slogans: the oldest are the best.

There is a third way, of course, which Labour will seek to chart: a temporary increase in borrowing which avoids both spending cuts and tax rises. But this is not much more politically saleable, and if Labour focuses all the extra borrowing on productive capital spending (as it currently suggests), it will not solve the problem. Increasing such borrowing is the right policy – with interest rates at record lows, borrowing for investment is entirely rational, and will gradually stimulate sufficient growth to improve the public accounts. But in the short term this will not help close the current account deficit.

At some point Labour – and the Liberal Democrats too, if they are thinking at all about how to govern in a centre-left coalition after the next election – will have to acknowledge the truth that dare not speak its name. Taxes in Britain are too low, not too high. It is simply not possible to provide adequate public services in a modern society if total public spending is held at under 38% of GDP. Since in the long term borrowing is not the answer, the only solution is for the public to pay for the services they expect.

Taxation is the most fundamental relationship between government and citizens; its level determines the kind of public services we have, and its incidence the fairness (or otherwise) of how we pay for them. Yet it seems impossible now to debate the subject of taxation coolly. Any hint of a tax increase of any kind is seized upon by the media as an evil without parallel: almost always a ‘stealthy’ one, even where government is entirely open about what it is doing. Indeed, every cost is today labelled a ‘tax’ in order to give it negative connotations – whether this is a consumer levy to pay for green energy or a proposal to allow the elderly to charge the cost of social care to their estates after death. Even Labour is driven to this, describing the new benefit penalty as a ‘spare room tax’ without any thought of the wider consequences of so doing. The result is a wholly unhelpful sense among the public – and therefore politicians – that taxation is always and everywhere bad.

This is deeply unhealthy for political debate and proper political choice. If the possibility of tax increases is simply ruled out as beyond the possibility of political discussion, we foreclose almost every option of a more social democratic society. For those on the right, this is just fine; but for Labour and the Liberal Democrats it is not. Given current Government spending plans, and the facts of an ageing society, a refusal to discuss the possibility of raising the overall level of taxation as a proportion of national income is to abandon the centre-left’s historic mission to create a society of greater social justice and public good.

There are two practical ways in which an electorally careful Opposition might address this. The first is to focus on the taxation of wealth. For it is not entirely true that all taxation is unpopular. The 50% higher tax rate which Labour imposed on those earning more than £150,000 a year was supported by a very large majority of those who did not have to pay it; and the Government’s subsequent cut to it is a source of continuing public disaffection with the Coalition. The wealthy are a small minority of the population; yet over the last two decades they have taken an increasing proportion of both national income and total national wealth, much of it through a combination of house price inflation, low rates of capital taxation and the entirely legal avoidance of inheritance tax.

As Labour’s tentative forays into this field have shown – in its proposal for a ‘mansion tax’ on homes worth more than £2m – there is public support for greater taxation of wealth. Unfortunately that particular modest proposition will not generate additional revenue for deficit reduction, since Labour has chosen to use it all on a reintroduction of the 10p starting rate of tax, targeted at the very same middle income households who will gain most from the £10,000 personal allowance. But this is by no means the only form of wealth taxation which Labour can explore. A reform of inheritance tax, turning it into an accessions tax on the recipients of unearned wealth and getting rid of the seven year exemption, is an obvious possibility. Land value taxation, though difficult to design within our planning system, is another option worth exploring.

The second approach to opening up the debate about taxation is hypothecation, or the earmarking of specific tax revenues for specific spending purposes. More than ten years ago the Fabian Commission on Taxation and Citizenship proposed the introduction of a hypothecated health tax, a proportion of income tax specifically earmarked for spending on the NHS. The rationale was simple: public attitude surveys showed that a majority of voters were willing to pay more tax only if they knew where it was going. It was lack of trust in government to spend money wisely or transparently that undermined more general support for taxation. The NHS is under immense financial pressure, with ever-increasing demand and rising costs from new drugs and technologies. A hypothecated health tax would enable governments to ask taxpayers whether they wanted to see more money going to the NHS, and if so whether they were willing to pay for it. It would not solve the general problem of consent for higher taxes for other purposes; but it might at least enable the rising cost of the NHS and social care to be accommodated without an ever-tightening squeeze on the rest of public services. It is an idea which deserves debate.

The wider case here is more fundamental. Because of the unwillingness to address the question of taxation, the Government’s spending cuts have brought ever increasing numbers of British citizens to rely on voluntary food banks. Councils are now giving claimants vouchers redeemable only against certain shopping items at named supermarkets. Longstanding London council tenants are being moved to distant towns with which they have no connection in order to comply with the housing benefit cap. Taxation, it has been said, is the membership fee we pay for living in a civilised society. How long will it be before others look at Britain and ask whether it should still be called one?

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    Michael Jacobs

    Michael Jacobs is Professor of Political Economy at the University of Sheffield. He was formerly a member of the Council of Economic Advisers at the Treasury, a special adviser to Gordon Brown in the No 10 Policy Unit, and Director of the IPPR Commission on Economic Justice.

    Articles by Michael Jacobs
Volume 95, Issue 1

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Volume 95, Issue 1

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