The Tory party obsesses about taxes on Sunday as it does every other day. A distant Shangri-La of low taxes, energizing tax cuts and low taxes is visible. This was last seen under Margaret Thatcher in 1980s.
If that is too strong of a word, one of her successors has been popping up again in recent times when it might have made more sense to keep quiet. Liz Truss once again argued for unfunded tax cuts despite all that happened last fall.
Boris Johnson, another, is not afraid to call for tax cuts and increase pressure on Rishi Sunak, the prime minister, and Jeremy Hunt (the chancellor) as he prepares to present his March 15 budget.
The Laffer curve is one of the most harmful aspects of economic analysis when it’s misused. It is not difficult to believe that tax rates can reach a level where they are too high, at which point increasing them will reduce rather than increase revenue. It has been so distorted that it is now dangerous.
It’s been 12 crazy months since Sunak, the former chancellor, gave his Mais lecture at Bayes Business School, City of London. His speech in which he spoke out about the need for affordable tax cuts deserves to be recited.
He said it as follows: “I am disheartened whenever I hear the flippant assertion that tax cuts always pay for itself.” They don’t. To cut taxes sustainably, you must work hard, prioritise, and be willing to use difficult arguments, which are often not popular, elsewhere.
He was correct. As those who established the Office for Budget Responsibility (OBR), have stated, it is also correct to know that the Treasury’s fiscal watchdog, the government’s fiscal watchdog, takes dynamic effects into account when assessing tax increases and cuts. These dynamic effects can often make tax cuts much more expensive than a simple analysis would indicate. However, they are rarely, if ever, free of cost.
The big surprise for me is that a simple debate about tax cuts has not turned into a discussion about tax reform. At the moment, the OBR predicts that the total tax burden will increase to 37.4% of GDP in the fiscal year 2023-24 and then to 37.5 percent the next year. These readings are among the highest ever recorded. The previous record was 37.2 percent in 1948, when records began. This is because the economy was recovering from wartime levels tax and spending.
Although the tax burden is lower in the past than it was in the present, how much did it drop during the Shangri-La period of the 1980s? It did not. It was 30.7 percent of GDP in Thatcher’s last year as an officeholder, 1989-1990, compared to 30.4 percent in 1978-1979, the final year of the Labour government in the 1970s. Under Tony Blair and John Major, the tax burden was 30.3 percent of GDP in the 1990s. This compares to 32.1 percent in 1980s.
Tax reform was what did occur in the 1980s. Two major shifts took place during this period. The first was the transition from direct to indirect taxes. The Thatcher era’s initial budget for tax cuts, which saw the basic income tax rate drop from 33 to 30% and the top rate drop from 83 to 60%, was actually a tax shifting budget. These cuts were made possible by an increase of VAT to 15% from 8 to 12.5 percent on luxuries and 8 to 10% on most goods.
The Lawson doctrine, which reduces tax rates by removing or restricting tax reliefs, was the second major shift. It was most prominently for corporations tax but later on it was followed by other taxes.
There is not much scope for net tax reductions given the current state of the public finances. However, the current state of the tax system means that there is ample scope for tax reform. This could have the effect of increasing revenue. One of the lesser-known acts of vandalism that occurred during the Truss premiership was abolition of OTS (Office of Tax Simplification), which was announced as part of the notorious mini-budget on September 23rd last year.
With its harmful idiosyncrasies, the income tax schedule is an example. The income tax rate starts at 20%, increases to 40%, which is the higher rate, and then drops to 40% for earnings above PS100,000. Some have higher marginal rates, such as those who are involved in income tax and child benefits withdrawal.
The logic behind the PS100,000.00 marginal rate of 60 percent was that higher-paid workers should not be able to benefit from the former-Tory policy of increasing the personal allowance by more inflation than inflation. This policy was abandoned and replaced with a prolonged freeze. The system is in dire need of reform.
The government is moving to reverse the Lawson doctrine in corporation tax. The government is increasing the rate to 19-25 per cent while reducing the super deduction and reliefs. It is important to offer incentives for investors if a higher rate becomes necessary.
There is also VAT. The current VAT turnover threshold for small businesses is PS85,000. Businesses above this threshold do not need to pay it. OTS, which was now extinct, pointed out that this causes a bunching of turnover below the threshold because small businesses are reluctant to go over it. This limits both their growth as well as the economy’s.
Tax Policy Associates, run by Dan Neidle who helped expose Nadhim Zhawi’s tax activities, suggests that this cliff edge be replaced with a gradual increase in VAT eligibility. This would start at a lower rate, and have a lower turnover. The people will have their own ideas on how to go about it, as well as any other areas in our tax system that need reform.
According to reports, “sources close the chancellor” claim that Sunak’s 5p per litre reduction in fuel duty is one of his budget priorities. This is an odd thing to do except when you consider the Tory backbenchers who also want other tax cuts. Petrol prices are now 14p per litre lower than they were in March last year. It is not the same as meaningful reform. According to the Social Market Foundation, it is “a reckless use of public money”. Tax reform is needed, not unnecessary gimmicks.
Friday at 7am is a significant moment in the economy’s calendar. It happens once per month. The monthly GDP figures are published at this time. We also had figures for the entire of 2022 and the fourth quarter at the latest for December.
It would be hard to believe that there was zero growth in quarterly figures. This meant that after the economy contracted in its third quarter, the UK avoided a “technical recession” of two consecutive quarters of falling GDP. The economy grew by 4% last year was something that the chancellor could also celebrate.
Each of these need some context. Most economists hate the two-quarter definition. It was created in America in 1960s for political convenience, but it is not widely used. You might be able to tell the difference between an economy that shrinks by 0.1% in two consecutive quarters and one that falls by 5% in one quarter.
If you don’t believe that 4 percent growth felt like it, then you are wrong. The comparison of the first quarter last year and the lockdown-affected second quarter 2021 explains almost all of the 4 percent. The year saw a decline in growth, with December’s GDP slightly lower than December 2021. The economy basically stagnated throughout the year. The economy will continue to stagnate, although the debate over a “technical recession” will continue for several months.
It is important to note that there was some positive news in GDP numbers — a welcomed 4.8 percent increase in business investments in the fourth quarter which brought it back to pre-pandemic levels. Its weakness has been a problem so it is encouraging to see some signs of life in business investment ahead of the April increase of corporation tax. Trade was also a problem, but that is another topic.