How To Support The Economy Today And Repair The Public Finances Tomorrow

Unhealthy finances Executive Summary8in recessions in a low interest rate environment. To do this, theGovernment should adopt a balanced current budget rule onceGDP returns to its sustainable level (i.e. when the output gap isclosed). Some fear that making such an announcement in thenear term risks choking off a recovery by signalling an intentionto tighten policy. In fact, making such an announcement wouldreduce policy uncertainty, ease coordination with the Bank ofEngland, reinforce the Government’s commitment to generatinga rapid recovery, and provide assurance of fiscal sustainability inthe longer term.Nature of the consolidation: economics and historydictate that this consolidation will be principally drivenby tax risesThe changed economic environment we face also profoundlyaffects the choice of instruments through which theconsolidation should be achieved. In the past, the choice ofhow to tighten fiscal policy was largely dictated by differentgovernments’ wider policy aims – for example, the overall size ofthe state – but the constraints placed on the timing and pace ofany fiscal tightening by the low interest rate environment meanthat we need to choose individual policies carefully so as tominimise the impact on the recovery.There are two reasons for thinking that this consolidation will,and should, be principally delivered through tax rises. First,there is a consensus that cutting government spending has alarger negative impact on the economy than increasing taxes.For example, the OBR and its US counterpart (the CongressionalBudget Office) both assume that the impact of spendingchanges on the economy are generally larger than those fortaxes. This means that a spending-led consolidation would haveto proceed slower than a tax-led one if it is to avoid underminingthe recovery. Second, the path of previous spending cuts – whichhave been unprecedented historically, and among the largestseen among advanced economies since they started in 2010 –makes it much less likely that achieving a further large-scaletightening mainly through spending cuts could be achieved, notleast given existing signs of deterioration in the quality of someResolution Foundation

Unhealthy finances Executive Summary9public services. Some areas of spending will undoubtably be cutor restrained in the years ahead, but both economics and historydictate that tax rises will do the lion’s share of the work in thisconsolidation.Tax increases of this order of magnitude would bepolitically challenging but not unprecedentedOur central estimate of the required consolidation – of around 40 billion in 2024-25 terms – is a very substantial sum to raisein taxes, but it is not without precedent. On a comparable basis,the budgets in 1993 increased taxes by around 48 billion, andthe budgets of 1974 and 1975 together raised 47 billion. Such anincrease would take the tax-to-GDP ratio to over 39 per cent ofGDP, the highest since 1983-84. But that would not be particularlyunusual by international standards: the UK’s tax take is over1 per cent of GDP below the (pre-coronavirus) OECD average,and over 10 per cent of GDP below some similar countries. Andthe direct tax burden faced by the typical employee has fallendramatically over time – with effective tax rates falling from 30per cent in 1975, to 25 per cent in 1990 and 18 per cent by 2019.Of course, while not unprecedented, delivering a tax ledconsolidation on this scale is a significant challenge. Doing sosuccessfully requires far more than simply identifying sometaxes to increase. We highlight three guiding principles that willincrease the chances of success. First, the burden of tax risesmust be shared fairly in the post-pandemic world. In practice,this means those who have gained from the crisis are seento contribute, and that tax rises reflect who has the broadestshoulders to bear them. It also means ensuring that measuresare fair between generations, reflecting long-term changes inthe distribution of wealth. Second, consolidation should supportthe recovery by aiming to reduce, rather than increase, economicdistortions, strengthening the weakest links in the tax system,and prioritising those tax rises that have a smaller drag ongrowth. And third, consolidation must be part of the answer,rather than a hinderance, to some of the broadly-accepted andfundamental challenges we face as a country, including tacklingResolution Foundation

