How Rishi hit Britain with a tax bombshell

Rishi Sunak tax bombshell
Rishi Sunak tax bombshell

Record taxes, higher spending and mass state subsidies aren’t usually the hallmarks of a Tory government. But Rishi Sunak has presided over all three this Parliament.

The Prime Minister’s raid on British workers and businesses – equivalent to £3,500 per household – amounts to more than Gordon Brown’s infamous 157 stealth tax rises during the Blair years that he brought in alongside a big increase in National Insurance and a 70 per cent hike in council tax.

It’s bigger than Harold Wilson’s introduction of capital gains levies in the 1960s, when the Labour prime minister also announced an income “supertax” of more than 90 per cent that inspired the 1966 Beatles song Taxman.

And Sunak can’t just blame lockdowns and Covid. The Institute for Fiscal Studies (IFS) says the steady ratcheting up of the tax burden is a result of conscious choices that it believes are part of a permanent shift towards a higher-tax economy.

It’s a shift that has seen millions more people dragged into higher income tax bands as part of a trend that will result in one in five of all taxpayers paying the higher 40p rate by 2027, including more than one in eight nurses and one in six machinists.

The shift has also seen the first increase in corporation tax since the 1970s, in a move that will see receipts climb to their highest share of the economy since the height of the Lawson boom, and far above the 2.4 per cent average of the past five decades. And it’s a shift that has resulted in a ballooning welfare bill as hundreds of thousands more people claim benefits that do not even require them to look for work.

So how did we get here?

Upward pressure

It was a triumphant Sajid Javid who stood up in the House of Commons to declare the end of austerity in September 2019.

After a decade of spending restraint, public debt was falling sustainably as a share of national income “for the first time in a generation” said the then chancellor. It meant the lean years were over, he told the House.

“We are turning the page on austerity and beginning a new decade of renewal.

“A new economic era needs a new economic plan, and today we lay the foundations with the fastest increase in day-to-day spending in 15 years.”

He promised voters who would soon head to the polls a Britain with safer streets, better care for its sick and improved schools. Four years and just as many chancellors later, the Conservative Party is gearing up for election again.

The political backdrop is hardly flattering: schools are crumbling, NHS waiting lists remain at record highs and retail chiefs complain criminals now have a licence to shoplift.

Meanwhile, taxes on households and businesses relative to national income have risen at the fastest pace since at least the Second World War.

Research from the Institute for Fiscal Studies published this week found that the increases in tax revenues amounted to £100 billion more. Every single year.

Many of the spending increases reflect conscious political decisions, says IFS economist Ben Zaranko.

“What we’ve seen over this Parliament is a big increase in the NHS budget, fairly chunky increases in school spending to try and undo the cuts of the 2010s and some increases elsewhere,” he says. “That’s led to lots of spending across the board and a bigger state than what we had at the start of the Parliament.”

Some boosts to spending can be traced back to the Conservatives’ election manifesto in 2019. Boris Johnson at the time pledged to put 20,000 more “bobbies on the beat”. By March 2023, England and Wales had 20,951 more officers, bringing the total to 149,572.

Schools would also receive more money for every pupil, he promised. Funding has since risen from £6,550 in 2019-2020 to £7,220 in today’s money – marking a real terms increase of 10 per cent.

Johnson also told voters hospitals would receive a boost of 50,000 nurses. In April, the number of nurses was 41,000 higher than in 2019.

“The upwards pressure on spending after a decade of austerity plus a pandemic is proving very difficult to resist. The easy options for savings have long been exhausted,” Zaranko says.

“It’s a very difficult set of choices to be made and so we’ve ended up increasing taxes as a result.”

Spending has increased across most parts of the state – be it education, defence, public order or transport.

Unsurprisingly, by far the biggest rise has been in health, costing the Government £27 billion more a year in real terms than in 2019-2020. The increase is the equivalent to a 15 per cent uplift in spending.

Some of this reflects £2 billion put towards bringing down uncomplicated but high volume procedures like replacing sore hips and creaky knees, says Siva Anandaciva from the King’s Fund health charity.

“That’s one area where the government specifically said here’s a portion of the extra billions we’re giving you that we want specifically targeted at increasing the number of operations that are done,” he says.

The rises in health spending over the past four years partially cover pandemic-related cash injections and then piles of money put into getting it back on track – although the distinction is not always clear cut.

