How to pay for all this furlough? | Nicholas Macpherson sums it up nicely

A longer read than usual for one of our posts but Nicholas Macpherson, former permanent secretary to three chancellors, hits the nail on the head, just like tax is going to hit us all in the pocket to pay for furlough in the not too distant future…

Nicholas Macpherson:

Taxes are going to have to rise.

As with war, the immediate cost of the coronavirus can be financed by borrowing. But as and when we return to normal times, the government will need to set out a plan which stabilises and then reduces public sector debt as a share of national income.

The problem is public expectations of healthcare are rising. Voters will expect greater spare capacity to guard against future pandemics and they will demand better care homes. Demographic pressures on spending are already on the rise. And Mr Johnson’s government has shown little interest in public expenditure control: it was elected on a platform of ending ‘austerity’.

My guess is that taxes will have to rise by at least £50bn a year. The question is how?

I worked on two major fiscal consolidations when I was at the Treasury: 1992–93 and 2010–12.

The first lesson I learnt is that tax reform and tax increases are difficult to reconcile. Extending VAT to domestic fuel in the early 1990s led to an almighty row and government defeat. Similarly, George Osborne had little difficulty raising an extra £13bn by raising the VAT rate from 17.5% to 20%, but he found it impossible to raise £100m by extending VAT to pasties and holiday caravans. It’s better to leave tax reform to the good times when you can lower the rate while extending the base, as Nigel Lawson demonstrated in the 1980s.

The second lesson is that introducing small new taxes can help, but if they are not to cause upset the government should not push them too far. Airport passenger duty and insurance premium tax have been nice little earners. But the revenue they raised initially was in millions not billions. Everybody is in favour of a carbon tax in principle, until they have to pay a higher price at the pump or on their fuel bills. There’s a wider point about tax acceptability: push a tax too far, as New Labour did with council tax and the fuel duty escalator, and you spend many years repenting at leisure as you freeze the tax.

The third lesson is about fairness. Voters won’t tolerate openly regressive taxes like the so-called community charge or poll tax. But at the same time, you won’t raise serious money by soaking the rich. It’s tempting to think that the rich and the companies they own can bear the burden of higher taxes. They won’t. Capital is mobile. Tax it more and it tends to move elsewhere. It’s irritating that digital companies operate out of Luxembourg or Ireland but, the United States apart, governments are never going to extract serious revenue from them. The same can be said of the rich. President Hollande’s tax hike in 2012 merely led to an exodus of the affluent, many of whom came to London.

Taxing wealth is tempting. But wealth taxes rarely raise much revenue, once the inevitable exemption for housing is introduced. And experience suggests that people will go to extraordinary lengths to avoid inheritance tax.

There’s a good case in principle for taxing land – after all, it doesn’t move. But the politics of property taxation are notoriously difficult. All the chancellors I worked for worried about the asset rich but income poor widow. And it is no coincidence that there hasn’t been a revaluation of council tax in 30 years. I much admired the Irish reform of reducing stamp duty rates and introducing a self-assessed property tax. Stamp duty rates are too high and discourage mobility. But I can’t see it happening here. And even if it did, it would be more likely to take the form of a revenue neutral package than as a serious tax raiser.

That does not mean the government should do nothing in these areas. Corporation tax rates were probably reduced too far too fast. And there’s a good case for higher tax rates on capital gains, though economists tend to overestimate the likely yield: experience suggests if you wait long enough a government is elected which will tax your gains at a much lower rate. It’s worth looking again at pensions tax relief though this is already constrained and fiendishly complicated. The government might also consider more council tax bands, though in the absence of a revaluation it might be difficult to make these stick. But measures like these will raise billions rather than tens of billions.

That takes me to the final lesson I learnt. If you need to raise serious revenue, there is no substitute for raising the main rate of one of the big taxes. There is a reason why income tax, national insurance and VAT account for the vast majority of tax revenue. They are easy to collect and they are paid by most of the population.

The problem, in the short run at least, is the government made a manifesto commitment not to raise the rates of these taxes.

Here, the solution is simple. Introduce a new tax: a ‘temporary’ social solidarity charge. It would be modelled on national insurance and based on ability to pay, but unlike NICs it would be paid by old as well as young, and on pension, dividend and rental income as well as earnings. Unlike income tax, there would be no reliefs, and so with the broadest possible base the increase in tax rates could be kept to the minimum.

The new charge could be sold as a way of spending more on health and social care. I’m under no illusion. It won’t be popular. Taxes never are. Sometimes, you have to raise taxes to recreate a coalition for lower spending. The pendulum will swing.