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UK Taxes: The Only Way is Up

Last week, the IFS released a great tool all UK voters should be forced to use. It gives you the chance to be the UK chancellor (not an envious position). You set government spending and taxes and it then projects the deficit and trajectory of debt over the next parliament. I’ve played around with it and confirmed two facts: the UK’s current fiscal plans are a fantasy, and taxes will have to rise. 

First, you notice all departments, barring Health, Defence, Education, and the Foreign Office, are facing real spending cuts of -3% over the next parliament. This is a bad sign. Our prisons are full. Our councils are bankrupt. Our transport infrastructure is crap. Our housing stock is the least value for money of any advanced country (see figures below). Spending money is not a silver bullet, but without real terms spending increases, there is almost no hope of solving these issues. These spending plans are not credible. 

However, problems start mounting as soon as you expand government spending. Eliminate any real spending cuts; debt remains stable, according to the IFS. The issue being, it leaves little room for manoeuvre in the event of a crisis. Debt-to-GDP is already at historically high levels (see chart below). Prudent fiscal policy would seek to reduce the debt-to-GDP ratio over time. The question is how to balance expanded public spending to solve the issues noted above and many more, whilst reducing debt over the medium term. The answer: tax increases. 

It is also worth remembering, even in the case above, spending is still conservative. Most departments are only maintaining their current spending power. Nothing else is changing, the two-child benefit cap, universal credit, state pensions; all remain the same. Even in this scenario, though, tax increases are necessary. 

Add in a cornerstone policy and the necessity of tax rises is even clearer. I set myself the task of finding what tax rises are required to get debt falling with the following (still somewhat limited) spending plan: scrap the two-child benefit cap and no real spending cuts. I started by raising taxes on the wealthy and corporations, as I presume these are more popular among voters and where the next Labour Government would start. Surely, they can provide us with the revenue necessary. They can’t.

Raise capital gains and inheritance tax (IHT) by 5 percentage points. Remove IHT relief for businesses and start charging capital gains on death. Add in Labour’s plan to charge VAT on private school fees. Increase corporation tax to 30%. Finally, raise the additional income tax rate to 50% from 45% and the higher income tax rate from 40% to 42%. Only now is debt forecast to fall. Again, all these tax increases only maintain real spending for most departments. In other words, you can expect most public services to not get any worse, but don’t expect them to get much better either.

The dilemma facing the UK is evident. Unless taxes on ordinary Britons are increased, we cannot improve our public services. Prisons will remain full. Housing will remain poor. Council’s will be squeezed further. Of course, there are other policies that could be implemented such as a land value tax. Moreover, these are only forecasts. Yet, the overall direction is clear. Taxes must rise or public services will deteriorate further.

Conservative MPs favour the latter albeit they don’t admit to it. The tax cuts enacted by Hunt in the Autumn budget were financed by the real spending cuts planned over the next parliament. Tory MPs are calling for further tax cuts in the hopes of an election boost. Anyone looking at IFS forecasts would think that imprudent, to say the least. Ironically, it was reported, most of the fiscal headroom has vanished as borrowing was higher than expected last year. 

However, the tool also provides reasons to be optimistic for those disappointed by Labour’s fiscal rectitude. The reason being, Labour will have to be far more radical than they are letting on at present. Without significant tax rises, there is limited fiscal room to improve public services without greater borrowing, violating their fiscal rules. Given the credibility of the Labour Government will rest on the state of public services, they will be forced either to loosen the fiscal rules or raise taxes. As noted above, debt is already at historically high levels. Given the Truss 2022 debacle, I doubt Labour would gamble with market confidence by playing around with the fiscal rooms to borrow more, hence I think it is far more likely Labour will pursue tax rises. 

And if whoever wins the election does not raise taxes, the UK will continue along its current trajectory. Public services will get worse. Economic growth will stagnate. We will all get poorer. Debt will rise. In sum, taxes must go up, there is no alternative. 

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