Taxes must be raised

The government has done well with spending cuts—but it’s not enough
August 21, 2013

Economic growth may finally be returning—but it won’t obviate the need for further fiscal tightening. To get the public finances back into shape will require more than the additional year of spending cuts, for 2015-16, set out by the Chancellor in June. Two more years of cuts have been pencilled into the Treasury’s plans. They are needed to meet the government’s target of closing the structural budget deficit over the next five years.

There is considerable satisfaction within some parts of government that cuts thus far appear to have been delivered more easily than many had feared. Nevertheless, the fiscal targets are incredibly challenging. They are all the more so if we try to do all the work with only a very small fraction of the tools. Pensions and healthcare, the biggest elements of spending, continue to be protected. And the other half of the fiscal equation—tax—is barely being discussed.

If the next government continues to do all the fiscal work on the spending side then more than 85 per cent of the total consolidation will have occurred through spending and less than 15 per cent through tax increases. Contrast that with the government’s initial plans to do “just” 80 per cent on the spending side and 20 per cent on the tax side.

There is certainly a plausible rationale for focusing on spending cuts. On these plans the state in 2018 will be much the same size as a proportion of national income as it was in 2004. Doing more on the tax side and less on the spending side would risk ratcheting up the size of the state.

But if the ring fences on pensions and healthcare are to hold then spending on large areas of public provision will be driven to historic lows. Real-term cuts for unprotected departments would average one-third by 2017-18—more in some areas. The consequences would inevitably be profound.

Perhaps the most persuasive reason for expecting tax increases comes if you reflect on history. In the last 30 years or so the average tax rise announced in a post-election budget has been around £7.5bn, undoing the average £2.2bn giveaway in pre-election budgets: a curious pattern. Past performance may be no guide to the future, but in this case it would seem perverse to ignore it.

The choice between tax rises and spending cuts is politically and economically serious. If there are no tax increases then we need to have the consequences for public service provision spelt out. These choices are becoming harder over time. Demographic change will require more money to be spent on health and pensions just to keep levels of provision steady. Not raising taxes implies either worse health and pension provision, or continued squeezes on everything else.

If there are to be tax increases the options should be examined and debated. The government takes about £4 of every £10 earned in taxes. This inevitably affects everything about how the economy works, has a huge effect on the distribution of incomes, and affects incentives to work, save and invest. There are many things wrong with the current tax system. And many proposals exist for putting them right, including those set out in the comprehensive review of tax policy led by Nobel laureate James Mirrlees and published two years ago by the IFS.

The trouble with taxes, though, is that nobody wants to talk about them. Governments and oppositions publish innumerable strategies for every area of spending; on taxes they are more silent. We were not told by George Osborne before the 2010 election that he was going to raise VAT. We were not told before the 2001 election by Gordon Brown that he was going to raise national insurance contributions. The increases were sprung on us in post-election budgets.

That does not seem like a good way of treating the electorate. It is not a good way of ensuring a robust debate about the choices between taxes and spending, or about the design of tax policy. There are real choices to be made about the shape of the state, how much it takes from us and how it takes it. These are genuinely fundamental to determining how we live. They should be at the absolute forefront of political debate.