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9 February 2022

The rise of high-tax Britain

Though the Conservatives still lionise Margaret Thatcher, they are raising taxes to the highest level since the early 1950s – and those who stand to benefit are the party’s core, older voters.

By Duncan Weldon

The modern Conservatives still aspire to be the party of Margaret Thatcher. Speeches and manifestos are peppered with references to the virtues of low taxes, deregulation and the spirit of free enterprise and individual liberty. But it increasingly resembles an ageing Anglican congregation. While some true believers remain, most are drawn to the services more by habit than conviction and are happy enough to mumble along to the hymns on a Sunday morning without ever listening to the message.

Rishi Sunak, their trendy new vicar, certainly gives a good sermon. “My goal,” the Chancellor announced at his last Budget, “is to reduce taxes.” He trotted out all the old 1980s favourites: “I want this to be a society that rewards energy, ingenuity and inventiveness. A society that rewards work.” Gesturing to his colleagues, he declared that “this is what we believe on this side of the House.”

But over the course of 2021, Sunak announced the steepest set of annual tax rises since the early 1990s. The UK tax take is set to rise from 33.5 per cent of GDP before the pandemic to 36.2 per cent by the mid-2020s. That will be the highest share of national income taken by the state since the early 1950s (see chart). Corporation tax is rising from 19 per cent to 25 per cent, income tax thresholds are being frozen in cash terms – dragging more workers into higher bands – and this April’s National Insurance increase (from 12 per cent to 13.25 per cent) will cost a worker earning £30,000 an extra £214 a year.

Britain, despite being in its 12th year of Conservative-led government, is becoming a high-tax country. The planned tax rises over the rest of this parliament will take the United Kingdom from the bottom third of the OECD group of advanced economies, in terms of tax levels, to the top half.

[See also: Is Rishi Sunak determined enough to end the farce of the Johnson premiership?]

While many Conservatives are uncomfortable with this direction of travel and some blame the supposedly spendthrift Boris Johnson, this pattern owes little to the whims of the Prime Minister or his predecessors. The trend towards a higher tax burden is being driven by longer-term demographic, political and economic factors.

Despite the Conservatives’ tax-cutting instincts, their recent historical record in office is more ambiguous than they like to think. Margaret Thatcher may have slashed the rates of income and corporation tax in the 1980s but she almost doubled VAT from 8 per cent to 15 per cent.

In the 1990s, as chancellor, Ken Clarke imposed the biggest tax rises since the Second World War to reduce the budget deficit. Two decades later, George Osborne may have increased the personal allowance to £11,500 and cut corporation tax but he also increased VAT from 17.5 per cent to 20 per cent. Yet even if the Conservatives’ low tax credentials are not quite as pristine as they wish to claim, the 2020s still appear to be a decisive break.

Partially, of course, this is a consequence of the Covid-19 pandemic. In 2020 Britain experienced its deepest recession in at least a century. But the government, like other states around the world, moved quickly to shield households and firms from the impact. Tax cuts, grants and cheap government-backed loans for firms, combined with the furlough scheme (the government in effect paid workers not to work), meant that, despite a collapse in economic output, the rise in unemployment was contained, the hit to household incomes was limited and business failures remained low. The impact of the recession was most visible on the public finances with the deficit rising to its highest-ever peacetime level (£323bn or 15.1 per cent of GDP) and the ratio of government debt to GDP growing from around 80 per cent to almost 100 per cent over the course of just 12 months.

But while the pandemic may have supercharged a trend, the path being taken was already clear. The last pre-pandemic Budget projected taxes rising to their highest share of GDP since the early 1970s. One underlying reason for higher taxes is weaker economic growth.

Before the 2008 financial crisis it was widely assumed that the trend growth rate of the British economy was around 2.75 per cent. That is to say, a combination of population growth and rising productivity (the ability to get more output from any given level of inputs) would allow the economy to grow by that much in a “normal” year without any danger of overheating or rising inflation. But over the past decade that trend rate has been closer to 1.5 per cent, and forecasters such as the Office for Budget Responsibility (OBR) and the Bank of England have gradually given up hope that the old normal is ever coming back.

Had wages grown at their pre-financial crisis pace of around 4 per cent per year, rather than their post-2008 rate of around 2 per cent, more money would have flowed into the Exchequer each month in the form of income tax payments and National Insurance contributions. A decade of lost income growth for workers has also meant a decade of lost revenues for the Treasury. And then there is the effect of Brexit, which the OBR projects will reduce GDP by around 4 per cent over the medium term, further reducing tax receipts.

[See also: Leader: The unworthy Boris Johnson]

All things being equal, to use an economist’s favourite phrase, anaemic growth equals anaemic tax revenues. But all things are rarely equal. Changes in the structure of the economy and the labour market over the past 20 years have made even the disappointing growth the country has experienced less tax-generating than it once was.

The share of retail spending carried out online rather than at physical shops rose from less than 5 per cent before 2008 to almost 20 per cent on the eve of the pandemic. Even with physical retailers now free of Covid restrictions, around a third of retail spending remains online. Such spending is more likely to find its way to global tech giants which tend to pay lower corporation rates and generate far less in the way of business rates because of the smaller premises they require.

