Budget 2021: Tax hikes are the same as austerity and will spell Rishi Sunak’s downfall
Chancellor Rishi Sunak’s budget marks the beginning of a damaging era of austerity that risks crushing Britain’s economic recovery.
While other countries are trying to jumpstart their economies, Rishi is expected to ratchet up income and corporate taxes to address the mounting deficit.
The Chancellor is right that Britain’s fiscal position is not sustainable.
It is justifiable to borrow a large amount, once-off, to fund temporary measures to keep businesses alive during a pandemic. It is also sensible to continue the furlough scheme and extend business rate reductions. Bricks and mortar retail have made no money this past year because they had no customers after the government shut their shops and made everyone stay at home where they could only buy goods from their online competitors. Rates are meant to reflect a value of the location of stores, the more premium the higher the rate just like rents, but this year that premium has been a burden, so relief is both equitable and logical.
It is not sustainable, however, to maintain higher levels of spending with lower revenues resulting in a large permanent deficit. To resolve this issue, the Chancellor wants tax increases. This is justified on the basis that the public is sick of “austerity”.
But make no mistake: higher taxes are a form of austerity. It is taking from the public’s pockets to fill the government’s fiscal hole. This is, according to the latest economic research, a particularly damaging form of austerity.
A comprehensive study, ‘Austerity: When It Works and When it Doesn’t’, looked at whether countries should cut spending or increase taxes to address a deficit. Authors, professors Alberto Alesina, Carlo A Favero, and Francesco Giavazzi, analysed 3,500 policy changes in sixteen countries between 1981 and 2014. They found that spending cuts did not reduce growth. Specifically, they found that the UK’s growth was higher than the European average after spending cuts in the early 2010s.
On the other hand, relying on tax increases was associated with “large and long-lasting recessions”. This is because tax increases reduce confidence resulting in less investment, fewer jobs and lower growth. In an ironic twist, tax increases ultimately have little impact on deficits because they result in smaller economies that provide less revenue for public services.
Just take the example of the corporate tax rate, which is expected to jump from 19% to 25% by 2024. In a globally competitive market, foreign investment is particularly sensitive to the corporate tax. A six percentage point increase can be expected to decrease foreign investment by around 15%, equating to about £7.5 billion per a year. This is precisely why the Chancellor’s Conservative predecessors reduced the corporate tax rate.
The increase in corporate tax will be particularly damaging if it is not accompanied by a more generous system of capital allowances. The UK may have a relatively low rate of corporate tax, but the lack of ability to immediately expense investments in machinery and buildings, as well as other anti-avoidance rules, pushes up the effective corporate tax rate. According to the Oxford University Centre for Business Taxation, 24 of 36 OECD countries have a lower effective corporate tax rate than the UK.
It will therefore be incumbent upon the Chancellor, to abolish ‘The Factory Tax,’ that is, allow businesses to fully expense investments in machinery and buildings. The Adam Smith Institute that abolishing the Factory Tax would increase investment by 8.1% and boost productivity by £2,214 per worker.
Meanwhile, freezing income tax bands will effectively break the key Conservative manifesto promise to not increase income taxes. This is because inflation will push lower income earners into higher bands: 800,000 of the lowest earners, who are not currently paying income tax, will be pushed into the basic rate. A further 800,000 will be pushed from the basic rate into the higher 40p rate.
This budget could prove the Chancellor’s downfall: slick social media graphics will not be able to hide less money in people’s pockets, higher unemployment and miserably slow growth.
The Government should be pursuing a ‘go for growth’ strategy that ultimately delivers more prosperity and funds for public spending. This would mean doing more to tackle wasteful spending — such as the £100 billion for HS2 — and pursuing tax and regulatory reforms that will boost the size of Britain’s economic pie rather than the state just taking a larger slice.
The alternative path, that risks a permanently smaller economy and a forever expansion in the size of the state, should be ruled out.