Tax is rising – but future cuts will happen, emphasises Chancellor

He also agreed with an assessment that “cutting tax matters so much that you are going to bake it in now and defend that position, and when the pressure for further fiscal measures that need to be taken in one direction or another come further down the line, you will hang on to that bit of it, and the pressure will therefore fall on spending”.

The committee took evidence on tax changes, other Spring Statement measures and wider economic issues, during three sessions this week. The first features representatives of the Office for Budget Responsibility, the second the Chancellor and a senior Treasury official, and the third (for which a transcript is not yet available) economists from the Institute for Fiscal Studies, Institute for Government and Resolution Foundation.

Session One: Office for Budget Responsibility – Monday 28 March (am)

Witnesses:

Richard Hughes, Chair at Office for Budget Responsibility

Andy King, Member of the Budget Responsibility Committee at Office for Budget Responsibility (leads on fiscal issues at OBR)

Professor David Miles CBE, Member of the Budget Responsibility Committee at Office for Budget Responsibility (leads on economic issues at OBR)

Fiscal headroom

In response to a question from committee chair Mel Stride, Richard Hughes explained the impact of changes to economic forecasts on the public finances:

“If you look at the headroom [the Chancellor] had against his target to balance the current budget by 2024-25, the amount that he had when we did our forecast back in October was around £25 billion—about 1% of GDP. Since then we have done a new forecast, produced last week, which gave him a £35 billion receipts windfall. Most of that came from income tax—about two thirds of it—and also from higher corporation tax.

“He got a £35 billion receipts windfall to add to that £25 billion, but it is important to bear in mind that inflation is good for receipts, but it also puts pressure on public spending, so he lost about two thirds of that receipts windfall—about £20 billion out of the £35 billion windfall—from higher spending, including on debt interest costs. Index-linked debt as well as conventional interest rates went up, and that consumed some of the higher spending. Welfare benefits are also linked to inflation; that consumed some of that receipts windfall as well. That left him with a net improvement in his headroom of around £15 billion to get the current budget balanced by 2024-25, taking the grand total to about £40 billion worth of headroom.”

Hughes said that at the Spring Statement the Chancellor spent about £10 billion of that headroom on cutting the basic rate of income tax by 1p from 20% to 19%, in addition to delivering more temporary support, which does not really affect the amount of medium term headroom. He banked the remaining £5 billion increasing his headroom against his fiscal rules from £25 billion in October to £30 billion now. He called this “a relatively modest amount of headroom” given levels of uncertainty.

Tax cuts – or not?

The Chancellor said that this was a tax-cutting fiscal event but the OBR’s analysis shows that the UK’s tax burden has gone up. Can you explain what has been going on, asked Dame Angela Eagle.

Richard Hughes replied that this was a tax-cutting fiscal event, but you have to put it into the context of all the Chancellor’s decisions on tax since he came to office: “If you put the 1p cut to the basic rate of income tax by the mid-2020s in context, that undoes about one sixth of the total tax rises that this Chancellor has introduced since coming into office.”

Eagle noted that the Institute for Fiscal Studies (IFS) has shown that because the income tax threshold is being frozen the tax yield for income tax is continuing to rise, even in the year in which the income tax rate cut comes into effect. “Even when the 1p cut comes in, the yield from income tax continues to rise. Can this, therefore, in any way be expressed as a tax cut?”

Hughes said that, looking at personal taxes alone, the 1p cut to the basic rate of income tax reduces the overall rise in personal taxes by about a quarter. Freezing of the personal allowances for income tax and national insurance (NI), especially in the context of higher inflation, is bringing millions of people more into the tax system through fiscal drag, he said. “Overall, personal taxes are going up,” he concluded.

Health and social care levy

The OBR told MPs that the expected tax take from the health and social care levy had been increased, despite the increase to its threshold, along with that for NI.

Andy King explained that the NI threshold change cost about £500 million to £600 million a year in terms of the health and social care levy itself. But the OBR have revised up tax forecasts in general, largely because of a higher outlook for wages and salaries in cash terms. “The forecast revenue from the health and social care levy prior to the national insurance measure had been revised up around £700 million to £800 million a year. Actually, in net terms, we have revised it up.”

The committee also explored what the hypothecation of the levy actually means.

King explained that the levy “obviously raises much less money than is spent on the NHS in total. The hypothecation is not in legislation. It does not flow from one's tax payment to the NHS. It goes via the general fund like everything else. The NHS budgets were not changed in the Spring Statement. In effect, other sources of funding are modestly lower.”

