Weak tax receipts spell trouble for Labour too

The United Kingdom economy looks pretty good compared to other developed economies at the moment. The IMF has forecast we will have the highest growth rate this year. GDP figures out today show the economy grew 0.7 per cent in the third quarter and three per cent over 12 months. Yet we are not seeing the growth in tax receipts that this implies. The latest public finance figures show receipts well below official forecasts. If that continues, it means George Osborne is going to have trouble delivering on his current plans to reduce borrowing, let alone pay for additional tax cuts. However, it also has implications for Labour’s plans for government.

In September, public sector borrowing was £11.8bn. We are halfway through the financial year and borrowing is running at £5.4bn more than this time last year. The Office for Budget Responsibility had forecast borrowing would fall this year by over £12bn. The main reason for the difference is that tax receipts are growing at 2.4 per cent, well below the OBR forecast of five per cent. This partly reflects timing differences as firms adjusted to the cut in the upper rate of tax and the OBR expects a boost when self-assessment payments are made next year.

However, the OBR is still concerned that tax receipts are going to be lower than it had forecast and it suggests some possible reasons. Low pay growth is depressing revenue growth from income tax and national insurance. Weak growth in wages, combined with strong employment growth, also means that a greater proportion of wages are below the £10,000 personal allowance threshold, reducing the amount of tax paid. Housing market transactions are 10 per cent below the OBR’s expectations, bringing stamp duty in a little below forecast. Finally, it seems that oil and gas tax revenues are disappointing, something that will be compounded if the 26 per cent drop in the oil price over the past four months is sustained.

Borrowing figures can be revised and the same set of accounting changes that applied to GDP figures also apply to government borrowing, but not yet to OBR forecasts. Yet perhaps the most interesting element here is the impact of the labour market. Employment growth has been strong, but wages have been weak. The cost of living crisis is a problem for government as well as citizens, as low wage growth means low income tax growth. This could mean the fiscal room for manoeuvre shrinks further and, should public finances not improve soon, will make the task for the winner of the 2015 election even harder than we expected. Labour plans to balance the current budget (ie no borrowing to fund current spending) by the end of the next parliament. Lower than expected tax receipts will make that harder.

Having missed its fiscal targets this parliament, the coalition now has harsh spending cuts planned beyond 2015 (though it has yet to say what they are), which could mean more than 35 per cent reductions in unprotected departments, according to the Institute for Fiscal Studies. An adverse change in the OBR’s fiscal forecasts could prompt the government to announce further spending cuts, which could force Labour to follow suit in the first year at least.
In this context it is no wonder that Labour’s tax plans are receiving much attention. At this year’s conference, Labour announced that its planned mansion tax would now contribute to a funding boost for the NHS. The tax will apply to properties valued at above £2m and the announcement raised questions about how it would be implemented and how much people would pay, with London mayoral hopefuls joining a chorus of concern. Ed Balls has now given more details. The tax will vary according to valuation band (eg £2-3m) and people on incomes below the 40 per cent tax band will be able to defer the tax until their homes change ownership. In practice, few people will be affected.

While controversial now, could the mansion tax become an accepted part of our tax system? After all, when William Pitt the Younger introduced income tax over two centuries ago, it was a short-term fix to fund a war yet, once reintroduced, the income tax remained. Perhaps, although tax on property and land will eventually need an overhaul. An important lesson is that any new tax can lead to fears it will be the thin end of the wedge and the conclusion that it indicates where a party’s priorities lie. At least four elements are needed: simplicity, so it is clear who will pay (and who will not) and how much; fairness, so no new injustices are created; context, since a new tax must clearly sit within a pro-enterprise and pro-investment economic policy; and efficacy, with a guarantee that tax proceeds will not be wasted. Any new tax plans must keep these elements in mind.

This article was first published by Progress on 24 October 2014.