The government’s planned deficit reduction strategy rested on a large increase in tax revenue. The June 2010 budget set out to increase annual tax revenue by £177bn in 2014-15 compared to 2009-10. The Coalition VAT increase added to the outgoing Labour government Income Tax and National Insurance increases were expected to do the job, aided by good economic growth over the ensuing years. This would allow the Coalition to raise current spending by £90 billion a year in cash terms over the period, and cut the deficit substantially.
Mr Osborne’s third budget, two years into the Coalition government, aims to raise tax revenue by £154 billion a year in 2014-15 compared to 2009-10, £23 billion less than the original proposals. A bit of this fall is for the good reason that the second and third budgets have brought some Income Tax cuts to standard rate taxpayers through the further increase in the threshold. The rest of the shortfall is the result of two other trends.
The first is slower growth, meaning less revenue from a less buoyant economy. The second reason is the falls in revenue brought on by higher tax rates. The latest Treasury forecast now assumes that self assessment income tax will fall by 10% this year compared to last year, despite the higher inflation and growth which would normally increase it. The higher 50% rate is having an adverse impact. The Treasury also now forecasts a fall of almost 10% in the Capital Gains Tax receipts next year, as we feel the full effects of the higher 28% rate, despite the good gains on London property and many business assets since the market bottom in 2009.
The government’s study of the 50% rate argues that the impact of the 50% tax could be negative, but their best estimate is that dropping the rate to 45% would lose the Treasury just £100 million in tax income. They rightly hedge their figures around with many uncertainties. They also have errors in their report – for example Chart 5.3 tells us that only 250 people in the UK had incomes of over £150,000 in 2010-11, when it must have been many times that. They show that the incomes of people on £150,000 a year or more fell by 25% in 2010-11, which implies a very large loss of revenue. As the official forecast is for a 10% fall in self assessment revenue we must assume that the fall comes from this sharp drop in top incomes, offset by some gains on lower incomes.
They show that the mean highest rate for the G7, the G20 and the EU 27 is below 40%. The UK was tax competitive when the government first cut it to 40%, but has long since been overtaken by the rest in the race to attract talent and enterprise.
This budget does not forecast any further economic weakness, and estimates that total borrowing over the five years will come out a bit lower than the high figures of the Autumn Statement 2011. It still leaves the UK state adding £528 billion to net borrowing over the planned five years of this Parliament despite the credit of £28 billion of Royal Mail pension assets. The Chancellor has adjusted the increase in spending down a little, from an extra £90billion in Year 5 to an extra £86 billion. I think we should ignore Table 2.3 of the Red Book where it says total public spending will be just £733 million, as I think they should have put “£ billion” rather than “£ million” at the top of the table.
The immediate politics of the budget are likely to revolve around the treatment of pensioner incomes and the reductions in tax credits, which offset gains being made for some through raising the tax threshold. Assessment of the longer term budget judgement will rest heavily on whether the various measures proposed to boost growth do do just that. We will return to that story another day.