As government expenditure continues to swell, think tanks like the National Institute of Economic and Social Research and the Institute for Fiscal Studies warn of an unavoidable reality: tax hikes seem inevitable. To sustain and improve public services without compromising fiscal rules, future governments will have to navigate the tenuous balance between economic growth and additional revenue through taxation. This article explores the potential pathways and their implications for a society accustomed to relatively low taxation models.
The Case for Tax Hikes
The Economic Rationale
The economic rationale behind the impending tax increases is unambiguous. Public services, cherished by citizens and foundational to a functioning society, require adequate funding. The current American-style tax model in the UK, characterized by relatively lower tax rates, stands at odds with citizens’ aspirations for European-level services. The math is simple and unforgiving; the quality and scope of public services will inevitably fall without an influx of revenue. This has led economic experts to question not if, but how taxes will rise.
The Institute for Fiscal Studies articulates the need for tax hikes as a matter of arithmetic. Balancing budgets is not merely an exercise in political will but an economic necessity. With every passing year, the difficulty of adhering to this balancing act grows, especially in light of evolving demographics and increased demand for healthcare and pensions. Moreover, economic shocks such as recessions or pandemics only exacerbate the strain on government finances, leading to a more pressing need for action on the taxation front.
Political Palatability and Public Reception
Politically, tax increases are a minefield. Successive governments have shied away from direct tax hikes, opting instead for stealth methods like freezing income tax thresholds. These gradual changes, while initially less palpable, have started to raise public awareness and ire, diminishing their utility as a long-term solution. Moreover, the political narrative often revolves around ‘taxing the rich’—a strategy that fails to produce the necessary revenue due to the limited size of the affluent cohort.
The difficulty inherent in raising taxes is not simply a matter of public acceptance but also the effect on the economy. Tax hikes can dampen consumer spending, discourage investment, and exacerbate wealth inequality if not carefully designed. The challenge for policymakers is to devise tax increases that are neither economically detrimental nor politically unviable. Yet, as the fiscal demand grows, these political concerns may need to take a backseat to the practical reality of funding public services.
Potential Avenues for Taxation
Addressing Wealth and Corporate Taxes
Wealth taxes targeting the rich and corporate taxes have been touted as possible solutions to the looming fiscal challenges. However, they often fail to generate the required revenue. For instance, a 1p increment in the additional rate for high-income earners would fetch a paltry £157 million—insignificant in the grand scheme. Similarly, while corporate taxes are a potential goldmine, international competition and the need to attract business can limit the rates that governments are willing to impose.
The reality is that broad-based taxes are the financial workhorses of government programs. Taxes such as VAT and employer contributions to payroll taxes like National Insurance are robust and consistently reliable. While less targeted, increases to such taxes can prove more profitable and less discriminatory, laying a fairer tax burden across the economic spectrum. Yet, it is critical that any increases maintain a balance that does not disproportionately affect low-income earners or deter business development.
Incremental Changes in Broad-Based Taxes
Incremental changes in broad-based taxes like VAT or National Insurance could provide the answer for funding public services. These incremental shifts can spread the tax burden more evenly across the population, avoiding the pitfalls of targeting narrow tax bases. However, public reaction to such changes remains unpredictable, and the government must tread carefully to navigate the potential backlash from a public unaccustomed to significant tax adjustments.
