David Herdson: The time is right for an income tax hike

Written by David Herdson on 28 November 2016 in Opinion
Opinion

Both prudence and politics demand that Philip Hammond abandons out-dated Treasury habits

Pollsters were put on this earth to make economic forecasters look good by comparison – and if these last 18 months are anything to go by, they’re performing their task admirably.

On one level, that’s a little unfair on the pollsters, or at least some of them.  Not all were all that far out on the UK 2015 general election, the Brexit vote or the US presidential election. But where they crucially failed – or where the analysts interpreting them did – was in translating those polls into wins and losses.  Get it 2% wrong when someone has a thirty-point lead and no-one notices; get it 2% wrong when the election’s on a knife-edge and everyone does.

Economic forecasters, by contrast, invariably get away with much worse errors because by the time the actual figures for a given timeframe are released, what someone said six or twelve months ago is much more readily forgotten.

Governments however can’t forget.  They make their plans on the basis of those predictions and if the predictions are out, then so are their plans – and Brexit, according to the OBS, has put a great big hole in those plans.

The question then is how to fill it.  In fact, the first question should really be whether it needs filling at all or whether a low deficit is both sustainable and preferable.  For the government to ask that though would be to concede too much ground to Labour and to undermine the message on fiscal discipline that proved so effective in last year’s election.

In reality, the Conservatives have no option but to play the prudence card, even if delivery is proving a much tougher challenge.  Back in 2012, George Osborne announced that borrowing for this financial year would be £21bn; this last week, Philip Hammond was working to an estimate of £68bn.  It’ll be another four years before the original figure is hit – if this week’s forecasts are correct.

But that increase reiterates how important the question is about where the money to close the gap is coming from.  The best part of £50bn is a lot of money and economic growth can only do so much to reduce spending, particularly when employment is already high and political pressure means that cutting the benefits bill further or pensioners’ benefits at all is a no-no.

Making cuts of the scale needed in any of the other big spending departments will be equally difficult.  Health care is practically sacrosanct and cuts would make the government an easy target for anything and everything that subsequently went wrong.  Just this last week, the Defence Select Committee criticised the government for underfunding the Navy.  And the list goes on.

There is scope to trim terms and conditions of public sector employees.  The salary-linked pensions are very generous compared with much of the private sector, for example, but not only would such a change be likely to outrage several million well-unionised workers all at once (and MPs) but it would have little short-term impact on finances as the pre-existing commitments would be unaffected.

So if the government can’t borrow more or spend less, then if it wants to cut the deficit, the only option is to raise taxes.

Again though, options are limited.  One of the first things the Conservatives did on re-entering government was to put up VAT.  To raise it again would create an impression of being anti-consumer, and of hitting those ‘just about managings’ in particular (despite many essentials being zero-rated).

With Corporation Tax also ruled out as a candidate, given the government’s desire to use it in marketing the UK as an attractive place to do business, and with other indirect taxes being too small to contribute the numbers needed, that leaves only one option: taxes on income.

They ought to be the logical choice anyway.  Income Tax is the fairest of all taxes: the most broadly-based and the one most closely linked to ability to pay.  Those at the bottom pay nothing and the JAMs pay very little.  Unlike National Insurance, the rate for any given income is (more or less) the same irrespective of the individual or the source of their income.

But to suggest raising Income Tax to ministers would see them jumping as if they’d seen a ghost.  In reality, they’d be jumping at shadows.

For all that cutting Income Tax has come to be seen by governments as a measure of their success, does the public really notice the benefit?  The Lib Dems for a while campaigned on putting a penny on Income Tax to fund education spending and it’s unlikely it did them much harm (although it’s possible that what was popular with their supporters might have had limited appeal beyond).

But if populist gesturing was the government’s aim, it wouldn’t be trying to close the deficit in the first place.  The qualities it’s after being credited with are competence and fairness. Income tax ticks the fairness box; a 2p rise at all levels should raise over £10bn, making a big dent in the deficit and so shoring up the government’s perceived competence.

Ken Clarke, when he was chancellor, said that good economics was good politics, and he was right.  Ultimately, competence is worth even more than a reputation for tax-cutting, if tax-cutting is seen to put the nation’s finances at risk.  Both prudence and politics now demand that Hammond abandon out-dated Treasury habits and for the first time in decades, increase income tax.

 

 

@DavidHerdson

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