Unhealthy finances Executive Summary10climate change, updating our system of wealth taxes for theincrease in household wealth, and providing for the health andcare needs of an aging population.Taxing those that have prospered during this pandemicis important, but cannot play a major role in the fiscalconsolidation 2020 has been tough for most, but some firms have profitedfrom higher than usual demand, and some individuals havereceived government support in excess of any income losses. But,contrary to the hopes of some, measures to directly tax thosefirms and individuals that have done well over the past year willnot be able to make major contributions towards repairing thepublic finances. This is mainly because, by their nature, suchmeasures will be temporary, whereas the need for higher taxrevenues is much longer-lasting. However, such measures shouldstill form an essential component of the coming consolidation;indeed, they are a pre-requisite for a consolidation thatmaintains public support.We propose two temporary measures that draw on the principlesof solidarity and fair burden-sharing. First, we recommend aPandemic Profit Levy of 10 per cent on windfall profits made byfirms during the pandemic, reflecting the fact that such profitsin many cases reflect the luck of some firms being presentedopportunities by the crisis or not being adversely affected bysocial distancing restrictions. Second, the self-employed whohave seen their incomes actually rise this year while claimingthe poorly-targeted Self-Employment Income Support Scheme(SEISS) grants should have their grants partially clawed back.This would narrow the enormous gap in treatment with the selfemployed who have seen income falls but been excluded fromsupport, and would raise at least 3 billion. and nor can green taxesEnvironmental tax changes would be desirable, even in theabsence of a large deficit, with a pressing need to get theUK’s carbon emissions onto a trajectory consistent with theResolution Foundation

Unhealthy finances Executive Summary11commitment to ‘net zero’. Unfortunately, they are not a majorpart of the answer to reducing the deficit. There is scope toreform such taxes to increase revenues, but carbon pricingdevelopments will take a long time to implement. And evenwhere specific proposals can raise substantial sums – such asraising levies on domestic heating – the changes are regressive,and any money raised will be needed for extra spending tosupport the behavioural change that net zero will require.Moreover, the loss of environmental tax revenue (particularlythe 38 billion a year of taxes on road transport) will requirepolicy change, such as a system of road pricing, just to standstill in exchequer terms. Reflecting the fast growth in onlineshopping during this pandemic, we recommend introducing aHome Delivery Congestion Charge as a pilot for broader roadpricing, raising 100 million.‘Easy wins’ should be embraced No tax rise is completely painless, but some are much easierto introduce than others. For permanent deficit reductionon the scale that is likely to be necessary after this crisis, theGovernment should look at two options that are relatively easyto implement (or stop) as needed: freezing tax thresholds andraising Corporation Tax (CT).On the first of these, substantial sums should be raised fromIncome Tax (IT) threshold freezes. The personal allowance hasbeen 12,500 for the past two years. Keeping it at this level wouldraise 5 billion a year by 2024-25, and still mean it was 50 per centhigher than if there had simply been consistent inflationaryuprating since 2010. Meanwhile the higher rate threshold forIT has been 50,000 for the last two years, where it is helpfully(if coincidentally) aligned with the withdrawal point for childbenefit. Keeping it at this level would raise 1 billion a year by2024-25. Of course, these freezes could be continued beyond 202425, or be discontinued earlier, depending on fiscal circumstances;and this flexibility is a key benefit of this approach.The Corporation Tax rate should also be increased. The UK’s rateof 19 per cent is low by international and historical standardsResolution Foundation

