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24 October 2022

How would Labour pay for its spending plans?

A new government could overhaul a tax system that is prejudiced in favour of ownership.

By Will Dunn

If a general election were held today Labour would win a 368-seat majority, according to the New Statesman’s latest modelling. The worry among Labour supporters, however, is that while polling indicates a landslide for the party, it would inherit an economy in tatters. After 12 years of Conservative government Labour would face a “guaranteed” recession, the highest borrowing costs for over a decade, the worst current account deficit on record, and inflation that could hit 18 per cent by the spring according to the bank Citi. What’s the point of being in power, some ask, if you can’t afford to change anything? 

One answer is that while the Conservatives have talked a great deal about the need to “reward hard work” (Liz Truss) and build an economy in which “it pays to work” (Rishi Sunak), they have created a tax system that is deeply prejudiced against work, in favour of ownership. A new government could raise a lot of revenue for public spending by addressing this principle, using some relatively straightforward measures.

Reform capital gains tax: £16bn a year 

After the mini-Budget Truss attempted to justify cutting income tax for the highest earners with the claim that “people at the top of the income distribution pay more tax”. This is a misdirection. While the richest people in the UK do pay a bigger share of income tax receipts, they pay a lower effective tax rate than even the lowest earners.

This happens because the wealthy make their money as gains rather than income, and gains are taxed less: income from selling shares is taxed at 10 per cent for basic-rate taxpayers, for example, and 20 per cent for higher-rate taxpayers. Selling a second or third home is taxed at 18 per cent or 28 per cent. Sell a business and you’ll only pay 10 per cent on the first million.

Arun Advani, associate professor of economics at Warwick University, has shown that the average person in the UK with an income over £10 million pays a lower effective tax rate (EATR) than someone earning £30,000 a year. Plot a line of how much people tax people actually pay, Advani told me, and “what you see is that as income levels rise, people pay a larger share of their income up to about £250,000, but then it flattens out until about £600,000, and then it actually drops”. The biggest gains, then, are concentrated within a group of fewer than 100,000 people. 

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Taxing gains in line with income should therefore be a relatively uncontroversial move – it was considered as a post-Covid measure by Sunak when he was chancellor – and the public would be mostly interested in the £16bn a year that Advani says the measure would raise.

[See also: We need a general election now – there is no mandate for austerity 2.0]

Expand National Insurance: £10bn a year 

Another way in which the tax system favours wealth over work is in National Insurance Contributions (NICs), which are not levied on the profits from owning assets. People who work, or who employ workers, have to pay NICs but landlords don’t, and business owners can avoid them by paying themselves in dividends rather than through a salary. 

Again, changing this should be relatively uncontroversial. “It’s not about punishing people for owning stuff,” said Advani. “It’s not about penalising them and stopping them from having the stuff they own. It’s just about saying: ‘It’s not clear why you pay a lower tax rate, if you happen to own stuff, than if you’re working hard to get your income’.” 

Of course, it would be unpopular with the roughly half a million private landlords in the UK, but there’s a lot to be said for encouraging these people out of the housing market; it could dramatically increase the supply of available housing, depress prices and therefore reduce one of the most damaging kinds of inflation.

Land value tax: £20bn a year

It’s not just that assets are taxed less than work in the UK; work, through public spending, actually increases their value. For example, if a supermarket chain buys a plot of derelict land and holds on to it for a decade while roads and houses are built around it, the plot will become much more valuable either as a site for a new supermarket or as an asset that can be sold on. Other businesses and the government have made the investment, but the increase in land value goes to the owner. Similarly, a residential landlord might not pay any council tax or even live in the same town as the property they own but they can take a profit, through the increase in the value of their asset, from the taxes and private spending of people who do.  

Lukasz Krebel, economist at the New Economics Foundation, says a tax on “economic rent” – rent extracted from a limited resource such as land – is good for growth because “it doesn’t discourage productive activity”. It could also, he argues, promote growth if it was used to replace business rates, moving the tax burden to landlords and enabling more investment by businesses. Commercial landlords might object, but Krebel says they are to a certain extent already paying something like this charge because business rates mean that businesses can only afford to pay a certain amount of rent. Krebel’s proposal is for a type of land value tax that raises around £20bn a year and supports much lower, locally controlled business rates, which he says would allow businesses to invest more, simplify local government funding and “incentivise efficient use of land”.

A land value tax could take many forms, however. It could address the inequality between council tax rates, for example, which place the same charges on properties with wildly different market values. 

Tax the non-doms: £3.2bn a year 

One important subset of wealthy people who could be asked to pay more tax are non-domiciled residents, or “non-doms”, who live in the UK but enjoy a provision in UK law that their income only becomes taxable when it, too, is moved to the UK.

Advani’s research has found that removing this provision, even after the behavioural responses that would result – the fact that people would move to other tax reliefs, or just elope to Monaco – would raise an extra £3.2bn a year for the Exchequer. There are fewer than 70,000 non-doms in the UK, so this is not going to lose a huge number of votes outside Mayfair, and in terms of legislation it is very straightforward – the provision has been changed in the past, most recently by George Osborne in 2015.

And yet, for some reason, this is a measure that does not appear to have been considered by Sunak. 

Alternative minimum tax: £11bn a year 

Another option would be to bring in a system similar to that used in the US, where the highest earners can use any tax reliefs the law allows, but if this brings their effective tax rate below a certain minimum threshold they are required to top up their payments so that they’re not paying a level of tax far below the median worker. Advani’s research suggests that were an alternative minimum tax of 35 per cent to be implemented in the UK, it could raise at least £11bn a year.

Restore fiscal credibility: £££££priceless 

The above are all adjustments to the way in which the government would raise revenue, but there’s an argument that a Labour government would to a certain extent mend its own finances simply by offering a more credible country for bond-buyers to invest in.

Banks advising these investors continue to observe a “political risk premium” – known less kindly as the “moron premium” – on the market value of gilts (UK government bonds) and sterling, which have a significant impact on the cost of imports (and therefore inflation) and the cost of debt (the less people pay for gilts, the more it costs the government to borrow). Restoring fiscal credibility with a functioning government would be the first and most important step towards protecting public spending.  

[See also: Boris Johnson’s path back to power is a treacherous one]

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