Is there any case for tax increases now?

Few people outside the Treasury think that now is a good time even to be talking about raising taxes, let alone actually doing so. Nonetheless, it seems almost certain that the Chancellor will start down this road in Wednesday’s Budget. This may not be as mad as it sounds.

The arguments against immediate tax hikes are well known. The UK economy is still in the midst of the worst recession in over three hundred years. The cost of borrowing is still remarkably low. Raising taxes prematurely could simply undermine the recovery and actually make it harder to bring the public finances back under control.

It would also be politically risky. Almost all independent commentators – as well as many on the Conservative backbenches – agree that fiscal policy should continue to focus on supporting growth. The financial markets are comfortable with this too. This is an open goal that Labour is unlikely to miss.

Despite all this, there is a strong case for at least signalling that the government remains committed to fiscal discipline. The Chancellor has already done so with the freeze on public sector pay and cuts in foreign aid. A gentle nudge on taxes would reinforce this message.

Even before the pandemic, public spending accounted for about 40% of national income. This was surely already more than enough to do the sort of things that most agree the state should do, including funding good public services and infrastructure, and providing a decent welfare safety net.

On top of this, the pandemic has increased popular support for a permanent increase in state intervention in a wide range of areas. Indeed, many argue that the response to the pandemic has proved that the government can raise and spend a vast amount of money quickly, wisely, and at little cost.

This is both wrong and dangerous. For a start, these are exceptional times. The current degree of state intervention has only been justified because the state itself has shut down large parts of the market economy, in order to save lives.

It has only been cheap and easy to finance because a global recession has created a deep pool of excess savings which investors are happy to lend to the government (or hold at the central bank) at record low interest rates.

It is not even obvious that the government has spent well. A large part of the additional public borrowing has been used to finance transfer payments to private businesses and households, rather than been spent directly by the government itself. Much of the rest has been spent poorly.

The Chancellor therefore has to pull off an almost impossible balancing act. On the one hand, it would clearly be wrong to implement any major tax increases now. But on the other, his instincts that these levels of borrowing and spending cannot be maintained indefinitely are absolutely right.

What to do? If the Chancellor wants to fire a warning shot to spending departments and the general public, the signal needs to be loud and clear.

If he is serious about ‘levelling with the people’ this also has to mean being open about ‘stealth taxes’: for example, any freeze on personal allowances would still be an increase in income tax bill, even if it does not break the strict letter of the manifesto commitment not to raise tax rates.

Similarly, corporation tax is still a bad tax. But if the Chancellor is determined to raise it, he could at least limit the damage by committing to a long-term plan to increase the main rate gradually (providing businesses with some certainty) and delaying the first increase until 2022 (a one percentage point increase this April year would only raise £2 billion in 2021-22 anyway).

Since this is about signalling rather than a serious attempt to slash borrowing now, any tax increases can and should be small. If the economy rebounds as quickly as I hope (and expect), further tightening may well be unnecessary. Increases in corporation tax could then be offset by reforms elsewhere in the system, including investment allowances and business rates, and income tax thresholds could be raised again.

Above all, as this crises passes, the focus should shift towards returning levels of public spending to where they were before the pandemic struck – and shrinking the state further. In the meantime, raising taxes could be both economically and politically damaging, but a few small increases now could at least send a signal that helps to keep spending down in future,

This piece was first published on 2nd March 2021 by the Daily Telegraph

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