An era of low taxes is coming to an end and people in the UK will have to get used to paying much higher levels for decades to come, the head of a leading UK economic research institute in the UK has told i.
A struggling economy combined with an unwillingness to see a wide variety of publicly funded services or political commitments axed means the Government has few options left to slash taxes, said Paul Johnson, of the Institute of Fiscal Studies.
He said the UK is likely to see taxes rise to a record high over the next two years and from then on such levels will “be permanent”. They will not change after that, he believes, for at least 30 years.
The tax-to-GDP ratio is the most common way of gauging how much tax is paid. Having remained stable for the past 40 years – between 30 and 32 per cent of our GDP – it is now 33.5 per cent and by April 2025, will hit 37.5 per cent according to projections by the Office of Budget Responsibility (OBR).
“Within a couple of years, taxes will be at a record high. With corporation tax and income tax going up so much – and the economy growing so poorly – it is a big and quick change,” he said. “My impression is that neither the electorate nor the government… can see acceptable ways of significantly cutting spending. And if we’re not going to, this shift up in tax… is something that will be permanent.
“It’s one of those difficult things that politicians find hard to talk about. Everyone wants better public services… they also want low tax. We could renege on our commitments to Nato and cut defense spending significantly. We could decide to shift up the state pension age, or cut the state pension… but I don’t detect a public appetite for these things.”
Johnson, who before heading up the IFS worked as director of public spending at the Treasury, also discusses, in his interview with i, other big issues that Hunt and Sunak have had to wrestle with for the Budget.
These include why the Chancellor is able to find £6bn to give to motorists but not for striking public sector workers, what the economy needs from any future Brexit renegotiations and migration, and how Hunt can help reverse the long-term trend of working younger people paying to maintain the lifestyle of older voters.
Here he answers i‘s questions about the Budget:
Could Hunt lower taxes on Wednesday if he wanted to?
The public finances will look better than projected in November, but they are still going to look much worse than a year ago.
OBR is likely to say that UK finances will still be pretty difficult in the medium term.
Unfreezing tax thresholds is also unlikely because it’s a politically easy way of raising a lot of money and much easier to do than increasing rates. One of the reasons household incomes are going to fall over the coming year is related to the freezing of these thresholds.
Will Rishi Sunak meet his target to halve inflation this year?
When he says it’s his inflation target, it is actually a repeat of the Bank of England’s forecast.
The Bank currently thinks inflation will come down over this year and I’ve got no reason to disagree. Of course, who knows what is going to happen to energy prices, but my expectation is that it will halve.
He won’t achieve it, but it will happen… but not through any work of his own.
How badly have younger people been hit by the downturn?
The first few months of autumn 2020 look catastrophic for young people entering the labour market. But it’s not turned out like that. They’ve not actually done worse than others, partly because they’ve got such a tight labour market [unemployment so low].
It’s a very strange downturn… contrary to a lot of previous recessions, this may not turn out to be worse for younger people than for others.
How will we get the over-50s back to work?
On Wednesday the Government might look at some of the rules around pension tax, although I think that’s a pretty small part of the picture and I can’t imagine [these changes] will be massively effective at reversing the trend.
To the extent that it’s about people voluntarily retiring, because they can retire early, it’s hard to know how to undo that.
It has been suggested that the lifetime allowance [the amount you can save tax-free, currently set at £1.07m] will be increased, but I don’t think there’s any evidence that this is a big issue other than for a small number of highly-paid doctors and a few other people in the public sector.
One question is whether it is this particular generation of people who were affected by Covid who are leaving – and whether the next generation will return to the pre-Covid trend [of retiring at the usual age].
The second question is: for those who have just left the workforce, is there a way of getting them back? At the moment, we are completely in the dark on this issue.
Should we renegotiate Brexit?
In terms of the growth of the economy, getting as close as we can to the European single market is really quite important. I don’t have any sense of what’s feasible, but we do know that more closeness would be beneficial.
Should we encourage immigration for the health of the economy?
Bringing people in from elsewhere is effective [for growing the economy]… and it’s a route that a lot of countries are using. But equally, there are trade-offs: open borders have significant political consequences.
My view is that, in the long run, surviving without high levels of immigration is something that we probably want to try to achieve. But there are gaps in the social care and health workforce, which we can’t fill locally, and some sort of higher immigration may be the only way through.
Are younger people unfairly paying for retiree’s lifestyles?
We’ve had a long period where younger people have done less well than older people.
Part of the problem has been that the monetary policy over the last 15 years, like low interest rates, has pushed up asset prices and the value of housing and pensions and so on. This has made it more difficult for younger people to buy houses and made it more difficult for them to save in pensions.
At the same time, fiscal policies have lent in the same direction, by protecting pensions and health at the expense of education and working-age welfare benefits. And if you graduated after 2012, you have a chunky extra 9 per cent of your income to pay in student loan repayments on top of what you are already paying in income tax.
I’ve got a lot of sympathy with younger generations here, but one shouldn’t look to address what is a big generational thing in a single Budget. But it needs to be addressed over time.
I hope interest rates do stay around 3 per cent rather than go back down to half a per cent for this reason.
Other things that will help are changing planning rules, which this government seems to find it very difficult to do, and building houses. This has been a sort of 20-year trend, and it will take a long period of policy and economic change to really change.
Did the Bank of England anticipate inflation early enough?
Coming out of Covid, we got everything wrong. In 2020, everyone really would have thought we had two main problems: unemployment, and that young people in the labour market were going to be in trouble. Well, it turned out that unemployment was not the problem, but inflation.
No one, I don’t think, predicted this big withdrawal of older people from the labour market. It has been been interesting how differently things have played out compared with what most people were projecting back in 2020 and 2021.
Only a small number of people were worried about inflation, and I think with hindsight, the degree of monetary loosening – quantitative easing – that we saw during Covid probably wasn’t necessary.
And again, with hindsight – and this is the sort of thing that some of us were a bit worried about – the the length and scale of it may have been, you know, more than was optimal.
But I don’t think that necessarily means that the policy was wrong at the time, given that they gave the given the risks in the other direction.
So it’s not surprising, given that we never experienced anything like that before, that some of the consequences were unexpected.
What will happen to fuel duty?
There’s a big choice to make about fuel duty – much bigger than usual – as public finance calculations have assumed that fuel duty will go up in line with inflation, and that the five pence in the litre reduction [introduced a year ago] will be reversed.
And if that doesn’t happen, it will cost the chancellor £6bn.
And I’ll certainly be asking the question: if he can find £6bn for that, why can’t we find it for public sector workers?