Rishi should raise income tax, not corporation tax

We are approaching the end of a financial year that has seen the deepest recession in over 300 years and the largest level of borrowing in our peacetime history, yet the Chancellor of the Exchequer, when he stands up to deliver his Budget tomorrow, will be able to deliver some good news.  As the Financial Times has reported, the success of the vaccine rollout means that the Office for Budget Responsibility is likely to upgrade its forecasts for economic growth for future years compared to its last predictions made in November.  The situation is bad but not quite as bad as it had looked.

Some will argue that an earlier recovery means that there is less of a case for action to reduce future borrowing.  If the lockdown ends earlier than expected then the economy is likely to be less scarred by COVID than expected and tax receipts may be more buoyant than expected.

This is true but the economic scarring of COVID is only one problem facing the public finances.  A much bigger issue is that the pressures on public spending in future years are going to be immense.  Reversing temporary support – such as the supposedly temporary uplift in universal credit – will be politically painful given that the national mood has shifted to favour a more generous welfare system.  At the same time, addressing the long term health and educational consequences of 2020/21 will not come cheap and local authorities will require very costly bailouts.

All of this means that, even after we have returned to normal levels of growth, the Government’s deficit will be sufficiently large that debt as a proportion of our economy looks set to grow.  Even if we take a relaxed view of the additional levels of debt we have accumulated in the last twelve months, it will still be necessary for the Chancellor to raise taxes if he wants to address the prospect of an ever-growing debt burden.

The economic consensus is that he does not need to raise taxes in aggregate now.  This is sensible given that the short term focus must be to support the economic recovery.  But with the end of the lockdown in prospect and, unusually for a recession, average household savings having increased, a rapid economic bounce-back is realistic.  The Chancellor will argue that this means that taxes can go up sooner rather than later – probably in 2022/23 - which, helpfully for the Government, avoids tax increases close to a General Election.

How, then, does he raise the additional revenue?  The three big taxes – income tax, national insurance contributions and VAT - bring in 64 per cent of all government receipts.  Unfortunately, the Conservatives promised not to raise the rates of these taxes in the 2019 manifesto.  This was never a wise pledge as subsequent events have demonstrated.  Allowances and thresholds can be frozen but if the Chancellor is serious about sustainable public finances he will need to look again at these rates.

Without doing this, he is forced into increasing business taxes, especially corporation tax.  This may be politically expedient but it will damage the UK’s reputation for competitiveness and make it harder to attract business investment.  Having reduced access to our biggest export market through a hard Brexit, abandoning a competitive corporate tax system would be a further blow to our international reputation and long term prosperity.

The Chancellor is right to think that taxes will – eventually - have to go up. But if he relies heavily on corporation tax, he will unnecessarily make the UK a less attractive and dynamic place in which to invest.