7 September 2021

The politics will pay off, but the economics of this new tax stinks

By

Today’s announcements on tax, health and social care are a triumph of political spin over economic substance. But worse than that, they are a missed opportunity for a fundamental rethink of the role of the state in looking after the elderly and vulnerable.

The politics at least was clever. The package is clearly a big gamble for the Government and the Prime Minister personally, but I would not be at all surprised if it pays off.

Johnson led with praise for the NHS and emphasised the importance of fixing social care, both obvious crowd-pleasers. He also explicitly acknowledged that the tax increases would break the manifesto commitment not to raise National Insurance Contributions (NICs).

Instead, he made a virtue of the readiness to take difficult decisions in response to a crisis, arguing (in effect) that the manifesto commitment to increase spending on health and social care was more important.

Here, the new ‘health and social care levy’ of 1.25% per cent was presented as the least bad way to fund about £12 billion a year in additional spending. In particular, it was spun as an improvement on the straightforward hike in NICs that had been widely trailed.

In part this is because the money will be specifically ‘ringfenced’ for health and social care, rather than just added to the general pot of revenues. This hypothecation is only a mirage, but it should be easier to sell the tax rise if voters think they are getting something new in return.

What’s more, two of the objections to a simple increase in NICs were addressed by extending the new levy to income from share dividends (thus targeting the ‘rich’), and to the earnings of workers over the state pension age (thus ensuring that the burden does not just land on younger people).

The one-year suspension of the earnings element of the ‘triple lock’ on the state pension, which will now ‘only’ increase by the higher of consumer price inflation or 2.5%, will be presented as sharing the burden too.

The leader of the opposition has then completed the job by failing to propose anything better, other than even more spending – and therefore even more taxes.

Nonetheless, the economics still stinks. For a start, it is important to challenge the premise that taxes need to rise at all.

The additional spending on social care was presented as a fait accompli. There has been little attempt to build a broad consensus on the most sensible combination of caps on contributions or floors on assets, let alone any serious discussion of whether there are better alternatives to yet another mandatory state scheme.

It certainly does not make a lot of sense to hike taxes now to fund the backlog in NHS work caused by the pandemic. This is a one-off cost which can simply be rolled into the existing stock of debt, allowing stronger economic growth to reduce the burden of that debt over time. Instead, tax increases (for whatever purpose) are likely to hold back the recovery.

The new ‘health and social care levy’ also still falls foul of the main objections to a straightforward increase in NICs. Indeed, why have the additional complications of extending the base to include share dividends and the incomes of older workers when you could just raise income tax instead?

Here, the Prime Minister made the point that by adding the levy to both employee and employer NICs, companies will end up paying a large part of the bill. This is more smoke and mirrors.

The key point, as usual, is that companies are only legal entities and cannot bear the economic burden of tax themselves. The higher cost of employing people will therefore be passed on to workers, in the form of lower pay, or consumers, as higher prices (and probably both). Even if the new levy does somehow stick with employers, it will effectively be a ‘tax on jobs’.

The upshot is that the new ‘health and social care levy’ does not really overcome the objections to a simple hike in NICs. As many thinktanks, business groups, economists and tax experts have pointed out, income tax is paid by more people on more types of income, and is not a tax on jobs. Instead, we have ended up with a new tax, and a further complication to the tax system.

However, the Government seems to think that people don’t understand how taxes, and especially NICs, actually work, and is banking on voters accepting that more public spending and state intervention is the answer to any problem. Unfortunately, the politicians may well be right.

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Julian Jessop is an independent economist.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.