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How Labour can win the coming argument over tax and spend

Demands for rapid deficit reduction must be resisted as economically unnecessary and socially harmful.

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The news that Pfizer and BioNTech’s Covid-19 vaccine has demonstrated 90 per cent efficacy in early tests, far above expectations for future vaccines, has provided cause for cheer at the end of a dark year. A vaccine is not going to return the world to a pre-Covid setting, but it is at least possible to move beyond the first phase of the pandemic. Disputes over the future shape of the economy are becoming sharper as a result. Prominent among them is the future of public spending and taxes, with the publication of two reports this week suggesting significant new tax rises will be necessary in the future. 

The Office of Tax Simplification’s report on Capital Gains Tax (CGT), commissioned earlier in the year by the Chancellor, Rishi Sunak, has, as expected, recommended that CGT is aligned with taxes on income. Under the current anomaly, capital gains are taxed at significantly lower rates than income (the legacy of tweaks by the last Labour government). The report suggests that £14bn a year could be raised from equalisation. The Resolution Foundation, meanwhile, has proposed a suite of new tax rises, including a “Health and Social Care Levy”, to meet future costs.

For all Sunak’s talk of a “sacred duty” to repay the debt accrued in the first phase of the pandemic, there is no earthly reason to rush to do so. Government borrowing costs remain at historic lows, for the UK as for countries across the world, and there are no signs of any future pressures from bond traders, even with UK government debt rising beyond £2trn (103.5 per cent of GDP). 

Earlier projections from the Resolution Foundation show that, even with the dramatic increase in borrowing necessitated by the pandemic, the total cost of borrowing remains far below the pre-2008 average, precisely because of the decline in government interest rates since then. Any attempts at provoking panic over the current costs of state borrowing, primarily the result of the lockdowns, are either economically illiterate or made in bad faith.

We might now reasonably hope that the exceptional costs of lockdown – a necessary evil only employed when the virus has run out of control – can be avoided in the future. But as that first viral tide recedes, new, higher, long-run costs are being revealed. These future costs were projected to be significant, even before Covid-19, while pressure on the tax base will only increase as the economy changes shape. Before the pandemic, these pressures were arriving in three different ways: from the transition to a lower-carbon economy; from the shift into an increasingly digital economy; and from the ongoing fragmentation of the labour market and the erosion of secure employment.

The shift away from internal combustion engines is, of course, essential to meeting the UK’s emissions targets, and promises huge benefits for the air quality in our choking towns and cities. But with £28bn a year now being raised from fuel duties, equivalent to 1.3 per cent of national income, there is a direct risk to tax revenues. The think tank Policy Exchange estimated the potential loss, given the pace of the change from petrol and diesel needed to meet the UK’s carbon budget, could be up to £23bn a year by 2030.

Digitisation, meanwhile, has significantly undermined the ability of governments across the world to raise taxes from economic activity undertaken on their territory. The digital giants pay notoriously little in the way of taxes, despite their large presence in economies across the world. Amazon paid just £220m in taxes in the UK last year, despite sales revenues here of £10.9bn. But solving the problem will require more than simply asking big tech to contribute a little more. We have a corporate tax system whose principles were laid down, internationally, in the 1930s, and designed for a world where corporate profits could be easily traced to their source and taxed accordingly. The rise of multinational corporations, with their ability to relocate apparent profits to more favourable regimes, and the growth of tax havens have been undermining the corporate tax system for decades. Moves to claim a fairer slice of big tech’s activities, such as the UK’s Digital Services Tax, have been strongly resisted by the US government, jealously defending its interests. International agreement on new corporate tax standards, therefore, remains some distance away.

Tax revenues from income have consistently fallen behind official forecasts in recent years. Stagnant real wages, a steadily increasing Personal Allowance of £12,500 (below which no income tax is paid), and the rise of self-employment have all eroded the income tax base, resulting in a comparatively small number of those in employment carrying a very heavy burden. A continuation of these trends – and the prospects for wages do not look good – would continue to depress future revenues.

These longer-term threats to the tax base were visible even before the Covid-19 recession. So, too, were long-term cost pressures. IPPR estimated two years ago that, simply to maintain current levels of provision, the NHS would require another £26.7bn a year by 2030. Social care, it estimated, needed a further £9.7bn by the same date to close the current gap in provision. If we assume that Covid-19 has made the case not merely to maintain existing provision of critical public services, but to expand their provision, the amounts needed become extraordinarily high. Former Treasury permanent secretary, Nicholas Macpherson, has floated a figure of £50bn a year of additional spending

The prospects for growth in the wake of the pandemic, meanwhile, are not good. The Office for Budget Responsibility already expects the economy to be 3 per cent smaller next year than this. The ongoing costs of, say, mass vaccination, testing, monitoring, and some degree of social distancing all point to serious, long-term risks to growth.

To call this challenging is an understatement. Labour governments have tended to rely on the same prescription as social democratic administrations across Europe to deliver higher public spending: increase taxes a little, and then rely on economic growth. Harold Wilson, Tony Blair and Gordon Brown all adopted some version of this.  But if requirements for spending are rising rapidly, even if only to maintain existing levels of service, and future economic growth looks uncertain, holding to that familiar social democratic balance will become harder. Labour could end up in the worst of all worlds: entering the next general election with a manifesto that both promised sweeping tax rises and real-terms cuts in public services.

To lessen the risks, Labour should try to shift some of the focus away from day-to-day public spending, and develop a programme for an economy rooted in its declared values – security, against job and income losses, and environmental decay; support for families, through reduced working time; and real stakes in the economy through a wider spread of asset ownership, from housing to worker-owned businesses. The green investment measures announced by the party this week were an important move. But to address the core challenge of tax-and-spend, there are four steps that seem sensible.

First, shadow chancellor Anneliese Dodds’s initial approach is the correct one: highlighting the sheer waste and graft of the Tories while looking to establish Labour as the party that understands the value of money is a smart political move – if (and only if) this is matched with a cast-iron refusal to accept that rapid deficit reduction is necessary. The point can simply be made about the hypocrisy of the Tories wasting billions on failed schemes and cash for cronies, but now expecting the deficit to be closed by the rest of us. However, this is a framing argument – not a policy proposal.

Second, proposals of one-off wealth taxes, such as the Resolution Foundation’s “Pandemic Profits Levy” on those companies that have outperformed during the crisis, are smart politics and policy. Even with some difficulties in assessing and levying the amount of the tax, the gains are potentially significant.

Third, a commission on the tax system should be established as soon as possible, led by a respected tax specialist, and look to report perhaps by the end of next year. It is clear that the current tax system will need to change significantly, adapting to long-term shifts in how the economy operates – most of which have been accelerated by Covid-19. But this will require separate elements of the tax system to work together, and a political consensus about large-scale changes will need to be achieved. Piecemeal, step-by-step announcements will not cut it and trying to creep towards the next election, one tax tweak at a time, is to risk disaster.

Fourth, and hardest of all, Labour will need to make the case for a looser approach to the deficit and government debt in the long term. Some of the heavy lifting is being done already, by the simple reality of the exceptional spending, combined with the extraordinary volume of quantitative easing (electronically created money from the Bank of England). 

But demands for rapid deficit reduction must be resisted as economically unnecessary and socially harmful. Labour’s earlier Fiscal Credibility Rule carved out the political space in which a permanent deficit could be maintained by the government, in line with best-practice macroeconomic management. Proposals to change the assessment of government finances – to include assets as well as debt – would help substantially. But the political argument has to be won well ahead of the next election. 

James Meadway is former economic advisor to shadow chancellor John McDonnell, and is currently writing a book on Corbynomics