Newspaper readers have over the past couple of weeks been subject to a bizarre series of government leaks revealing apparent planned tax rises. It is difficult to understand the rationale for this operation. Perhaps the powers that be think portentous leaking will make the tax rises they do enact seem less harsh. There’s a risk, however, that suggesting ill-conceived interventions just makes them look economically illiterate.
Hiking tax going into a recession simply exacerbates that recession which in turn further undermines tax revenues. Moreover the tax rises they have chosen to float would be especially damaging to Britain’s economic prospects.
Let’s look at them in order of potential economic damage. Unfortunately the worst tax rise is the one that is already firm policy, the 30% increase in the corporation tax rate. It will have a significant adverse impact on aggregate investment, foreign direct investment (FDI) and entrepreneurial activity. Even the IFS has now admitted that ‘there was some truth in the Truss/Kwarteng critique that a rise in the corporation tax rate could be damaging’. Academic research suggests that FDI falls by 2.5% for every percentage point rise in the corporation tax rate.
Increasing capital gains tax (CGT) will be the second most damaging step. It’s pretty much like pouring sand into the gearbox of the economy. CGT impedes the flow of capital from less profitable investments to ones with higher rates of return, thus limiting the growth of newer more profitable businesses. As the tax is largely a voluntary one, (because most people don’t need to sell assets at a particular time), revenues will decline because gains will simply not be realised.
After leaked suggestions that the CGT rate would be increased, the most recent story is that the annual allowance will be cut. This would seem a particularly dim move, as it would persuade the largest number of people not to realise capital gains.
Another possible change that’s been touted recently is lowering the point where the 45% rate of income tax kicks in, from £150,000 to £125,000 or lower. This would be particularly futile, as it would actually reduce tax revenue. The revenue-maximising rate appears to be no more than 40%, as confirmed by the IFS Mirlees Review. When Geoffrey Howe started cutting the top rate of tax in 1979, the top 1% of UK taxpayers paid only 11% of the total income tax take, but successive reductions in the top marginal rate have increased that proportion to 30%. Why would any Government want to reverse that progress?
Let’s remember that we are talking about quite small numbers of individuals. Only 560,000 people pay the additional rate. That’s 0.8% of the population who account for 36% of income tax revenues. The Government will be on thin ice if it decides to alienate this group. A limited number leaving for lower tax climes such as the USA will greatly reduce overall tax revenues. And given the huge increase in remote working, moving to a lower-tax country has never been easier. We’ve just had the bad news that Paris has overtaken London as Europe’s largest stock market. Our financial sector finances a major part of public sector costs. If a chunk moves elsewhere it’s lights out for the British economy.
Proposed restrictions on pension tax relief seem the next most damaging. Freezing the lifetime allowance when we have inflation running at 10%+ is a threat to confiscate a substantive proportion of many people’s pension savings. The primary and most economically damaging effect will to be persuade people – particularly successful and productive professionals – to work less and retire earlier. Already an extra 250,000 people in their 50s and 60s have retired early since the pandemic in a major blow to the economy.
But, more broadly, the effect is to persuade people that it isn’t worth investing in pensions. Just this week I was saying to a 27-year-old that it was important to save into her pension. But she replied that it wasn’t worth it because the Government clearly was not in the least committed to protecting pensions or preserving incentives. She has a strong point.
Proposed attempts to increase the inheritance tax take are the next most counterproductive idea. People starting businesses mostly rely on private capital, not bank lending. IHT shrinks this pool of capital, slowing economic growth & harming productivity. IHT is taxation of already taxed capital – triple taxation in which first income, then savings and, finally, inheritance are taxed. It punishes the middle classes and starves the economy of capital. So dragging yet more people into its net by further extension of the threshold freeze or changing the CGT rules on inheritance is yet another own goal.
Considering this range of proposed tax rises, one could almost imagine an operative in SMERSH or the FSB dreaming up how to promote the particular cocktail of tax rises that would wreck the British economy most effectively. Thankfully, conspiracy theories are rarely the best explanation for anything – in this case the far simpler diagnosis is a very bad case of ‘Treasury Brain’.
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