Unhealthy finances Executive Summary12– suggesting headroom for a rise. With each 1p rise potentiallyraising 3 billion a year, raising the rate to 22 per cent would raise 10 billion a year from profitable companies, while keeping inplace two thirds of the 9 percentage point rate cut since 2010-11and ensuring the UK’s headline rate remains below the OECDaverage. as should overdue reforms to wealth related taxesOne of the major challenges facing the UK tax system is thatit has not kept pace with changes in the overall amount anddistribution of wealth. Over the past four decades, the totalamount of household wealth in Britain has grown from threetimes national income to over seven times, whereas wealthrelated tax revenues have stayed roughly constant as a shareof GDP. So we propose a package of reforms in this area thatrationalise the allowances (including for capital gains) that givethose who can choose the form in which they take their incomethe ability to pay significantly lower taxes, and restricting orabolishing exemptions that are either unjustified or too oftenabused. We also set out longer-term changes that are desirable intheir own right and could be called upon if the scale of necessaryconsolidation increases.The immediate package is made up of five elements. First, areform of Capital Gains Tax (CGT) and taxes on other formsof income to work towards parity of tax treatment betweendifferent forms of income, thus raising revenue while improvingfairness. Here we propose abolishing Business Asset Disposal(BAD) relief, and ending the step-up in the basis of capital gainsupon death, which can incentivise people not to sell or passon assets before they die. Second, changes to the tax reliefs onincome from savings and investments, including merging severaltax-free allowances (including for capital gains, dividends andsavings income) and the abolition of the Lifetime ISA. Third, areform of pension tax-free lump sum allowances that in theircurrent state are both highly expensive and highly regressive.Fourth, several reforms to Inheritance Tax (IHT). And fifth, aCouncil Tax Supplement on properties worth over 2 millionResolution Foundation

Unhealthy finances Executive Summary13that partly fixes the regressivity of Council Tax. Collectively,these measures would raise 9 billion.Looking further ahead, there are more fundamental reformsin key areas that are desirable and could be brought in if alarger consolidation is required. IHT could be replaced witha tax that is paid by recipients rather than donors, thusaddressing concerns about its high rate, ease of avoidance andthe perception that it ‘taxes giving’. Property taxes in the UK– notably Council Tax and Stamp Duty Land Tax – are ripe forreform. The former is highly regressive, outdated, and shouldbe overhauled, while the latter reduces the volume of otherwisedesirable property transactions and should be cut. Lastly, welook beyond the parameters of the existing wealth tax systemtowards a new idea that has rapidly gained traction in policydebates both in the UK and USA: taxes on the ownership of netwealth.We propose the introduction of a ‘Health and Social CareLevy’ to raise significant revenue, improve our tax systemand deliver badly-needed resources for social careFor a consolidation on this scale, it is hard to escape theconclusion that some increase is needed in the marginal rates ofincome or expenditure taxes. An option that has regularly beenturned to historically is to raise the main VAT rate. With each 1praising 8 billion, this could be a substantial revenue raiser. Butthis would not be a progressive change and would exacerbateexisting distortions between standard-rated and non-standardrated expenditure. So while acknowledging a strong economiccase (though weak in political terms) for broadening the VATbase, we do not think changes to VAT are the answer. Likewise,governments have regularly turned to NI rate rises, but repeatingthat approach would not be a fair way to raise revenue. NIapplies only to working-age earnings, and so those over the statepension age, however well-off, or those receiving other formsof income would not contribute. IT rate rises would be sensible,given its broad base and progressive impact. Increasing every ITrate by 1p would raise 7 billion a year, and more could be raisedwith larger increases for higher earners. However, a simple ITResolution Foundation

Unhealthy finances Executive Summary14rise might be considered a missed opportunity to improve thetax system and to address the challenges faced by the country.Moreover, such a change would explicitly break Conservativemanifesto commitments to not raise the rate of IT, VAT or NI.Given these considerations, we propose that the centre pieceof the coming consolidation should be a new Health and SocialCare Levy. It would be set at a simple flat rate of 4 per cent, paidabove a threshold of 12,500. This would be combined with theabolition of Class 2 NI for the self-employed and a 3p cut in thebasic NI rate for employees. The Levy would apply equally acrossdifferent generations and across different forms of income,including taxable capital gains.This approach is designed to deliver the bulk of the necessaryconsolidation in a way that protects those on lower incomesand supports broader national priorities that have been put intostark relief by the pandemic. It would: Be highly progressive. Employees earning below 19,500would be better off. Raise significant revenue for social care. Such a tax wouldraise 17 billion, with 6 billion of that set aside for socialcare. Reduce the tax gaps that heavily incentivise selfemployment, with the greater insecurity that can bring. Itachieves this by levelling down NI rates for employees tothose paid by the self-employed. In the longer-run, it would be desirable to go further andcompletely replace personal NI with the new Health andSocial Care Levy.Resolution Foundation

