Will we need big tax rises after the Covid crisis is over?

The government has spent tens of billions of pounds in the coronavirus pandemic to protect household incomes, keep businesses afloat and on various public services to cope with the emergency.

It has also paused the collection of some taxes to ease the pressure on private firms.

The result of all this additional spending and collapsing tax revenues is that public borrowing has ballooned to levels not seen since the Second World War.

The national deficit in this financial year is expected to come in at around £400bn, or just under 20 per cent of the size of the overall economy.

The government has had no problems raising these funds in the short term – indeed the rate of interest it has to pay has slumped to record low as the private sector has lent willingly to the UK state.

And economists are in agreement that to reduce state borrowing now, while the economy is in crisis, would be entirely counterproductive because output would slump without the fiscal support and tax revenues would fall still further.

Yet a big question with which policymakers and analysts are beginning to consider is the size of the long-term damage to the sustainability of the UK public finances resulting from this crisis, specifically the question of whether it will require tax rises when the emergency is over.

The Chancellor, Rishi Sunak, is preparing his budget for 3 March, and briefings suggest he is examining the case for tax increases at some point in the future, with ideas such as raising corporation tax, increases in the capital gains levy and new digital sales taxes in the frame.

The chair of the Treasury Select Committee, Mel Stride, a Conservative MP, this week mooted the idea of a one-off wealth tax, an idea also recently proposed by a respected independent committee which examined this question in depth.

But just how big is any post-Covid hole in the public finances likely to be? And what sort of tax rises – and in what form - would be needed to fill it?

The Institute for Fiscal Studies (IFS) suggested in its pre-budget analysis that the UK could come out of the crisis with a persistent gap between day-to-day public spending and taxation of £60bn by the middle of the decade.

They arrive at this figure by taking baseline current annual government borrowing of around £46bn, adding on £7bn to make last year’s increase in the generosity of Universal Credit benefits in the crisis permanent, plus an assumption of an extra £12bn of public spending relative to current plans and £2bn of more assistance to local governments.

It’s an entirely plausible estimate given the political and practical pressures acting on ministers.

And given that the IFS, in line with most other groups, reckons there is no realistic possibility of cutting public spending after a decade of austerity, it gives an indication of the size of any tax rises which would be needed to “balance the books” and prevent public debt, as a share of the size of the economy, rising every year.

However, it’s important to stress that the size of the hole (and the implied tax gap) will depend on the strength of the overall recovery and how much permanent “scarring” is inflicted on the economy’s growth potential by the crisis.

Macoreconomic forecasts from Citi, fed into the IFS’s public spending model, suggest that public borrowing in the middle of the decade could be as high as £190bn in a very weak recovery or as low as £50bn in a very strong one.

That could push the implied size of the tax UK gap up or down by £50bn in either direction. That’s equivalent to around 9p on the basic rate of income tax or 7 percentage points on the standard VAT rate according to official projections - so uncertainty is very high.

Still, the conclusion from the IFS, taking the long-term pressures on the public finances from an ageing population into account, is that “sizeable net tax rises will, at some point, be needed.”

Should a one-off post-Covid wealth tax be part of the solution? The IFS points out that a one-off tax can raise money and help compensate those who have lost out in the pandemic - particularly the young - it could not, by its nature, fill a ongoing hole in the public finances.

Yet that doesn’t mean it might not be helpful. The authors of the Wealth Tax Commission report - Dr Arun Advani, Emma Chamberlain and Dr Andy Summers - argue that a one-off tax would help delay the point at which such other permanent tax rises would need to be introduced.

“A one-off wealth tax would smooth the transition before these rises come in,” they argue.

One advantage of this approach from Rishi Sunak’s perspective is that it would demonstrate a willingness to take tough decisions on tax, while not breaching the Conservative 2019 manifesto, which committed them not to raise VAT, income tax or National Insurance over the coming parliamentary term.

Given these taxes raise the bulk of the UK’s revenues (some 75 per cent in 2019-20) it’s hard to raise serious sums permanently – and £60bn would be a serious sum – without tapping these sources.

Yet those around Mr Sunak have suggested that new wealth taxes – even a one-off - would not be in keeping with the “values” of the Conservative party (despite the fact that existing levies such as capital gains tax, council tax and inheritance are all, substantively, already forms of wealth taxes).

This attitude probably explains why those close to the Chancellor have mooted various stealth taxes such as keeping income tax thresholds frozen and allowing “fiscal drag” to raise some £6bn revenues.

Another option is raising the money from companies. While new digital sales taxes would be unlikely to raise serious money, official estimates suggest that putting up corporation tax back up from 19 per cent to 28 per cent - where it was before the cuts of 2010 by George Osborne and the level targeted by the new US administration if Joe Biden - could raise more than £20bn a year.

The projections from the Office for Budget Responsibility – the Treasury’s official forecaster – might help the Chancellor. If they project a strong recovery with little scarring on 3 March it will imply a smaller tax challenge.

But most will probably depend on what Mr Sunak thinks he can get away with politically.

He has insisted a willingness to take tough decisions to bring down borrowing is necessary to differentiate the Conservatives from Labour – but at the same time he is under pressure to increase public spending from Tories in “Blue Wall” seats, while other Tory backbenchers have already starting to lobby against possible tax increases.

Mr Sunak’s ability to please everyone in his party would appear to be running out.