Reeves is about to witness the fallout of her damaging tax rises
Adam Smith
6 min read
Rachel Reeves ‘will have to own the impact of higher taxes’ - Jordan Pettitt/PA Wire
In March this year, the previous government reduced employee National Insurance Contributions (NIC) for the second time and reformed the High Income Child Benefit Charge – which is levied against high-earners who get state support for childcare costs.
Overall the OBR stated that these changes – together with the expansion of free childcare, welfare reforms and the original 2pc point cut in NIC – would increase labour supply by 300,000 and boost GDP by 0.4pc.
The OBR had scored the positive impact of supply-side measures and tax cuts, something critics on the right had long said they wouldn’t do. But there was a sting in the tail. For the first time, the OBR also factored in the impact of the continued freeze on income tax thresholds.
These frozen thresholds would reduce the number of people in work by a total of 130,000 full time equivalent workers. Crucially, around 60,000 of these lost workers had yet to exit the workforce.
And that is one of many reasons why I think the Government’s first Budget will be a complete jobs killer.
The biggest such killer measure will be a significant increase in employers’ National Insurance. The last time this tax was increased, the OBR noted that it would be “passed through quite quickly into lower pay for employees in the private sector”.
Overall it argued that a 1.25pc point increase in employer and employee NICs would reduce whole economy wages and salaries by 0.5pc. To raise £40bn in additional taxation it is likely the Government will have to increase employers’ NICs by the equivalent of 2pc, so I expect the impact on wages and salaries will be larger with a significant negative knock-on effect on labour supply and therefore GDP.
Further threshold freezes and a big increase in National Insurance risk killing the jobs miracle we’ve seen in the UK stone dead. But other measures we are likely to see will also put downward pressure on growth.
Any increase in capital gains tax or abolition of entrepreneurs’ relief will damage the UK’s overall level of competitiveness. Likewise closing business relief or Aim relief in inheritance tax will have an immediate negative impact on thousands of companies across the country.
There have also been reports that sector specific taxes will be increased. A hike in gambling or alcohol duties may raise a few hundred million but the knock-on impact for those two sectors, which employ thousands of people, will be significant.
And finally, an increase of 7p a litre on fuel – as will happen if the Government reverses a 5p temporary cut in the duty and unfreezes the inflation-linked escalator – will increase costs for commuters and businesses alike.
Any one of these measures would be damaging in isolation. Do them all together and the OBR will surely conclude that the impact on GDP is significant, durable and additional, and therefore worthy of inclusion in the economic forecasts? The same should be true for the Employment Rights Bill, which the Government’s own impact assessment says will cost business billions.
A Budget that actually reduces GDP below what it otherwise would have been would be quite something for a government whose overriding mission is apparently economic growth. And it is true that they will likely receive some positive scoring from the OBR for any increase in capital spending that they announce.
A recent discussion paper the statutory body published suggested an increase in public sector net investment equivalent to 1pc of GDP could increase growth by 0.4pc in five years time. It sounds like the Chancellor will announce an extra £20bn of capital spending. However, other measures we are expecting in the Budget means she won’t see all of the growth upside you would expect from such an increase.
This is because any benefit should be netted off against the damage that an even bigger rise in the tax burden as a proportion of GDP will do.
Even if we assume a certain amount of expectation management, total tax rises of £30bn, equivalent to just over 1pc GDP, are very likely. Given the positive benefits the OBR ascribed to cuts in National Insurance, it is not unreasonable to conclude that tax rises of this magnitude would reduce GDP by around 0.4pc.
It is possible tax rises will actually damage growth more than this. I find it hard to see how the OBR can contend that the series of tax rises outlined above – all of which will negatively affect either the economy as a whole or certain high-profile sectors within it – will have less of an impact on growth than a relatively small increase in capital spending.
Particularly as not all of that capital will go on growth-enhancing measures.
As worthy as the repairs budget for the NHS or schools estate are, they will not provide additional, durable and significant growth benefits. The Government is therefore about to test to destruction the theory that government spending is a better driver of growth than good old-fashioned enterprise supported through lower taxes and proportionate regulation.
It is at about this stage in the Budget process that the Treasury starts to see drafts of the OBR’s Economic and Fiscal Outlook. Officials pull together summaries of the helpful and critical comments included in the document for the Chancellor. I’m sure there will be glowing verdicts on the benefits of increasing capital spending in the “helpful” column.
But I’m equally sure the “critical” section will focus on the implications for growth and will dampen the pre-Budget mood in 11 Downing Street, because this should set out in black and white the exact reduction in jobs and GDP the OBR ascribes to each of the damaging tax rises Ms Reeves is planning.
Warm words about prioritising growth will be just that. The Government will have chosen higher taxes and it will have to own the impact they have on people’s jobs and the country’s growth rate.
Adam Smith is former chief of staff to Jeremy Hunt.