Unhealthy finances Executive Summary15Summary of our recommendations for raising around 40billion in 2024-25Policy recommendationsRevenue raised(2024-25,nominal bn)Environmental tax reformsReform Vehicle Excise DutyIntroduce a Home Delivery Congestion ChargeSubtotalFreezing tax thresholds and raising Corporation TaxFreeze IT personal allowance at 12,500 (from April 2021)Freeze IT higher-rate threshold at 50,000 (from April 2021)Freeze IHT thresholds at a combined level of 1m (from April 2021)Extend the VAT threshold freeze (from April 2022)Raise Corporation Tax rate from 19% to 22%SubtotalReforming wealth taxesScrap BAD relief and curtail voluntary liquidations CGT loopholeRemove capital gains uplift on deathMerge allowances for CGT, dividends, savings income & ISA incomeScrap Lifetime ISAsCap pension tax-free lump sums at 100,000End the tax-free treatment of inherited pensionsAdd a 2.5m cap on business/agricultural property IHT reliefIntroduce a Council Tax Supplement on properties worth over 2 millionSubtotalIncreasing major tax ratesExtend VAT to private school feesScrap the IT marriage allowanceIntroduce a 4% Health and Social Care Levy on most income over 12,500: net4% Health and Social Care LevyCut basic employee NI by 3p & abolish Class 2 NIBoost social care spendingSubtotalTOTALResolution 60.10.50.61.48.81.60.511.331.5-14.2-6.013.540.2

Unhealthy finances How to support the economy today and repair the public finances tomorrowSection 1IntroductionIn the face of a global pandemic and huge recession, policy makers face the challengeof tackling the health crisis and supporting the economy. Both are expensive. Indeed,borrowing looks set in the coming years to reach levels unprecedented in peace time.So this report discusses how best to approach fiscal policy, given this damage to thepublic finances. At the heart of our approach is a recognition that the low interestrate environment constrains the Bank of England’s ability to support the economy,profoundly changing the size, timing and nature of the appropriate steps to repair thisdamage compared to past recessions.The immediate priority should be for fiscal policy to provide the absolutely essentialsupport that the economy needs in the short run. While some would argue that thepriority should be minimising the damage to the public finances, such an approachis short sighted. This is because fiscal policy has a crucial role in minimising thehardship faced during the crisis, and also because more active fiscal policy todaycan reduce the size and longevity of the economic hit, which will reduce the need forfuture fiscal tightening.Looking further ahead, policy makers must also do what is necessary to ensuresustainable public finances. In this context, there are those who would say thatthe current low level of borrowing costs means there is little need for future fiscaltightening. But this ignores the need to repair the fiscal damage done by thestructural hit to the economy, and build fiscal space ahead of future recessions inorder to ensure that policy can respond. This need is real even if interest rates remainat their current historical low.In this report, we set out how the Government should approach achieving theseobjectives, considering jointly the macroeconomic objectives and the detailedpolicies needed to achieve them. In doing so, we wrestle with the reality that anystrategy devised today has to be set in the face of vast epidemiological, economic andfiscal uncertainty.Resolution Foundation16

Unhealthy finances How to support the economy today and repair the public finances tomorrow17The approach in this report is based on the lessons of the past decade. Mostsignificant here is the need for fiscal policy to play a much greater role than in pastrecessions in supporting the economy given the constraints placed on monetarypolicy makers at the Bank of England by the low level of interest rates. This meansthat we must postpone fiscal consolidation until it is clear that the recovery issufficiently entrenched to ease the monetary policy constraints. But it also meansdoing more tightening once the recovery begins to ensure fiscal policy has the spaceto fight fut

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