Could we just have borrowed for the increased spending on the health service and social care, asked Kevin Hollinrake.

“If the country wants the health service that it is being promised by this Government, it has to pay for it somehow in the long run,” said Richard Hughes. “To allow debt to accumulate forever to pay for a health service that you are not funding out of annual tax revenue is going to get you into trouble at some point.”

What kind of trouble, asked Hollinrake. “At some point markets take a look at your debt as an investable proposition and worry at some point about whether you are going to be able to pay it back,” replied Hughes.

Business investment incentives

Kevin Hollinrake asked whether the super-deduction was working in terms of bringing forward business investment.

Professor Miles said the OBR’s prediction for this year is that investment will grow pretty strongly, at about 10.5%, though that is less than they thought back in October. However, he added, as you get nearer to the end of the super-deduction, companies’ ability to bring stuff forward is eroded. “What we have done in this forecast is reduce a bit the investment that we thought was going to be brought forward. You do not lose that forever, because you get slightly stronger investment in the years after the super-deduction finishes, because we assume that it did not get brought forward. We have weaker investment this year, but it is actually a bit stronger in 2024 and 2025.”

Hollinrake asked what the increase in corporation tax will do to investment. Miles said there would probably be a net increase in the rate of return you would need to get, but it depends a bit on the mix of funding that companies use for investments. Being able to deduct interest payments on debt against corporation tax cushions the impact of a higher corporation tax rate on the incentive to invest. Conclusion? “My guess is that having higher corporation tax is a marginal negative.”

Hollinrake explored possible non-tax causes of low business investment in the UK before returning to whether levers such as cutting or reforming taxes would make a difference. “The super-deduction was supposed to do this, but the indication is that it has not been massively successful for various reasons, not least because of the pandemic and other things. Are there levers that we should be reaching for?”

Miles said he was sure there are levers but they all come at some cost and impacts are unclear. Richard Hughes emphasised workforce skills: “If you unleash a new piece of equipment on an unsuspecting workforce, they will struggle to make good use of it. Empirical evidence shows that investment is higher in countries that have higher workforce skill levels, because they are able to use it productively.”

“If the super-deduction had a greater lifespan, if it was a less generous super-deduction, say there were a 100% tax break on it but it was over 10 years, would that bring forward business investment or stimulate business investment over that cycle and over that period,” asked Hollinrake.

“The real challenge with business investment at the moment is the uncertainty created by other factors,” said Hughes. “It may have been the case that, if you gave a longer window, you would have had a longer period to bring forward investment into it, but, given the uncertainty and shocks we have faced since that policy was introduced, I am not sure it necessarily would have implied that in practice you would have seen more investment now.”

Asked about the employment allowance, Andy King said that very small companies account for a very small share of whole-economy investment. However he noted that the capital allowances regime has changed very frequently, “particularly annual investment allowance, where the limit has moved dramatically up and down and been extended and so on. In recent years, it has been the case that there is a degree of an uncertainty over the tax system itself.”

King noted that the low investment rate is common to business investment, residential investment and, until very recently, public investment. He suspects that the planning system is something that affects all three types of investment in the UK but not other countries.

King would not be drawn on whether the annual investment allowance should be at a consistent level for longer, but noted that the CBI has put the case for more stability.

Other issues

Gareth Davies asked whether a cut in VAT would be inflationary. Professor Miles said a cut in VAT would have a material impact on the inflation rate, but the question is what else you would change if you were to cut the VAT rate.

Responding to Harriett Baldwin, Andy King said the assumption for 2023’s pension increase, based on a return to the triple lock, is it would be 7.5 per cent, as that is the inflation forecast for September.

Alison Thewliss asked about tax receipts from the dramatic increase in oil and gas prices. North Sea oil receipts go up from £3.1 billion to £7.8 billion, she noted. Richard Hughes acknowledged that, saying it was because North Sea oil companies are making more profits as a result of the higher oil and gas prices. But the OBR have it falling back to about £5 billion the year after and then it is between £2.5 billion and £3 billion in the medium term.

Questioning of the OBR also explored falling living standards, energy prices and below-inflation benefit increases, among other issues.

You can read the full transcript here.

