Economic policy and tax reform

Over recent months of political and economic turmoil in the UK, tax and economic policy became a topic of popular debate, receiving a level of attention well beyond that normally given to the country’s fiscal policy (taxation and government spending) and the Bank of England’s monetary policy (central bank’s control of money supply). Media and the general public alike have been more informed about and interested in terms such as Bank of England base rates, debt to GDP ratios and GDP growth than ever before. 

After coming to power in September, Liz Truss and her Chancellor of the Exchequer, Kwasi Kwarteng, announced the government’s “Plan for Growth” at the Conservative party conference. This plan included proposals for the largest cuts to tax in 50 years. The plans were unfunded and missing any independent review by the Office of Budget Responsibility which would normally accompany changes of this kind. It was swiftly rejected by the financial markets, by the general public and by her own party, resulting in the replacement of Kwasi Kwarteng by Jeremy Hunt and a vault-face in tax policy. Liz Truss subsequently resigned and was replaced by Rishi Sunak as Prime Minister, with Jeremy Hunt remaining as Chancellor of the Exchequer. Monetary and fiscal policy have major implications for the world of work.

Economic state of the nation 

As the second Elizabethan era comes to an end, like most major economies, the UK is facing challenging economic times and a cost of living crisis. A lengthy period of stagflation – high levels of inflation accompanied by low and now negative economic growth – is predicted with the UK entering a recession (two successive quarters of negative growth) from Q3. The Office for Budget Responsibility predicts this will last for over a year. Over the last fifty years the UK has experienced five previous recessions: 1973/4 and 1975 (three followed by two quarters of negative growth caused by the oil crisis); 1980/81 (five quarters caused by a tight monetary policy to bring down inflation); 1990/91 (five quarters caused by multiple factors); 2008/09 (five quarters caused by the banking crisis); 2020 (two quarters caused by Covid)

The challenge for any government faced with stagflation is that the traditional policies to address low or negative growth and those to address inflation are mutually contradictory.

Stagflation is not new to older generations but it has been over forty years, as the chart below shows, since the UK experienced a combination of low or negative growth and high inflation. Indeed, the mid 1970s and early 1980s featured significantly higher inflation that we are seeing today.

Inflation rates in the UK have now reached 11.1%, at around the peak predicted by the Bank of England. The UK government’s intervention to give support to meet the cost of rising energy prices appears to have staved off earlier predictions of much higher inflation rates. The Bank foresees rates gradually declining over the next two years, eventually falling to its target of 2% by the end of 2024. Inflation rates are at levels not seen for forty years in most major economies.

This year overall, the UK experienced modest growth with a Q1 2022 GDP rise of 0.7% and 0.2% growth in Q2 2022 followed by a fall of 0.2% in Q3. The Bank of England predicts that the economy will shrink by 0.75% in H2 2022, and then shrink by a further 1.9% in 2023 and a further 0.1% in 2024, representing the longest recession in a century. The latest data from the Office for Budget Responsibility, published after the Autumn Statement, is slightly less pessimistic and forecasts a fall of 1.4% in 2023 with negative growth ending in 2024 and annual growth in that year of 1.3%. 

If the above predictions prove accurate, the UK will see a period of stagflation last seen fifty years ago. However, without the much higher inflation rates forecast before the government intervened, this looks more likely to resemble the early 1990s (albeit with potentially somewhat higher rates of inflation) than the periods of economic turbulence in the early 1980s or mid-1970s.

Growth and the world of work

Growth in the UK and throughout the G7 nations has been relatively low (around an average of 2% in the UK) over the last 30 years. Between the pre-pandemic days of late 2019 and Q3 of 2022, growth has returned albeit in most cases, economies are only fractionally bigger now than they were three years earlier. Office of National Statistic figures show that the UK’s economy is now smaller than before the pandemic. 

In a speech at the 2022 Conservative party conference, Liz Truss – then the UK Prime Minister – described her priorities in three words: “growth, growth and growth”. Few would contradict the importance of economic growth in creating jobs and increasing wealth. There is, however, a view among some that continuous growth is unsustainable and that a better, more sustainable strategy would be one of “de-growth” towards a “steady-state”.  

The central economic and political drivers which contribute to growth are relatively uncontroversial. While it is generally accepted that increased business investment is a key driver of growth, the extent to which tax cuts and deregulation are effective drivers of investment is more controversial.

Tax

Corporation tax rates influence where multinationals base themselves. Income tax and employee social security rules can impact on where individuals, particularly high-earners, choose to work and how “employment” relationships are structured. Attractive rates of tax on capital gains or dividends can encourage innovative remunerations schemes. High employer social security rates (effectively a tax on employment) can incentivise investment in automation to replace work carried out by humans. 

The UK has relatively low tax revenues in comparison with other Western European countries, with tax revenues as a proportion of GDP relatively unchanged much over the last 20 years though marginally higher than for many decades and projected to increase over the next five years. 

Taxation policy has evolved over many decades but remains equipped for a different world: one where multinationals had less scope to manage their affairs to reduce tax; where online shopping was not replacing physical stores; where people’s jobs weren’t at threat from automation; where a younger population meant less demands on health and social care and unfunded state pensions; and where inequality of wealth and income was not so pronounced. 

Overhauling how and at what rates taxes are levied will be of increasing importance over the coming years. However, raising taxes can be politically unpopular, as is illustrated by Joe Biden’s failure in the US to garner the necessary support to reform the taxation of carried interest. 

In the UK, the government’s failed experiment with major tax cuts may increase the potential shift leftwards in politics in the long-term which would bring some significant changes in the years ahead. The Autumn Statement signalled a change of approach from the Conservative government with various tax raising measures including freezing the thresholds at which different rates are paid (effectively raising them in real terms) and lowering the threshold at which the highest rate of income tax is paid. 

In the UK, support has grown for tax rises to pay for public services. Recent polls suggest little opposition to raising those taxes which are less likely to affect most voters. Concerns that raising taxes on the well-off “punishes success” look to have little resonance today (though higher income tax rates or CGT would have to be raised significantly to make a big difference). This sentiment was reinforced by the public reaction to Liz Truss’s government’s now-abandoned plan to remove the top rate of income tax. The very rich even called to pay higher taxes as the failures to tackle inequalities of wealth around the world become embarrassing for many of the systems’ beneficiaries. 

Journalist scoops have exposed tax avoidance and evasion of an industrial scale and the scope for multinationals to organise their affairs to pay very low levels of tax in many countries has elicited frequent media headlines. 

As the UK navigates the economic headwinds, tax policy will become a higher profile political issue in the years ahead. The 2021 Report predicted a move left in politics which would see higher taxes in the future. As forecast in the 2021 Report, the questions will be which additional taxes to rise and when to do so. 

The word “tax” has, for many at least, pejorative connotations. A task is “taxing” if it is onerous or demanding. One possible reform of tax policy is to rename “tax”. Taxes levied in the UK are applied, in order of magnitude, to: health and social care; state pensions; social security payments; education; and other public services. Renaming tax as “social contributions” better reflects the contribution the “tax-payer” makes to society and may, over time, influence attitudes to paying tax; for example, it has been reported that the BBC is reviewing its use of the term “tax burden” as it has been claimed that the terminology could reinforce bias against the payment of taxes.