In the two decades before the pandemic, the number of self-employed workers rose, from around 12 per cent of the workforce to more than 15 per cent. Trade unions and campaigners called much of this growth “bogus”, but whether genuine or not it was hardly great news for Her Majesty’s Revenue and Customs: the self-employed pay considerably lower National Insurance contributions.

Higher energy bills in the months ahead, as the domestic price cap is raised by £693 in April, will create another headache for the Treasury. Domestic energy attracts a VAT rate of 5 per cent rather than the 20 per cent charged on most items. A family whose energy expenditure rises by £500 and that reduces its discretionary purchases by the same amount could end up paying £75 less tax despite making no change in its overall spending.

Weak growth, and less tax-rich growth, does not have to equal higher tax rates. The response could well be lower public spending or higher government borrowing. But politics has effectively closed both options for the Conservatives.

The modern Conservative electoral coalition is rather different from its 1980s ancestor. While it was possible to govern Britain from the centre right in the 1980s by arguing for lower taxes and lower spending, that is a trickier proposition today. Britain is an older country now and age has become the single greatest predictor of voting behaviour. At the 2019 general election the Conservatives beat Labour by 62 per cent to 18 per cent among the over-65s, by 49 per cent to 27 per cent among 55- to 64 year-olds and by 43 per cent to 35 per cent among 45- to 54-year olds. The older the average age of a seat’s constituents, the more likely it was to swing towards the Conservatives.

Older voters have long skewed to the right in Britain, but the age divide has never been so extreme. Nor, until recently, did the underlying demographics of the electorate allow for a party to rely so heavily on older voters. In the mid-1980s, at the height of Thatcher’s electoral hegemony, those of pensionable age represented around 15 per cent of the population compared with around 20 per cent today. That share is forecast to rise towards 25 per cent by the mid-2030s. Differential turnouts by age magnify the impact. Margaret Thatcher won older voters but to retain power she needed to maintain the support of a substantial proportion of the working-age population; Boris Johnson has less need of them. Indeed, Labour led the Tories among the latter at the 2019 general election. The problem, for a party supposedly wedded to low taxes, is that older voters are rather keen on some types of government spending.

The Tories’ new electoral base – home-owning older voters who have either retired or are approaching retirement – have a different attitude to tax and spending from the Thatcherites of the 1980s. They may not like the notion of government spending in the abstract but they certainly do not want spending on the NHS, pensions or social care to be cut back. And such spending is an ever-larger part of Britain’s state. As the OBR noted last year, the overall size of the state is forecast to be around 42 per cent of GDP in 2024-25, strikingly similar to its pre-Thatcherite level in 1978-79. But while health, social care and pensioner welfare represented less than a quarter of government spending in 1979, they will account for more than a third by the mid-2020s.

Even during the austerity years of the 2010s, NHS spending was protected in real terms and the state pension was “triple locked”: rising in line with average wage growth, inflation or 2.5 per cent (whichever was highest). Pensioner benefits were excluded from the benefits freeze. Osborne, like Thatcher, could always find less politically salient areas of public spending to reduce (most notably, local government). But a decade of tight spending reviews for non-health and pensioner-related departments have left little room for further cuts.

[See also: Leader: Britain faces two lost decades]

All of this long pre-dates Boris Johnson’s own brand of Conservativism. Some Tory MPs place the blame for higher taxes on him. They fear he is a soft populist who gives way too easily on spending and is too keen on grands projets. He did, after all, commission a report on building a bridge from the British mainland to Northern Ireland. And his taste in wallpaper is hardly indicative of one careful with money.

But it is the need to keep an ageing voting base on-side that has caused higher spending, rather than Johnson’s pet projects. Most of the much-touted spending due to be lavished on the Red Wall seats won from Labour takes the form of investment rather than day-to-day spending and, under Sunak’s fiscal rules, it can be funded from borrowing rather than taxation. It is hard to see how a Johnson successor could cut public spending significantly without disappointing the Tories’ core electoral coalition.

The other route to the Tories reclaiming their tax-cutting reputation would be simply to accept the resulting deficits and higher government debt ratios. Donald Trump and Ronald Reagan did just that. Sunak, driven by both a conviction that high borrowing represents a potential economic vulnerability and the desire to maintain a political dividing line with Labour, seems genuine in his claim that he is a fiscal conservative. Indeed, the revealed preference of his actions is that he values a “balanced budget” over lower taxes. But as long as the Tories remain wedded to such fiscal orthodoxy, Osborne’s agenda of low taxes, low spending and low deficits will give way to Sunak’s one of higher taxes, higher spending and low deficits.

The politics of taxation in the 2020s is set to be radically different from that of the previous four decades. With the Conservatives unable to promise cuts credibly and Labour supportive of a larger and more active state, the debate will move from the overall level of taxation to its balance. Labour notably opposed the National Insurance increase last year, arguing instead for new taxes on the well-off and firms; party outriders look to wealth and property taxes as an alternative to raising revenue from middle and low earners after a lost decade for living standards.

Higher-tax Britain, then, is here to stay. The question in the 2020s will be: who pays?

Duncan Weldon is the writer of the Value Added Newsletter at Substack and the author of “Two Hundred Years of Muddling Through” (Little, Brown).

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This article appears in the 09 Feb 2022 issue of the New Statesman, Sunak's Game