What does the biggest tax rise in a generation mean for the economy?

What does the biggest tax rise in a generation mean for the economy?

A Conservative prime minister has announced the biggest tax rise since the 1970s to fund social care and NHS spending. The way that the burden has been shared could have significant consequences for the UK’s economic recovery.

To understand why, it’s necessary to look at the impact on an average household. Most of the £12bn a year will come from a 2.5 per cent increase in National Insurance Contributions, half paid by the employer, half by the employee.

It means the average worker on £25,800 will take home £244 a year less. In a household with two people on the average wage, that’s close to £500 a year less to spend.

According to the Resolution Foundation think tank, a typical 25-year-old today will pay an extra £12,600 over their working lives from the employee part of the tax rise alone, compared to nothing for most pensioners.

If one of the key arguments for the furlough scheme was keep the economy whirring along by putting money in people’s pockets then Boris Johnson has announced a clear reversal of that approach.

Further hits to household incomes are on the horizon. Rishi Sunak’s last Budget included a four-year freeze on the thresholds for basic and higher rate income tax, meaning that workers will pay more.

People on the lowest incomes face a £1,040-a-year cut to their incomes when a £20-per-week uplift to universal credit is withdrawn in October.

Any cut to universal credit means a reduction in spending in the wider economy because poorer groups necessarily spend almost all of their income. They cannot afford to save.

Businesses will need to deal with customers who have less money while paying an additional 1.25 per cent cost on employees’ wages.

“While some firms will absorb the tax hike, others will employ fewer workers or hike prices,” explains Samuel Tombs of Pantheon Macroeconomics.

All of this comes at a time when firms are already facing a toxic mix of circumstances. Supply chains are grinding to a halt, government support such as the furlough scheme is being withdrawn and the UK has a shortage of workers exacerbated by Brexit.

There is a mismatch between the skills that workers have and the jobs that are available. Businesses are also saddled with billions of pounds of loans taken out during the pandemic, much of which will never be repaid.

The Federation of Small Businesses estimates smaller firms will pay an extra £5.7bn, meaning 50,000 fewer jobs.

For these reasons, some analysts have downgraded their economic forecasts in response to the government’s announcement.

Pantheon Macroeconomics says that the changes will delay the recovery. Pantheon forecasts the UK economy will grow 5.2 per cent this year, not 5.5 per cent as it had previously thought. Taxing wealth instead of incomes would have had less of an impact on spending, Pantheon points out.

“While real government expenditure will rise too, we doubt this will fully offset the hit to households’ spending,” says Mr Tombs, economist at Pantheon.

Some have argued that the prime minister should be praised for taking “tough decisions” and finally facing up to an issue that has been kicked down the road for years.

There is no doubt that tax rises were necessary to pay for the NHS and social care in an ageing society that has historically underfunded both systems.

But, with three years to the next general election, an 83-seat working majority and a lead in the polls, Boris Johnson could have been far bolder in how the burden is to be shared.

The impact of the pandemic has been uneven and existing inequalities have deepened. The least well off have been more likely to die from Covid and to see their incomes fall. Meanwhile the relatively wealthy have put away billions of pounds of additional savings.

With help from low interest rates and a stamp duty cut, house prices rose at their fastest pace in 14 years. The owner of the average home gained £31,000 on the value of their property in the year to June – more than the median household made by going to work.

Tax rises could have helped to redress the balance by shifting some of the burden away from wages and on to unearned income – such as rent, capital gains or inheritance. To repurpose an old Tory attack line: tax the “skivers” not the “strivers”.

By choosing instead to do the opposite, Johnson has avoided the genuinely tough decision of standing up to his electoral base of older, wealthier voters.

The government may think this was the most politically expedient option. Conservatives will be acutely aware of Theresa May’s disastrous attempt to tackle the thorny issue of social care in the 2017 election campaign.

Asking people to use the value of their homes to pay for their care, and not capping individual contributions, was quickly labelled a “dementia tax” and helped May to squander most of her huge poll lead to Jeremy Corbyn.

A change has been brewing in Conservative ranks, however, and Johnson has seen a backlash from the back benches. Free market think tank the Adam Smith Institute labelled the plans “morally bankrupt” and accused the government of asking “poorer workers to bail out millionaire property owners”.

Even the Spectator magazine, which Johnson used to edit, has argued that tax rises should fall on wealth rather than income.

As it is, in April next year working people will see their take-home pay reduced for a benefit that they may not see for many decades.

If, as some economists forecast, it slows the economic recovery and leads to insipid growth it could hamper the Conservatives’ chances of re-election in three years’ time. It may well turn out to be one difficult decision that the prime minister will regret having fudged.

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