Policy is about to change substantially once more. After nine years of the austerity pattern set by George Osborne and Philip Hammond, a new Chancellor of the Exchequer is likely to set a new course as early as the autumn budget.
The reasons for this change are several. First of all, the government has succeeded in bringing the deficit as a percentage of GDP down from 10% in 2010 to about 1% in 2019. Moreover, the current deficit is less than the amount spent by the government on capital investment. In essence the government is more than covering its day-to-day expenditure with the taxes that it raises. The debt is being used to fund capital formation and thus increasing the assets of the government. The debt which has been accumulated is also falling as a percentage of GDP and is due to fall every year.
This success leaves some fiscal headroom in terms of being able to either reduce taxes or increase public spending or a combination of the two. The likelihood is that as ever there will be a combination of the two.
Secondly there is a belief that the UK needs to reinforce its attractiveness as a destination for foreign investment by cutting taxes in a post BREXIT era.
With regards to taxation there are a number of proposals for tax cuts which have been proposed by the candidates for Prime Minister. Some of the justification for tax cuts has been found in the arguments used by Art Laffer and his eponymous curve. The theory is that you raise no taxes at 0 %but you also raise next to no taxes at 100% percent and therefore it is important to find the “sweet spot” at which it is most efficient to maintain rates of tax. The theory goes on to propose that lowering the rate of most taxes whilst reducing allowances will lead to higher government revenues through increased business activity and changes in taxpayer behaviour.
It is common ground that taxation does reduce economic activity in the area in which it is levied. However, any government has to balance that with the need to raise revenues to fund public services. Finding the optimum rate of tax for a particular impost is a matter of art rather than science. Moreover, that optimal rate would change according to the world economic conditions.
In the 1960s and 1970s both corporate and personal rates were generally very high across the Western world. The highest rate of corporation tax of 52% in the UK and the top rate of personal tax was 98%. The reduction in those rates in the 1980s to 35% corporate tax and 40% income tax actually increased revenues because it changed taxpayer’s behaviour and make the UK more competitive. Many other countries have since reformed their tax systems to reduce their rates of tax whilst also increasing their tax base by reducing allowances.
We are seeing at the moment a further round of corporate tax rate reductions either planned or implemented across the developed world. The UK is planning to reduce CT rates from 2020 to 17% and it is quite possible that there would be a move to reduce it further to 12 .5% to match
that of the Republic of Ireland. This proposal is designed to attract companies to invest in the UK and also to source their proper income there. The 12.5% corporate tax rate has been a major contributor to Ireland’s successful economy. Some argue it would do the same for the UK.
Stamp Duty is another area where proponents of the Laffer curve would say that the rate has been raised to the level which is inhibiting property transactions and is probably reducing the amount of revenues which the government receives. A cut in Stamp Duty Land Tax may free up the London property market and would lead to more transactions and therefore higher revenues.
Other changes such as the increase in higher rate threshold to say £80,000 over a period of time are less likely to result in counterbalancing revenues. One of the substantial issues with increasing the higher rate tax band is the accompanying increase in the national insurance upper earnings limit. Accordingly, half the benefit of the increase in the tax threshold would be absorbed by the NIC rise. However, those who do not pay UK national insurance would see the full advantage of this change, notably those who are above the state pension age.
It has been argued by proponents of lower flatter taxes that the consequential economic changes mean that the loss revenues are recouped because of greater economic activity. The experience of the Reagan years in the United States, 1980-1988 is that there is normally still a hole left in the budget as a result of the tax cuts and eventually this needs to be filled in other ways. This would indeed seem to be the case where there are across-the-board tax cuts.
However, the experience of corporate tax in the UK has been that the drop in CT rates to 19% accompanied by a restriction on allowances has seen increasing corporate tax receipts. The likelihood is that cuts in stamp duty on a targeted basis could have the same effect. We may see a debate about which taxes have a disproportionately adverse effect on the workings of the economy and may see action in the next Budget which radically strikes out in a new direction.
Primondell is running a number of courses in the Autumn on the economic and tax outlook for the UK in the post BREXIT era.