Do taxes need to rise in the wake of the coronavirus crisis – and which ones should go up?

Public finance experts are sceptical that it’s possible to properly fund higher public spending without raising one of the ‘big three’, writes Ben Chu

Rishi Sunak will deliver an economic update this week (PA)

In response to the coronavirus pandemic, the Treasury has borrowed significant sums of money to fund worker and business support schemes and to keep public services funded as tax revenues have collapsed.

Public borrowing is expected to breach 10 per cent of GDP this year, higher than during the financial crisis.

As a result, the UK’s public debt, according to the Office for National Statistics, is already roughly equivalent to the size of the total UK economy.

Boris Johnson last week ruled out a return to austerity.

The bulk of the impact of George Osborne’s fiscal consolidation after 2010 was made up of public spending cuts.

And so the spotlight has turned to taxation.

The Conservative manifesto at the last election pledged no increases in VAT, national insurance or income tax – the three biggest revenue raisers. Yet that was before the Covid crisis inflicted such damage on the public finances.

Questioned last week about the prospect of tax rises in the wake of the crisis, the prime minister did not rule it out.

But are tax rises really necessary to repair our public finances? And if they are, which ones should rise?

Do we need tax rises?

It’s important to make a distinction.

Economists are agreed that, despite the deterioration in the public finances, there is no case for immediate tax rises.

They would take money out of consumers’ pockets and, at this time of grave uncertainty, likely impede overall spending and result in a smaller economy. And a smaller economy would result in lower overall tax revenues, making the action self-defeating.

Indeed, there is a case for temporary tax cuts in the present environment, with some advocating a VAT cut to encourage spending, or a reduction to employer national insurance contributions to encourage firms to hire.

So taxes should rise when the economy has returned to normal?

Here too it’s important to separate some things out.

While some commentators argue that the jump in the size of the national debt itself means that taxes must rise to bring it down, most economists now caution against that view.

UK market interest rates are low – and have fallen further in this pandemic – meaning that the annual costs of servicing that higher national debt will still be very low by historic standards.

In other words, it will not be crowding out other types of spending such as education and health.

The general view is that the government should aim to reduce the size of the debt relative to the economy over time but that this need not be done rapidly through major tax hikes.

So perhaps taxes never need to go up then?

There are several arguments as to why that’s not the case. One is that interest rates might not be low forever and so that even if debt repayments are comfortable now that might not be true in the coming decades and so it would be prudent for the government to act ahead of that possibility.

Another is that even when the economy has fully recovered there might well be a structural (as opposed to cyclical) annual budget deficit which, if unaddressed, would result in the debt rising steadily even in normal times – and that tax rises would be necessary to close this gap.

Related to this is the concern that the ageing profile of our society is putting long-term upward pressure on public spending, particularly healthcare and social care.

The Office for Budget Responsibility argues that the public sector finances would come under increasing stress over the next 50 years due to rising age-related spending, and calculates that, unaddressed, these pressures would open up a primary (excluding debt repayments) budget deficit for the UK deficit of between 6 and 11 per cent by 2067.

Many argue that, regardless of the level of the debt, this alone makes the case for higher taxation over the medium and long term.

In other words, if we want properly funded public services we need to pay more tax as a society.

But don’t higher taxes harm growth?

This argument is frequently made by those on the libertarian right. And some commentators point out that UK taxes were already set to rise to their highest sustained level as a share of GDP since the end of the Second World War.

But economic studies do not support the argument that higher taxes always hurt growth. In some cases they might even support it if the proceeds are spent in areas that enhance our productive capacity such as education or infrastructure.

And while UK taxes are high by post-war standards, they are lower than in many other prosperous peer European economies.

These economies also, incidentally, mostly spend more on health care per person than the UK.

So which taxes should rise?

Public finance experts are sceptical that it’s possible to properly fund higher public spending without raising one of the “big three” of VAT, income tax or national insurance, which is why they criticised the manifesto commitment by the Conservatives to rule this out.

However, experts have also started examining the possibilities of some sort of wealth tax.

This would be new to the UK and would bring practical implementation challenges, but last week the former cabinet secretary Gus O’Donnell suggested that the political ground could be relatively fertile for such an innovation.

“Quite often wealth taxes have been attacked because people say they are too lefty [and] what communists and socialists do,” he said.

“If the debate is put in terms of ‘we want to increase spending on the NHS, but we don’t have any money’, then tax increases become more acceptable.”

Another innovation is proposed by Arun Advani of Warwick University and Andy Summers of the London School of Economics who have also proposed a new “alternative minimum tax”, which they think could raise around £11bn a year.

The merits of this would be that it would ensure that very wealthy people could not dramatically lower their effective tax rates below those of people much lower down their income distribution by taking their remuneration primarily in the form of capital gains, which attracts a lower tax rate than income tax.

Another advantage of wealth taxes for many is that they would reduce wealth inequality, which is high in the UK and a source of growing popular concern.