“There was a period where in the middle of Covid-19 there were record budget increases, but they were very specifically tied to Covid-related factors like PPE and test and trace,” he says.

“The government did top-up funding again for the NHS to give it two spurts of £3.3 billion in the Autumn Budget.”

The overarching message, however, says Anandaciva, is that when removing the Covid cash injections, spending increases have actually been roughly in line with the long-run average of 3.7-3.8 per cent. This is far lower than when Tony Blair’s New Labour was in charge, with budgets rising by around 6.5pc in real terms every year.

But the recent period follows a decade of austerity when spending increases were kept to around 1.2pc in real terms – with lower capital spending and falling real pay for healthcare staff.

Ballooning benefits

Productivity in the NHS has also fallen over the pandemic meaning that even as more money goes in, the waiting lists keep growing.

The British population is also getting sicker, which has resulted in a ballooning benefits bill.

There are now more than 2.5 million people out of work because of long-term health conditions.

Almost half a million more are struggling with mental and physical health issues such as anxiety, repetitive strain injury and back pain compared with a few years ago, with around 350,000 more economically inactive people compared with before the pandemic.

An overwhelmed benefits system that moved to online-only assessments led to some welfare applications being waived through automatically, official figures suggest.

At one point during the pandemic, everyone who applied for incapacity benefit, which pays an average of £10,000 per year, was approved, up from 81 per cent on the eve of Covid.

This has led to a roughly £6.8 billion annual increase in the UK’s benefits bill for the near million people who are in poor health, almost half of whom are economically inactive.

Those who are not at work are also not paying income tax or national insurance, losing the Treasury an average of £5,000 per person in tax revenues.

Altogether, the Office for Budget Responsibility (OBR) estimates the foregone income tax, national insurance contribution averages and other government receipts amounts to around £8.9 billion.

Then comes the healthcare costs themselves.

“We estimate that each individual moving into health-related inactivity costs the NHS between £900 and £1,800 a year,” says the OBR.

Worse is to come “given the well-documented negative effect of worklessness on people’s health”.

The longer this persists, the worse it will get, according to the fiscal watchdog.

The OBR estimates one in eight of all working age people will be claiming some form of disability benefit by 2027 at a cost to the taxpayer of £77 billion a year, according to the Department for Work and Pensions.

An ageing population and the Government’s so-called triple lock pledge to uprate pensions by the highest rate of inflation, pay growth and 2.5 per cent every year are also contributing to a ballooning welfare bill.

The IFS has warned that keeping the triple lock in place could increase spending by £45 billion a year by 2050.

And it’s workers and businesses who are footing the bill.

‘From warfare to welfare’

While the headline rate for income tax remains unchanged, the Government is also placing far greater pay demands on workers.

Despite inflation having spiked to its highest level in more than 40 years, Sunak has chosen to freeze income tax brackets.

He first announced the freeze as chancellor in 2021 and Jeremy Hunt has since extended the policy until 2028.

Rishi Sunak
The Prime Minister’s raid on British workers and businesses amounts to more than Gordon Brown’s infamous 157 stealth tax rises during the Blair years - Julian Simmonds

The policy means nearly 2.5 million people will be dragged into the higher-rate 40p and 45p tax brackets in the next five years as a result, according to the OBR.

Many will be unaware that their tax bill has actually risen massively. The six-year stealth tax raid will be larger as a share of national income than Hunt’s decision to raise corporation tax from 19 per cent to 25 per cent.

It is also a bigger tax grab than Gordon Brown’s decision to abolish the 10p income tax rate in 2007, and is the equivalent of a 4p increase in the basic rate of tax.

Meanwhile, businesses are also facing higher levies for their workers.

In last year’s Autumn Statement, Hunt froze the thresholds at which employers must pay national insurance until 2027-28.

The OBR estimated this will cost businesses an additional £5.7 billion by the final year of the policy. These already very significant rises come in addition to windfall tax on the energy industry.

The policy has raised oil and gas production taxes from 40 per cent to 75 per cent and is set to remain in place until 2028.

Higher inflation has meanwhile boosted the tax take from these policies by far more than expected – but have so far not resulted in any actual tax cuts.

But like the pattern of the past 15 years, chancellors rarely use windfalls to lower taxes despite unexpected shocks nearly always resulting in higher levies, the IFS points out.

These challenges point to a wider economic shift over the past decades, which Zaranko describes as moving from “warfare to welfare”.

