Let’s talk about tax

Published on Welfare & Tax Reform

Something unusual is happening in this general election campaign. Everyone is talking about raising taxes. Last Sunday Theresa May told Britain she wouldn’t be repeating David Cameron’s mistake of ruling out ever raising any of National Insurance, income tax or VAT. Before that Labour’s Shadow Chancellor, John McDonnell, had hinted that people earning over £70-£80,000 (or “the rich” as he called them) might be asked to pay more. Now the Lib Dems have gone further – not just leaving open the option of tax rises or hinting at them, but setting out a clear, concrete policy for a fairly hefty tax rise.

Tim Farron is proposing increasing all rates of income tax by 1 per cent, bringing in £6 billion to be spent on the NHS and social care. If done today that would mean the basic rate of income tax would rise from 20 to 21 per cent for earnings between £11,500 and £45,000, the higher rate would rise from 40 to 41 per cent on earnings from there up to £150,000 and earnings above that level would face a 46 per cent tax rate.

So what should we make of this tax rise plan? Here’s five things to bear in mind about the proposal:

First, this policy would raise substantial funds – in line with the Lib Dems costing of £6 billion a year by 2019-20. Indeed the direct effect of the tax rise, if nothing else changed, is probably slightly above that, but assuming a degree of behavioural response the ball park figure is reasonable and draws on HMRC illustrative costings.

Second, this is a brave tax rise in the sense that it is broad based, putting up taxes for 30 million people. This bucks the trend of recent politics of focusing on tax rises that affect only richer households (or that people can’t tell affect them). The additional 50 per cent tax rate, introduced at the end of the last Labour government, only affected people earning over £150,000 – now amounting to just 333,000 people or 1 per cent of the number affected by the Lib Dem plans. To reinforce how against the grain of recent politics the proposal is, this would be the first increase in the basic or higher rates of income tax since 1975-76 – with the less visible National Insurance or VAT often rising instead. However, it should be noted that 21 per cent would still be a lower basic rate than in 2007-08 (when it was 22 per cent) or earlier.  

Third, although a lot of people would be affected by this tax rise, like most increases in income tax it would be highly progressive. The rich would pay much, much more with 95 per cent of the revenue coming from the better off half of households and half from the top 10 per cent of households. A typical earner in 2019-20 on £25,000 would pay £129 more tax, while someone on £100k would pay £879 more.

Source: RF analysis using the IPPR tax-benefit model & Liberal Democrat / HMRC costings

Fourth, this tax rise would have an odd effect on low and middle earning families on benefits. The UK is currently in the midst of a big switch of such families from an old system of tax credits to a new Universal Credit system. Universal Credit merges lots of benefits together, hopefully making the benefits system simpler. But it does something else seemingly technical but which matters when thinking about tax rises and cuts – it shifts means testing of benefits from pre-tax to post-tax income. The result is that families on UC would be protected from nearly two thirds of the effect of this tax rise, while identical families still on tax credits would face the full tax increase – a pretty rough justice.

Fifth, £6 billion extra spending amounts to a substantial increase in health spending, but possibly not as much for the NHS in England as the Lib Dems hope – remember devolution. The Health department in England has been set a budget of around £130 billion for 2019-20 – compared to which £4 billion extra (the Lib Dems say £2 billion at least would be for social care) is a 3 per cent rise, and would be more than a 50 per cent increase in the health spending rise currently planned between 2017-18 and 2019-20. But, while this is a UK wide general election, if the Lib Dems did form a government then the full policy could only be directly implemented in England – health is a devolved policy in Scotland, Wales and Northern Ireland, and income tax is almost entirely devolved to Scotland. The result is that although £6 billion would be raised by the tax increases that is not the amount of extra spending available for the NHS and social care in England – with a high hundreds of millions going to devolved governments to spend as they see fit. So the Lib Dems would have nearer £5 billion to spend in England, meaning slightly lower increases than detailed above. The SNP government in Edinburgh meanwhile would have to decide whether to follow such a tax rise, something they may be reluctant to do given that a penny on all income tax rates is currently a Scottish Labour party policy proposal they have attacked.

People will obviously have very different views about the desirability of this policy proposal. Some will argue Britain’s tax burden is already too high, heading above 37 per cent of GDP in the next few years. Others will point out that UK public health spending is actually set to be falling as a percentage of GDP in the next few years – something likely to put significant strain on a system already seeing longer waiting times and a crisis in social care. Whichever side you’re on its good that all parties have, intentionally or not, started talking about tax. How to raise and spend it is, after all, what we elect governments for.