Which taxes should go up?

by Ed Bowsher on 15 September 2009  |  14 comments
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Nobody likes tax rises. But the rotten state of the government's finances mean that rises are almost inevitable. I thought I'd run through some of the obvious tax-raising options for the next government.

The UK government's public spending deficit is forecast to reach £175 billion this year. That's a very chunky number given that total public spending will be £661 billion.

Just about everyone agrees that we can't carry on with such a big deficit forever. The only question is whether we start trying to cut that deficit now or wait a couple of years.

My view is that we should wait. If we increase taxes now - or cut spending - we risk choking off our nascent economic recovery. And a struggling economy will produce less tax revenue for the government.

But there's a good chance that we'll be in full recovery mode by 2011. That economic recovery will automatically go some way towards reducing the deficit as tax revenue rises and the government's social security bill falls.

But the growth dividend won't be enough. Our next government will have to go further. It will either have to raise taxes or cut spending. I reckon the government will need to find at least £25 billion a year. Probably more.

So what it should do?

Well, I've been reading an interesting report by accountants BDO Stoy Hayward called Time to break the silence? 

The report highlights a range of options for tax increases and also estimates how much revenue these tax hikes might raise. I thought I'd go through some of these rises and give my view.

1.       Do not increase income tax allowances in line with inflation

This is a classic 'steath tax.' The headlines say that the basic rate of income tax is staying at 20%, but once you take rising prices into account, you're paying more tax.

BDO Stoy Hayward reckons it would raise £5 billion a year although that would depend on the level of inflation at the time.

Politicians are always drawn to this one thanks to its stealth element. I dislike it for the same reason. Another minus point is that it hits lower earners especially hard. In the current tax year, the personal allowance is £6,475. If you're only earning £12,000 a year, and inflation is at 5%, no increase in the personal allowance would make a big difference to your spending power.

2.       Increase alcohol and tobacco duties by 12% above inflation

Chancellors love to push up the price of cigarettes but surprisingly this one would only raise £1 billion. But I'd do it nonetheless. These are taxes that people can avoid if they wish. I'm also a killjoy.

3.       Abolish all higher rate income tax relief on pension contributions

This would raise £6 billion. It's a tempting one to go for as it doesn't hit the poor. On the other hand, it's really important that we all save for our pensions, and it's also important that the pensions system is simple.

The government's recent move to reduce pensions tax relief for people earning over £150,000 has already complicated matters for some taxpayers. Let's not make things confusing for a larger section of the population.

4.       Increase VAT on domestic fuel

In other words, increase VAT on gas and electricity from 5% to 17.5%. This would raise £3 billion.

This particularly appeals to me as I'm a bit of a green.

The downside is that this will hit some pensioners hard, but the government could always increase the winter fuel allowance as compensation. That, of course, would partially reduce the tax gain. Let's increase the winter fuel allowance by £1 billion and get a net gain of £2 billion from increasing VAT on domestic fuel.

5.       Increase VAT to 20%

This would raise around £12 billion.

There's a sound economic case for this rise. The theory is that it's better to raise revenue by increasing VAT rather than by raising income tax. That's because higher income tax discourages enterprise and hard work whereas higher VAT discourages consumption. And discouraging consumption is often a good thing - especially if the economy is doing well.

But if I were Chancellor, I wouldn't do this. I've already increased VAT on fuel. To push up general VAT as well would be too harsh.

6.       Increase basic rate of income tax to 22p

Yes, an increase in income tax is a disincentive for work.

But there's also a simple honesty about increasing the basic rate. What's more, although it's a tax rise that will hit most of the population, those on the lowest incomes won't suffer as much. That's because a big chunk of their earnings aren't subject to income tax thanks to the personal allowance.

Using Treasury figures, this should raise about £7.5 billion a year.

So I've gone for 3 tax rises:

-          Increase income tax basic rate to 22% (£7.5 billion)

-          Increase VAT on gas and electricity to 17.5%, but also raise winter fuel allowance (£2 billion)

-          Increase duties on cigarettes and alcohol by 12% more than inflation. (£1 billion)

Altogether this will raise £10.5 billion. That's not enough. So I'm going to have to cut expenditure too. I'll write another blog this week that will look at some of the options for cuts.

Do you disagree with my views? Write a comment below and let me know what you think.

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