Chancellor Rachel Reeves is having to consider a host of different ways to boost the Treasury’s coffers – so just what are her options?
Rachel Reeves’ “dream job” of becoming Chancellor must fast be feeling like a nightmare.
Saddled with an eye-watering national debt, left to clear up the mess from the Tories and 15 years of pitiful economy growth, and hemmed in on all sides, she and Labour have a battle on their hands after the first year back in office.
To hammer it home, the Office for Budget Responsibility recently published its doom-laden summing-up of the country’s plight, which included warning from its boss Richard Hughes that: “The UK cannot afford the array of promises that are displayed to the public.” It further fuelled talk of tax rises in the Autumn Budget, with the debate set to rage.
Labour is sticking with its manifesto pledge to not raise income tax, national insurance contributions, and VAT – which together account for two-thirds – of all tax collected. So just what is the state of the country’s finances, and what options does the Chancellor have to boost the coffers?
The problem
The numbers are almost unfathomable. Take how much the UK owes – public sector net debt – at more than £2.8trillion. That is almost as big as what the UK churns out a year – gross domestic product – at 96.4%, the highest level barring the Covid pandemic since 1963.
With borrowing soaring, so is the interest racked-up on the nation’s credit card. The OBR predicts we will shell out £111billion on debt interest alone this year, around half the NHS’s entire annual budget. One reason is the rates the UK has to borrow – among the highest for any major economy – and more than double Germany’s. Shelling out that much means less for the government to spend on essential services. And with outlays outstripping tax income, that means still higher borrowing.
Income tax
One option is extending the freeze at which income tax and national insurance kicks in.
By 2028/29, it is set to mean 4.2 million more people paying income tax, 3.5 million the higher rate of 40%, and another 600,000 the higher still 45% band. Ms Reeves has previously ruled extending the freeze beyond April 2028 because it would “hurt working people”. The Institute for Fiscal Studies (IFS) says pushing it back to the end of parliament would raise up to £10billion.
James Smith, an economist at ING Bank, said: “The only obvious piece of low hanging fruit is to extend the tax threshold freeze.”
But dragging even more people into paying tax – or the higher band – would be controversial. Another option is raising the 45% rate to 50%. Paul Johnson, until recently head of the IFS, warned there was “real uncertainty” about how much it would raise.
Wealth tax
Former Labour leader Lord Kinnock recently reignited the debate over a wealth tax by suggesting a 2% levy on assets of above £10million would bring in up to £11billion a year. Downing Street fuelled speculation by not ruling it out.
A wealth tax has overwhelming public support but experts say it is devilishly hard to implement, as other countries have found. “The top 1% of income taxpayers are paying about 30% of income tax,” Paul Johnson told The Rest Is Money podcast.
Critics also argue it will drive the super wealthy away – something campaigners reject. Other options could include the effective 60% tax band on incomes between £100,000 and £125,140.
But a far more radical route would be overhauling the council tax system. Mr Johnson said: “A £50million mansion in Westminster pays about the same council tax as a three-bed semi in Hartlepool. It is utterly outrageous.” It would be game-changer but there is a reason successive government have dodged reform. As well as being time consuming, it’s home owners in property pricey southern England who would likely come off worse.
Pensions
Taxing pensions is “where you can get really serious money,” is Paul Johnson’s view, but he warned doing so would be “terrible idea”.
There was speculation ahead of the last Autumn Budget about the amount that people could take tax-free from their pension. In the end, nothing changed, but reports suggest it spooked a flood of people to rush to withdraw savings.
A more targeted move could be to cut the upfront tax relief on pension contributions for higher rate taxpayers. Limiting it could raise £15billion a year, say reports, but may also hit middle income workers, including some teachers, nurses and other public sector staff. Labour will also be conscious of not doing anything that deters ordinary people saving for their retirement.
One big outlay for the government that looks unlikely to change is the “triple lock” pledge, the promise that the state pension will rise every year by average wages, inflation or 2.5% – whichever is higher.
Fuel duty
The levy on petrol and diesel used to rise in line with inflation but was frozen in 2011. Successive government maintained the freeze, and the Tories announces a supposed temporary 5p cut in 2022 – that stayed.
Fuel duty is set to bring in £24.4billion for the Treasury this year, equivalent to £850 per household. But the Social Market Foundation estimates maintaining the freeze has deprived the exchequer of about £130billion.
Changing the duty – even ending the 5p cut – risks backfiring on the government, given the hit to ordinary drivers. But encouraging motorists to switch to electric cars – the government unveiled taxpayer-funded grants of up to £3,750 this week – mean the tax take from duty is likely to fall.
Businesses
Labour suffered a backlash from firms when it hiked employers’ national insurance in April, in a move designed to raise £25billion a year. Business lobby groups have already warned against using the next Budget to unleash another raid.
Corporation tax generates a lot for the Treasury, but Labour has pledged to cap the headline rate at 25% for the lifetime of the this Parliament. It could look at tinkering with other levies, including the bank levy and surcharge. But the Chancellor will be keen to not do anything that will further hit growth.
As Helen Miller, the new director of the IFS, said this week: “I think growth should be the number one mission. We should be throwing the kitchen sink at it”, as she questioned whether Labour was doing enough on that front.
