Dealing with the debt: big tax rises are not the answer right now

Tax rises can’t do much to reduce the two-trillion-pound hole in our public finances. And the economy is too fragile for a tax grab now anyway. So where is the money going to come from? asks Merryn Somerset Webb.

At 07.45 last Saturday morning one of my sisters arrived at Pets At Home in Trowbridge. She’s smart: the next mother arrived at eight; the third at 08.15. When the shop opened at 09:00, my sister got the first choice of the four guinea pigs on offer. The third mother left in tears. Guinea pigs are sold in pairs; her daughter will go without the birthday present she was promised two months ago.

The residents of Wiltshire are not the only ones to have run up against the great pet supply shortage. Last week, our house rabbit died. I cried so much I got a victim support call from the vet followed by a letter of condolence (the UK does have a brilliant service economy). But much as we loved the rabbit it did not immediately occur to me that it would be tricky to replace him. It was.

No local breeders replied to our messages. Pets at Home was empty. The apparently unwanted ones we called about on Gumtree were all gone. Eventually we filled in a seven-page form for the rescue centre; subjected ourselves to a full WhatsApp tour of our house and garden to assess our suitability; and, a week after applying, were allowed to attend a hostage ransom style handover in a car park in Glasgow.

Inflation is building

There is a point to these seemingly boring anecdotes of the mini traumas of middle-aged mothers: they might tell a story about how inflation is building in the economy.

In the short term, supply shortages are biting (even on the John Lewis website a surprising number of white goods come up as “out of stock”, for example) just as demand is rising fast (all the cash dished out during the pandemic has to go somewhere).

And in the medium term, social distancing is bumping up costs too: the huge extra time commitment aside, Bramble, the new rabbit, cost a tenner more than he would normally have because I was not allowed to use my own, possibly toxic, pet carrier. Instead I had to buy a Covid-clean one from the rescue centre online in advance so they could load and leave him in the car park for me to pick up – after they had walked a safe distance away, of course.

You might say this is mad (I’m with you) but that’s still the way it was – which is part of the reason why the UK Consumer Price Index rose to 1% (from 0.6%) in July and why it may come out higher than expected in August too.

This matters because public debt is now so high – at £2trn and more than 100% of gross domestic product – that something has to happen to deal with it, or at least to offer some confidence that it might be dealt with. Time-honoured ways to do this include actual default (not a UK thing); default on promises to citizens (austerity); default via inflation (the state effectively pays back less in real terms); or sharp rises in taxation, which have the same effect as austerity on those who take the new tax hit.

Some taxes will have to rise

None of this is painless for a population. But inflation is probably the least painful – as long as you can get it going and keep it contained (3%-4% over a decade would be the policymakers’ dream, I suspect). But it seems unlikely in this crisis that we will get away without tax rises too – to show willing to our creditors, if nothing else.

The conversation around these so far has focused on wealth taxes. Make the rich pay, says almost everyone (although only a few of those that are considered rich by the majority consider themselves rich). The ideas here range from bumping up capital gains taxes to align them with income taxes, cutting pension tax relief (the rate and the tax-free lump sum, perhaps), dumping a few more inheritance-tax reliefs, or even going all-in for a proper annual wealth tax.

The difficulty with all these is that, while they might make the non-wealthy feel better and the government look a little more alive to social justice, they won’t raise enough money to touch the sides of the problem. To do that you have to make everyone pay – with rises in income tax.

Add on a percentage point to the higher rate of income tax in the UK (from 40 to 41%) and you will get about £1bn in extra tax revenue, according to the Institute for Fiscal Studies. Political posturing about broad shoulders aside, this is obviously completely pointless.

Add the one percentage point to all rates and you get £5.7bn. Do the same to all employee and self-employed national insurance contribution (NICs) rates, or the rates of VAT, and you would raise £6.4bn and £7.2bn respectively. Do it all and you get around £19bn – a little under 1% of GDP (or what GDP used to be at least).

That’s getting closer to real money, but it isn’t particularly close to £2trn. Tax rises can’t do much for us in the short term. It is also clear that even if they could, now is not the time to raise taxes hugely.

The debt needs to shrink relative to GDP

We are seeing nice signs of the V-shaped recovery we were hoping for but the economy is far too fragile – and everything far too uncertain – for a tax grab now. We don’t even yet know how bad things really are: if the pandemic keeps subsiding and the recovery keeps going as it is, things will soon look less urgent.

If Sunak is sensible, he won’t do much in the way of raising taxes in the autumn. He will signal some intent with a fiddle or two, but do little else. We can then hope that his next Budget will bring some proper restructuring of the tax system (lower, flatter, simpler) to make it into one that gives us a better chance of constant real economic growth in the future. After all, making the debt look small relative to GDP by enlarging GDP would be a lot better for us than making it look small by shrinking it in absolute terms.

The positive here, such as it is, is that we all have time to prepare even for the token changes we might see in the autumn. Use your allowances (pension and capital gains in particular); don’t buy too many new houses; and don’t make too many assumptions of continuity of policy when thinking about inheritance tax.

Finally, remember that supply constraints and inflation are working their way into our economic mix. Invest with that in mind (in, say, long-term equities and gold). Don’t be the equivalent of the mother who arrived at 08.15.

• This article was first published in the Financial Times

Recommended

The coronavirus is scary – but it's irrelevant to your investments
Investment strategy

The coronavirus is scary – but it's irrelevant to your investments

The spread of the coronavirus is causing alarm around the world. And, while it could be a serious short-term threat to human health, it’s not somethin…
24 Jan 2020
The MoneyWeek Podcast: Barry Norris on why he's shorting vaccine-makers
Biotech stocks

The MoneyWeek Podcast: Barry Norris on why he's shorting vaccine-makers

The news of Covid vaccines has delighted many. But not Argonaut Capital's Barry Norris. He tells Merryn why vaccines aren't the panacea people think t…
3 Dec 2020
UK stocks finally start to rise – but not as one
UK Economy

UK stocks finally start to rise – but not as one

The UK Stockmarket recovery is finally getting some traction, says Merryn Somerset Webb. But not all stocks will recover in the same way.
3 Dec 2020
3 December 1984: BT is sold off in a gamble over privatisation
This day in history

3 December 1984: BT is sold off in a gamble over privatisation

In a landmark test of privatisation, the government sold off over half its stake in British Telecom, on this day in 1984.
3 Dec 2020

Most Popular

Time for investors to be fearful, not greedy – and sell?
Investment strategy

Time for investors to be fearful, not greedy – and sell?

The Covid-19 crash proved a great investment opportunity. Does the vaccine mean it’s time to sell?
23 Nov 2020
How to avoid inheritance tax by giving your money away
Inheritance tax

How to avoid inheritance tax by giving your money away

Ruth Jackson Kirby explains how to avoid inheritance tax by passing money on to your family while you are still here.
24 Nov 2020
Once Covid-19 is over, we’re going to see an economic boom
Investment strategy

Once Covid-19 is over, we’re going to see an economic boom

After the dust from the pandemic has settled, we’re in for a consumer boom and a huge bout of government spending, says John Stepek. Here’s how to tak…
24 Nov 2020