Session Two: The Treasury – Monday 28 March (pm)

Witnesses:

Rt Hon Rishi Sunak MP, Chancellor of the Exchequer

Dan York-Smith, Director, Strategy, Planning and Budget at HM Treasury

Fiscal headroom

The Chancellor agreed that the Treasury’s fiscal headroom could be wiped out by a move of just one per cent in interest rates, during a testy evidence session.

Committee chair Mel Stride asked him why he took the decision to cut income tax in 2024 at this point: “Why did you bake that into the numbers now rather than, say, not do that and increase the headroom to see how things go, and then if it was prudent to cut tax a bit further down the line, do it then?”

The Chancellor replied that, in the autumn he had said ‘very clearly’ that the direction of travel on tax would be for reductions going forward: “I set out that direction of travel in the autumn Budget, and we have fleshed that out in this Budget because it is good to give people a sense of direction and a plan for where we are trying to head. Also, it is helpful because it creates a discipline that is very beneficial.”

Stride asked whether that should be interpreted as saying that “cutting tax matters so much that you are going to bake it in now and defend that position, and when the pressure for further fiscal measures that need to be taken in one direction or another come further down the line, you will hang on to that bit of it, and the pressure will therefore fall on spending, and maybe your fiscal targets as well? You have really put a stake in the ground that you are going to defend at all costs. Is that what it is effectively about?”

The Chancellor said that that was a fair summary with one exception: he would not sacrifice a fiscal target.

Tax fairness and progressivity

Mel Stride also asked the Chancellor how progressive the tax rises that he has brought in across his period as Chancellor are, and how progressive the tax reductions announced in the spring statement are.

The Chancellor said he was ‘very confident’ the measures are fair and progressive. “If you look at the two measures that were announced and legislated for in the 2021 spring Budget, which are the two measures that largely solve the problem of coronavirus on our public finances, one was a rise in the corporation tax rate, so large companies that are profitable will pay more in corporation tax.”

The other measure, said Rishi Sunak, “was freezing the income tax personal allowances, which was widely recommended by a range of different people as being a progressive way to raise money. Just by the nature of the income tax system, which is progressive, obviously freezing thresholds raises more money from those on higher incomes. It also does so in a way that supports the recovery, because it builds over time, and of course people are not cash losers from that, because it is about a threshold increase rather than taking cash out of people’s pockets. Those two measures, I think, are progressive.”

Turning to the health and social care levy, he said there were three ways you could have raised that amount of money sustainably: “one is VAT, one is national insurance, and one is income tax. Of those three, VAT is the least progressive, so the choice was left between income tax and national insurance.

“People will have their view as to which one of those would have been the better base for the levy… [T]here are reasons why income tax is progressive—potentially more progressive than national insurance—but there are other downsides of income tax, as well… not least that it is not a UK-wide tax in the same way anymore, businesses do not contribute to it directly in the same way, and there is no history in this country of operational or other hypothecation of that tax to the health service in the way there is with national insurance. But no one can say that national insurance is not a progressive way to raise that money. The top 15% of NICs payers will contribute over half the revenues from that levy.”

In terms of the tax cuts, the Chancellor continued, the raise in the NI threshold was described when it was announced in the election campaign as the best way to help low and middle earners through the tax system. “[S]o do I think the tax cuts we are doing are progressive? Yes, I do.” He added that cutting the taper rate in universal credit was also ‘a £2 billion tax cut’ that disproportionately benefits those on the absolute lowest incomes.

The tax cutting Chancellor?

Angela Eagle (photographed below thanks to Parliament UK) took exception to the Chancellor’s claim to have cut taxes for people in work: “Chancellor, you have increased taxes for people in work. Seven out of eight people in work have a higher tax burden this year. The tax burden is higher at the end of what you’ve done than it was before.”

The Chancellor responded that because of the increase in the NICS personal threshold, 70% of NICS payers will pay less tax than they would otherwise.

“I am talking about your entire period as Chancellor,” Eagle replied. “You cannot talk, Chancellor, about only one side of this equation and expect everybody to be fooled by the distorted view that that gives of the tax burden. The fact is that the tax burden is going up. It was going up before the spring statement and it is going up after the spring statement, is it not?”

“I completely accept that,” the Chancellor replied. “I am not remotely saying that that is not happening. I also confirmed that that is a progressive thing to do.”

Eagle: “Chancellor, you style yourself as a tax-cutting Chancellor, but you are not, are you?”

