All gain, no pain? – the Chancellor’s cunning tax plan

Published on Public Finances and the Economy

British politics is odd these days. But even by current standards something very unusual looks set to happen in next week’s Budget. A basic rule of British politics is that tax rises tend to happen soon after a general election, with the Chancellor betting that we’ll all have forgotten about them when the next election comes around. Philip Hammond may well be about to shred that rule with the Treasury considering plans for tax rises that would take place just a few months before the next General Election is due in 2022.

Some Conservative MPs will say that shows the Chancellor doesn’t understand the rules of politics. But there is more than one rule of politics. Another key rule, to paraphrase Lyndon B Johnson, is that you never call a vote before you can win it.

Faced with the twin challenges of a looming economic downgrade from the Office for Budget Responsibility and spending commitments from the Prime Minister, the Chancellor looks set to see a significant reduction in the headroom he has against his main fiscal rule to “reduce cyclically-adjusted public sector net borrowing to below 2% of GDP by 2020-21”.

Raising revenue from additional taxation is the obvious way to square that circle without looking like you’ve given up on the whole fixing the public finances thing. The only difficulty is that the self-employed NICs debacle earlier this year showed that the Chancellor can’t currently win a vote on even the most innocuous of tax rises.

But while you can’t put up taxes without a vote (something American independence taught us a while back), you can control the timing of one. Here’s how.

The Chancellor is looking at policy proposals for the Budget to freeze the Personal Tax Allowance (PTA) and higher rate threshold (HRT) once he has met the Conservative Party manifesto commitment to raise them to £12,500 and £50,000 respectively. This could raise serious amounts of cash.

If the Chancellor does nothing else those thresholds are set to reach nearly £13,000 and £51,000 respectively in April 2022, due to faster than expected inflation (the thresholds are automatically uprated in line with September’s inflation rate the following April). Instead of allowing that to happen, a policy of freezing the PTA & HRT once they hit the manifesto pledges would raise £3.1 billion a year in 2022-23.

Actually making the tax rise happen is a whole other ball game – but crucially one where kick-off is very very delayed. Thanks to the Rooker-Wise amendment back in 1977 it takes primary legislation to prevent income tax thresholds rising in line with inflation. But that primary legislation does not need to be passed when the announcement is made but instead in the period between a Budget and the April in which a change to the threshold is due to take place.

So, by freezing the tax thresholds from 2022-23 onwards, the Chancellor can bank the revenues in his upcoming Budget, while delaying a vote on the tax rises until Autumn 2021 or early 2022. Winning that vote may be someone else’s problem, given the average tenure of Chancellors. If he was still in post at that point he would be doing so as the fourth longest serving post-war Chancellor.

So that’s why it’s a cunning plan but is it a good one? The wish to avoid votes in the short term would leave an odd pattern of tax threshold rises now and cuts later, instead of a more sensible, slower pace of increases across the parliament. But that aside, raising money by ending the recent big increases in the Personal Tax Allowance is the right thing to do.

First, raising further tax revenues could help rebalance our fiscal approach given that too much of the government’s consolidation is currently planned to come from welfare and public service cuts. Indeed freezing thresholds for more than one year could raise very significant sums – a further 2023 freeze would save £5.5 billion a year.

Second it is a progressive form of taxation with revenue raised coming overwhelmingly from better-off households. Four-fifths of the revenues raised would come from the richest half of households.

Third, low-income households on Universal Credit would be cushioned from tax rises. Unlike tax credits, UC awards are means tested on families’ post-tax income, so 63 per cent of any income losses from tax rises are cushioned by an increased UC payment.

Fourth, this is just a minor correction to a whopping tax cut.  A typical earner would still be paying around £700 less a year in 2022-23, compared to a situation where the PTA had simply gone up in line with existing policy since 2010.

Fifth, it would bring to an end the recent erosion of Britain’s income tax base. Years of above inflation increases in the PTA have left the Treasury reliant on a dwindling pool of taxpayers for income tax revenues. The top 1 per cent of income tax payers now account for 28 per cent of all income tax receipts.

Now before you start feeling sorry for the top 1 per cent we should remember that this percentage is so high mainly because they have far too high a share of income. And of course it ignores other taxes. But the fact remains that big increases in the starting point for paying income tax, combined with truly awful earnings growth, is a big problem for sustainably funding our public services. It has also allowed a rhetoric to become established about lower earners not contributing, when in reality they continue to do so, through VAT and NICs.

The Chancellor faces acute Budget pressure on three fronts – from his boss, his economic watchdog and a House of Commons wary of supporting tax rises for a volatile electorate. To navigate that triangle while maintaining a sense of discipline on the public finances is a hard task, so pencilling in some tax rises for later in the parliament is an understandable strategy. Divisions in parliament may have died down by then, but it will take a lot of long, economicky words to persuade Conservative MPs to vote for tax rises just months before they go to the polls. But if a week is a long time in British politics, four years is an eternity.