In the run-up to 3 March Budget, there’s been a great deal of speculation about whether taxes would rise; by how much and which areas would be targeted. It is always a difficult challenge to raise revenues. In particular, raising taxes further when they sit at a 70-year high, has economic consequences as well as political ones.
Whilst not all taxes are equally damaging to the economy, is fair to say that adding additional tax burdens, when taxes are high and the economy is fragile, may backfire.
My attention was drawn to the latest proposals for funding social care, which might involve a further increase in national insurance contributions. The challenge with this is that when an employee’s earnings exceed £12,500, they are already faced with 20% income tax; 12% national insurance and 4% auto enrolment contributions (net of 1% rebate). This marginal rate of effectively 36% is already uncomfortably high. When one considers the impact of non-deductible expenses that most employees face; travel clothing etc, then an increase in either the basic rate of tax or national insurance is likely to erode work incentives.
This does not mean that the areas where the government is intending to spend money such as extra amounts for the National Health Service and social care are not necessary. What it does mean is that the government does face a real risk that higher taxes will damage incentives and therefore stymie economic growth. It is of course economic growth that is most likely to provide additional tax revenues.
The Chancellor does therefore need to pursue a very fine balancing act between the need to assure the financial markets that he will bring the finances back into balance and avoid strangling a nascent economic recovery with higher taxes that reduce incentives to work. Not an easy task.
