How to raise taxes

Labour has the political freedom to make unpopular decisions.

Photo by Jeenah Moon/Bloomberg via Getty Images

On 12 separate occasions since 2021 Rachel Reeves has told the Commons that people in the United Kingdom are enduring the highest “tax burden” for 70 years. The same claim appeared in Labour’s manifesto. It is true that tax receipts as a share of GDP have risen to a postwar high, and that the Conservatives’ claim to be responsible managers of the economy is a fiction. This fact, however, has begun to cut in both directions: when Reeves presents her first Budget on 30 October, she will need to explain to the public why taxes need to rise still higher. In this she must be first honest, and then bold.

These are qualities distinctly lacking in Ms Reeves’ predecessors at the Treasury. Under Rishi Sunak and Jeremy Hunt, the budgets of government departments were maintained at levels set in 2021, before Russia’s full-scale invasion of Ukraine, a historic surge in inflation, and 14 consecutive rises in interest rates. To make Mr Sunak, Mr Hunt and their colleagues appear more competent, government itself was asked to pretend that dramatic changes in the economies of the UK and the wider world had never happened. The Treasury’s estimate of the resulting spending shortfall is £22bn in this year alone.

Mr Hunt’s last Budget, in March, contained the unspoken assumption that tens of billions would be cut from unprotected public spending (reaching £19.1bn by 2027-28, according to the Office for Budget Responsibility), without saying where these cuts would fall. A scrupulous Chancellor can now be clear that our public services would not survive such austerity intact, and that the only way to maintain or restore them is by raising the money to do so.

A truly honest Chancellor must also concede, however, that the “highest tax burden for 70 years” has not fallen on most people. According to the OECD, the typical tax “wedge” (tax as a proportion of labour cost) paid by middle-class workers in the UK has changed little since 2010 (in fact, it has fallen slightly). Britain is still a relatively low-tax state compared with other countries, especially our neighbours in western Europe such as France, Germany and Italy.

This is especially true when it comes to taxing wealth. Research by Arun Advani, professor of economics at the University of Warwick, has shown that a person making £10m a year typically pays a lower effective tax rate than someone earning £30,000 a year. The rich will lobby against raising the rate of capital gains tax in line with income, if for no other reason than that they can afford to do so.

Britain’s relatively low-tax environment will remain attractive, however. The tax exiles of the 1970s were fleeing a top rate on income of 83 per cent, charged by an economy that was the sick man of Europe; today, an estimated 9,000 of the UK’s millionaires have threatened to leave this year if capital gains are taxed fairly. This is 0.3 per cent of our millionaire population, and Ms Reeves can afford to call their bluff. Similarly, a handful of private equity executives will warn of dire consequences if “carried interest” tax relief (known to financiers as the “Mayfair loophole”) is removed. Landowners and the bosses of certain companies will warn that closing the loopholes in inheritance tax will bring about economic disaster, because they do not wish to lose the benefits of investments they have in some cases made specifically to avoid paying tax.

Such measures fall within Labour’s commitment to ensure that those with the broadest shoulders take the burden: only 369,000 people paid capital gains tax in the 2022-23 tax year. Other measures open to Ms Reeves, such as reducing the tax relief on pension contributions or increasing employers’ National Insurance contributions, would have an impact on working people, perhaps not immediately but in their retirement savings and in their wage growth. Taxing landlords fairly could lead them to charge rent that is even more unfair. There are plenty of hazards on the way to a fairer tax system.

The Chancellor should be blunt that without such reform – and without laying the groundwork for still greater reforms of council tax and business rates – the UK will continue to be hobbled by the obfuscation and timidity that prevented the Conservatives raising revenue for a healthier and more productive economy. With a large majority and at a safe distance from the next election, Labour has the political freedom to make unpopular decisions. Rachel Reeves must act boldly while she still can.

[See also: Germany’s lesson for Labour]