Hamish McRae: What if revenues fail to recover?

Could the UK become the new Japan? The two bits of news that spark that question are the public finance figures for June, released yesterday, and the creation by the Chancellor of this new Office for Tax Simplification. The June numbers are disturbing, for they show that the apparent recovery in tax revenues seems to be petering out, while the latter matters because a radical simplification of the tax system may be the only way the Government can generate enough tax to dig its way out of the fiscal catastrophe it inherited.

The parallel with Japan first, for if you add all the debts of the UK – government debt, company debt, personal debt and so on – we join Japan at the head of the league table of shame. The composition of the debt in the two countries varies, with public debt being bigger in Japan and personal debt being smaller, but in both countries total debt is more than four times GDP.

But now look at something else. I was aware, as most of us are, that Japan had experienced two decades of stagnation, with wealth rising very little or not at all, but I had not fully appreciated the damage that slow growth had done to tax revenues. A couple of weeks ago the Japanese finance minister reported that revenues for the last fiscal year, the one that ended in March, were Yen 38.7 trillion. That was actually a little higher than had been feared, but was still the lowest since 1986. Yes, 1986. Back in 1990, at the end of the boom years, they were Yen 60 trillion and since then there has been more or less steady decline. It is true that this is the central government tax take and there are other local taxes, but the broad picture is of a public sector that has to manage with less money coming in each year.

We are not used to that. Revenue has plunged over the past three years but the explicit assumption in all the budget forecasts is that it will recover. Yes, everyone accepts that we have to cut public spending and the only area of debate is about the speed at which that should be done. But the numbers only add up if you also assume that revenues will recover. What if they don't – or at least not to the extent expected?

We are only one quarter of the way into this fiscal year but the fiscal numbers don't look great. The Government had to borrow £42.4bn in the three months to end June, whereas last year it had to borrow "only" £41.4bn. This period does relate to policies under the former regime and the emergency Budget was not until 22 June. Nevertheless it has been a period of some growth, which is more than can be said of these three months last year. My worry is not that the Government is failing to control spending, for it is too early to expect much to be happening on that front. Rather it is that revenues are weakening and may weaken further.

For the first two months of the financial year revenues were decently up on 2009 but in June, though VAT was up, income tax revenues were flat. We will have to wait for some months to be sure but what may have been happening has been that people have been bringing forward purchases ahead of the emergency Budget to escape a possible rise in VAT. They may also have been taking capital gains to get the benefit of the 18 per cent rate, in the correct anticipation that this would be increased. That would explain the strong numbers there.

As for the weak income tax figures, people may now be starting to cut their income in response to the rise in the top rate of tax to 50 per cent.

To many people that must sound a bit odd – people just cutting their income – because that is not what most of us would choose or even be able easily to do. But you have to remember that a quarter of income tax revenue comes from the top 1 per cent of earners and many of this top group do have flexibility as to whether to take income or not. If they own their own businesses, for example, they can leave the money in the business. A few are moving offshore, which is hard for UK citizens but easy for non-nationals. (I see that JP Morgan is relocating its head of international business to New York because of the high personal taxes in the UK.) We don't know what the leakage will be but it is perfectly possible that three or four years down the line, income tax revenues may actually be lower than they were last year.

So there will be huge pressure on improving the tax system so that we get the revenues in but don't encourage people to move out, or simply not come here in the first place. That is where the Office for Tax Simplification comes in.

I find here a bit of scepticism coming on. I can't quite see why you need an office to make things simpler. Why not just stop complicating them in the first place? We no longer have a Chancellor with a compulsion to fidget. Remember all those little announcements that Gordon Brown used to scatter like a condiment over his Budget speeches? There is a huge case for radical simplification, not least because even the revenue can't cope with the present system but that should be mainstream, not something bolted on the side. Still, since we have it, its mission should surely be not just to simplify the system but to tune it so that we increase our chances of avoiding the plight of Japan.

h.mcrae@independent.co.uk

For further reading

'The Mystery of Capital', by Hernando do Soto (Basic Books, 2000)