Chancellor: “I have not actually said that… Given the damage that the pandemic has done and the desire to continue investing in more nurses, greater social care, more police on the street and levelling up, the choice we had was either to cut public spending significantly or to continue delivering on our plans to improve people’s quality of life through all of those things, but to make sure that it is paid for as we continue to get our borrowing under control to a level that I believe is responsible. That is why the tax burden is going up.”

Siobhain McDonagh also challenged the Chancellor on tax increases later in the session, labelling him a ‘fiscal illusionist’ and saying that when you add up all the proposed tax increases and subtract the planned cuts, the net result is a 3.3% rise in the tax to GDP ratio between 2019-20 and 2026-27.

Increasing national insurance

Anthony Browne asked the Chancellor why he had not acceded to calls to delay or scrap the NI increase.

Rishi Sunak replied that this was because (a) the country’s No. 1 priority (the NHS, with social care alongside it) should have a dedicated source of funding so that we can be confident about its future and make sure that it has the funding it needs going forward, and (b) because it is so progressive that the majority of the benefit of scrapping it would accrue to the top 15% of taxpayers.

Browne asked whether the NI and income tax thresholds would be kept together in future. Sunak described the equalisation of the thresholds as a simplification, implying this would be so, but did not answer directly.

Fuel duty and VAT on energy saving materials

Anthony Browne also asked about the cut in fuel duty. Rishi Sunak denied it would compromise the Government’s net zero target.

Browne observed that the RAC had said that it would have been a lot more progressive to cut VAT, rather than duty, because it is charged at the petrol pump. Why had the Chancellor not done that?

Sunak replied that: “Fuel duty is something that we do, and we have done in the past. It is administratively easier, because it is done at distribution point, rather than at retail.”

Dan York-Smith added that cutting VAT over fuel duty would not benefit businesses, because businesses are able to reclaim their VAT. About 40% of the overall impact on fuel duty is on business, said the Chancellor.

Browne suggested that after 11 Budgets without taking the fuel duty escalator it seems “a bit of a fiscal fiction to keep saying you are going to do it, and to cost it every year, and then not actually do it”. Sunak said it was scored (costed) because it remains the legislative default, but he did not challenge Browne’s premise.

Turning to the scrapping of VAT on energy efficiency materials such as solar panels, heat pumps and insulation, Browne welcomed this, but asked whether a distributional analysis had been done, as “only people who can afford solar panels and heat pumps will benefit”.

The Chancellor thought that was ‘fair’ (presumably referring to Browne’s assessment though he might have meant the policy itself). “You are right that they are not cheap in the first place, but they save you about £300 on average on your bills every year thereafter, so there is a reasonable payback period.”

Other issues

On Brexit and trade Mel Stride noted that there had been, as predicted, a slump in our trade with the EU when the pandemic/Brexit struck. “The other countries have now come back up quite strongly, but we have stayed down. Does that not tell you that the main distinction between ourselves and them is that we went through Brexit and they did not?” The Chancellor said that might be the case but it was too early to be definitive about it.

Emma Hardy (photographed below thanks to Parliament UK) asked if the Chancellor could make it possible for someone not earning enough to pay tax to be able to gift aid their Ukraine relief donations (and, it appeared, others they were collecting). Sunak said there is an existing small donations gift aid rebate scheme that works on a charity basis. Would it work in this case? He would get back to her.

Gareth Davies said the UK has one of the most generous R&D tax credits in the world but one of the lowest R&D investment levels. Is that something the Chancellor is looking at? Sunak acknowledged that we are less than half the OECD average for business self-financed R&D investment. “Something in that system is not working, because we are not getting value for the taxpayer pounds that we are spending. We are going to look at that, reform it and, in the autumn, come up with what the solution should be, to take effect in the spring and help drive up that number.”

Kevin Hollinrake claimed there are two measures preventing investment: (1) If you invest in plant and machinery, your business rates go up. (2) The high level of the UK VAT threshold, which lots of businesses stay below deliberately. Should we look at these?

The Chancellor replied that for businesses that invest in plant and machinery, there are two reliefs to discount their business rates bill—one is an improvement relief (being consulted on), the other is a green relief (already happening). On the VAT threshold the Chancellor noted that it is frozen for the next few years in flat terms.

Other issues the Chancellor was questioned on included increases to benefits, whether he is doing enough to help people with the rising cost of living, the extent of fraud around coronavirus support schemes, the sanctions regime against Russia, support with energy bills, disability benefits, P&O World’s redundancies and student loans.

You can read the full transcript here.

By George Crozier, CIOT External Relations Manager