Since the Second World War and the end of the Cold War, governments saw less and less need to put money towards defence, resulting in it falling from over a fifth of total managed expenditure in the 1950s to below 5 per cent in recent times.

This freed up fiscal space to put more money towards doctors, nurses and hospitals – and also pensions, parental leave payments and sickness benefits.

“For a long time, those two things largely offset each other. We spent more on health, we spent less on defence, we spent less on things like housing and stuff over time as well. We were able to keep the tax take pretty constant whilst expanding the welfare state,” he says.

“Now we are in a world where we’ve played that trick, and we can’t really do it again.”

Over the decades, the UK’s tax burden has moved significantly as a result.

Figures from the OBR show that during the Wilson years of the 1960s, the tax take in Britain was almost 30 per cent of GDP, noticeably above the share in other similar countries. The strain of paying down the national debt after the Second World War pushed up the tax burden relative to the size of the economy.

By 1980, after a series of global economic shocks and the expansion of welfare states in many other countries, Britain’s taxes were lower than average for a G7 nation.

Through the Thatcher and then Major years, taxes were generally cut, lowering the burden on the economy even as other nations took a greater share from families and businesses.

Through the Blair era, the tax burden went back up again, getting back to the rich world average by 2006 and briefly rising above typical OECD levels in the immediate aftermath of the financial crisis.

Since then the burden stayed roughly steady at around 32 per cent of GDP – until the pandemic.

Now it is racing towards 37 per cent – a peacetime record.

A trend of spend

Tax receipts are not only high by historical standards. They are also rising compared to those in other nations.

Britain’s tax burden has already moved above Canada’s. The OBR predicts that in the coming years it will also leapfrog nations including New Zealand, Estonia, Iceland and Portugal.

Critically, by 2027-28 the UK’s tax burden is on track to move back above the OECD average, putting Britain towards the wrong end of the competitive scale of nations.

It’s not just tax receipts. Spending is rising quickly, too, in a way that has alarmed the Chancellor.

Hunt will set out his plan on how the Tories will stop an ever expanding state when he addresses the Tory faithful at next week’s annual party conference.

Jeremy Hunt has since extended the freeze on income tax brackets until 2028
Jeremy Hunt has since extended the freeze on income tax brackets until 2028 - PA Wire

Public spending as a share of GDP ballooned to more than 50 per cent of the economy during Covid and is expected to settle at around 43.4 per cent, its highest sustained level since the 1970s, according to official projections.

The state is currently growing faster than the economy, a trend that is also putting the UK on course to look more like France than the US.

Hunt himself acknowledged this summer that while the UK economy is expected to expand by around 1.6 per cent a year from 2030, public spending – even excluding debt interest – is expected to grow by 2 per cent a year.

“You don’t need brilliant Treasury analysts to tell you the consequence of a state growing faster than the economy: higher borrowing, higher taxes or a combination of the two,” Hunt said this summer.

If these trends continue, this suggests the size of the state will grow to almost 65 per cent of the economy in 50 years time, requiring the government to borrow more than half a trillion pounds a year in today’s money to plug the gap between tax revenues and public spending.

The debt burden would rise from around 100 per cent of GDP today to more than 300 per cent. “This is simply unsustainable,” says one top official.

Gregory Thwaites, an economist at the Resolution Foundation, says growing spending is at the core of the tax problem.

At a time of low economic growth, successive Governments sought to fund ever-rising NHS and welfare payments by shrinking other areas of the state instead of raising taxes.

“We cut defence spending for many years, and that has probably run its course. Other bits of expenditure that were cut in the 2010s, in the austerity period, on local government, courts and so on, you cannot keep doing that,” he says.

“We have exhausted the savings we can make from other bits of public spending.”

Mervyn King, the former governor of the Bank of England, has long warned of the significant pressure for higher spending and the sacrifices this will entail.

“The challenge is if we want European levels of welfare payments and public spending, you cannot finance that with American levels of tax rates,” he said in a television interview shortly after the high spending, high borrowing mini-Budget last autumn.

“So we may need to confront the need to have significantly higher taxes on the average person.”

The problem, says Thwaites, is that countries including America, Germany and the Nordic states are significantly richer than Britain, so can pay for better public services for any given level of taxes.

Given the woes plaguing the British public sector, this raises an unpleasant prospect – could Britain end up with American levels of services with European rates of tax?

“We are not there,” he says. “Yet.”