The state of the UK's public finances is not healthy. Keir Starmer’s government has identified a black hole of £22bn in the UK's public finances as well as significant under-investment in public services such as the NHS, education, and prison services.
The backdrop is almost 100 per cent debt to GDP ratio, which significantly rose due to the pandemic and energy price hikes following the outburst of war in Ukraine.
Chancellor Rachel Reeves has identified growth through additional investment as the sensible way to raise prosperity and government’s revenues.
However, she has also repeatedly warned about the need to raise taxes and cut expenditure to uphold the fiscal rules of a falling ratio of debt to GDP over a five-year period and a balanced Budget (excluding borrowing for investment purposes) in the fifth year.
These rules are subject to interpretation and extremely sensitive to slight variations in different parameters when set for a five-year period, according to the Institute of Fiscal Studies.
As an example, an increase of half of 1 per cent a year in GDP would result in more than 2.5 per cent additional growth of GDP in year five, a more significant addition to the tax take and a potential reduction in cost of social benefits, thereby reducing the required borrowing by a higher magnitude, other things being equal.
Therefore, the ratio of debt to GDP at the end of year five, may drop substantially. It is also likely that the definition of the ratio of debt to GDP may be revised to exclude borrowing for investment, too.
Nevertheless, it is becoming increasingly clear that substantial tax rises are on the cards for the near future, even though it may be electorally preferable to get the bad news out fast.
The total amount of tax raised is directly affected by the structure and composition of taxes, as well as by the applicable tax rates and the breadth of tax take across taxpayers.
According to the IFS, the lion’s share of 2023-24 UK forecasted tax revenue of £950bn belonged to income tax at 28 per cent, followed by national insurance contributions at 18 per cent, VAT at 17 per cent, company taxes at 11 per cent, other indirect taxes at 10 per cent, business rates and council tax at 8 per cent, capital taxes at 4 per cent and other taxes and royalties at 4 per cent.
The government has indicated that the tax rates applicable to the first four categories are not going to change through the lifetime of this parliament. Together, they amount to 74 per cent of the total tax take.
This analysis also indicates that about two-third of the total taxes raised are from individuals and the balance from businesses.
Furthermore, well over half of the total tax revenues are collected from working people’s wages and salaries, as well as VAT on their expenditure. Capital taxes including capital gains tax, inheritance tax and stamp duty in comparison only amount to 4 per cent of the total tax revenues.
