What taxes might Labour raise?
To win big in general elections, the Labour Party needs to convince fretful voters that it can be trusted with the economy. Clement Attlee sold post-war nationalisations with the mien of a staid bank manager. Ahead of the party’s landslide win in 1997, New Labour pledged to copy years of restrictive Tory spending targets. Rachel Reeves, the shadow chancellor, has adopted a similar tactic ahead of Labour’s widely expected election win on July 4th.
Barring a few titbits of extra spending—worth around £10bn ($12.7bn, or 0.4% of GDP) annually and funded by taxes on private schools, home purchases by foreigners and the like—she wants to stick to plans set out by Jeremy Hunt, the chancellor, in March. She has also committed herself to the fiscal rule that government debt must be projected to fall as a share of GDP in the fifth year of five-year forecasts from the Office for Budget Responsibility (OBR), a watchdog.
Squaring that with Labour’s pledge not to return to austerity will be tricky. The commitments that New Labour inherited were a squeeze; those that Ms Reeves has signed up to are suffocating. They imply hefty real-terms cuts to frayed courts, policing and local government. The Institute for Fiscal Studies (IFS), a think-tank, reckons that it would cost around £30bn extra annually by 2028 to prevent them.
Labour says that growth, not tax, is the answer. But it takes time for growth-enhancing policies to have an effect and the OBR’s GDP projections are already bullish compared with those of other forecasters. Falling interest rates could also help a little by pulling down debt-servicing costs. Year-on-year inflation stood at 2% in May, back in line with the Bank of England’s (BoE’s) official target. The IFS estimates that a one-percentage-point decline in gilt yields would boost fiscal headroom by £12bn. But rates will not reliably fall.
That leaves two other options: more borrowing or higher taxes. Labour is likely to opt for a bit of both. Britain’s fiscal rules are pretty loose for those willing to stretch them. The binding fiscal rule governs borrowing only in the last year of the OBR forecast. A short-term borrowing spree spent on public investment would comply with the rules Ms Reeves has committed to. A more radical option would be to change how the BoE books its quantitative-easing (QE) losses, which are projected to cost around £20bn per year until 2032. Most rich countries realise them more gradually, reducing their fiscal impact.
Still, too large a borrowing splurge would be foolish when interest rates are so high. Labour will also be especially wary of denting its aura of fiscal credibility. That leaves taxes. Post-election tax hikes are a well-worn political formula. Within a year of being elected British governments have raised taxes by 0.5% of GDP on average since 1979, The Economist calculates (see chart). That would be around £14bn today.
Small increases to broad-based taxes like income tax, national insurance or VAT would be best. But Labour has ruled out raising the headline rate of all three, as well as of corporation tax (though it may have left some room in its manifesto wording to fiddle with income-tax thresholds).
Capital-gains tax (CGT) looks a more likely target. Labour has said it has no plans to raise CGT but ruled it out firmly only for primary homes. Secrecy here has a valid economic rationale: asset-holders could cash out early if an increase were pre-announced. And there are also some grounds for raising it: capital gains are taxed at a much lower rate than salary or dividend income. But Labour should tread lightly; capital can be flighty and a high CGT rate may deter investment. Increases should also be coupled with reforms to ensure that only returns above inflation are taxed. Fully equalising CGT with income taxes, and taxing only non-inflationary gains, would raise £16.7bn annually, says Arun Advani of Warwick University.
Labour will probably opt for a jumble of smaller levies, too. “The Treasury is quite creative,” says Thomas Pope of the Institute for Government, another think-tank; mandarins won’t struggle to conjure up new taxes. The challenge is doing so without further distorting the economy and complicating the tax code.
Updating out-of-date council-tax valuations would be sensible but politically unpopular, as would other reforms like widening the VAT base. Labour may opt for smaller fiddles: narrowing inheritance-tax reliefs for small-cap equities, farms and the like; raising sugar taxes; or lifting tinier levies like insurance-premium tax. Stealth taxes will have obvious appeal. Income-tax and national-insurance thresholds are frozen until 2028, quietly pulling more people into higher tax bands as wages rise. Labour could well extend that freeze.
Thankfully, however, Ms Reeves has ruled out another stealth tax: tiering Bank of England reserves so that banks are paid interest on only a fraction of them. That proposal is central to the economic plans of Reform UK, Nigel Farage’s populist outfit. It is in effect a tax on banks, but far more convoluted than a direct levy. It risks gumming up the transmission of monetary policy as well as turning QE into a reliable money-spinner for the Treasury.
It looks likely that a Labour government would try to muddle through with a bit more borrowing, a sprinkling of tax rises and a little trimming to spending, in the hope that growth will eventually change the fiscal picture. But it will struggle to skirt tougher choices. If Labour wants to make swift progress on improving public services and alleviating poverty, more money will be needed. And although the forces squeezing the British state—most obviously, the impact of an ageing population—have featured only sporadically in the campaign, they will be inescapable in government. ■
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