In this briefing we assess the extent to which instability in tax revenues risks becoming an increasing problem due to the types of policies that the main parties are proposing.
This could have significant consequences for future borrowing and public spending.
One of the key priorities for the next Government will be to reduce the deficit. All three main parties have committed to doing so by the end of the next term, although as set out in A Deficit of Growth II, the parties differ in the extent of their ambitions.
The Chancellor’s Autumn Statement in December 2014 implied that overall departmental spending is set to fall in real terms by about 14% after 2015-16. But all three main parties have some room to ease up on these cuts and still meet their respective deficit reduction targets, with Labour having the most room, and the Conservatives having the least.
Since 2010, the current Government has focused primarily on reducing the deficit by cutting spending; but the net effect of its overall package of tax changes has nevertheless been to increase taxes by £16.4 billion since 2010-11. The way in which the next Government plans to collect tax revenues will determine its spending options, whilst also fulfilling the commitment to cutting the deficit. The different parties differ on their appetite for tax rises in the next Parliament. Indeed, there are even promises of tax cuts, such as increases in the Personal Allowance that would reduce income tax. Unless such promises are offset by tax rises elsewhere, that could mean that even more spending cuts are needed, or that the commitment to reducing the deficit will not be met.
However, the effect of tax policy on Government finances goes further than this. An important element of the overall stability of Government finances is the volatility in tax revenues. Recent trends in tax policy have, in some cases, reduced the size of the tax base – the numbers of people or businesses paying tax. The Government has, for instance, estimated that 3.2 million fewer people are paying Income Tax in 2015 as compared to 2010. There is evidence that a smaller and less diverse tax base is linked to increased volatility in tax revenues.
This briefing note:
- Sets out the main sources of the UK’s tax revenue; recent trends in Government tax policy; and what is known of the plans of the three main parties for tax policy following the 2015 General Election.
- Highlights how recent trends in tax policy, and some of the proposals on tax being made for the next Government, contribute towards a reduction in the tax base; and demonstrates how a small or concentrated tax base can create problems for volatility in Government tax revenues. Given that the main parties are all committed to reducing the deficit, a stable stream of revenue should be a priority.
- Demonstrates the connection between a reduced tax base for personal taxation such as Income Tax and National Insurance, and debates over those that ‘contribute’ to society, including those on low pay and migrants.
- Recommends maintaining the current levels of the Personal Allowance and National Insurance thresholds; and advises against further business tax reliefs and exemptions. Further increases in these thresholds and exemptions would reduce the tax base further, not only decreasing much needed tax revenues in the short term, but in the long term would put the UK in a poor position to deal with another economic downturn. If a future Government – faced with improved public finances – wished to cut taxes, reductions in overall tax rates would be better than tax giveaways through exemptions and higher thresholds. This would retain a wide tax base and reduced volatility, and also strengthen work incentives.