The Great Recession triggered the two largest annual falls in real government receipts since at least 1956. Yet, by the end of the decade, tax receipts as a share of national income are due to return to almost their pre-recession level. But, beneath this apparent stability in the overall tax take, there have been significant shifts in the composition of tax revenues.
A new IFS Briefing Note, published today, sets out ‘The changing composition of UK tax revenues’ in the decade up to 2020. Tonight, the IFS and the Chartered Institute of Taxation will hold a debate – ‘Mind the Gaps? What are the biggest risks to the UK tax take and how might tax policy and administration respond to this?’ – on how taxes are changing, and what risks this poses to tax receipts.
Under current forecasts, tax receipts in 2020–21 are due to come in at 37.2% of national income. Compared with 2007–08, the taxman looks set to raise more from VAT but less from other indirect taxes, about the same from personal income taxes but with more of that coming from the highest earners, less from the main property taxes and substantially less from corporation tax. The Treasury will be more reliant on a range of small taxes, including five entirely new taxes that, combined, are forecast to raise an additional £7.3 billion in 2020–21.
The most notable changes, highlighted below, are driven by policy choices. Whether these changes have been part of a clear and coherent overarching strategy is, to put it kindly, unclear.
Tax revenues have been boosted by an increase in the rate of VAT to 20% in 2012. Revenues from other indirect taxes have fallen, largely because fuel duty has been consistently frozen at 2011 levels. This (political) choice to deviate from increasing fuel duty in line with inflation costs £4.4 billion a year in 2015–16 terms. Should freezes persist over the next five years, fuel duty revenues will grow even more slowly than the OBR forecast and be substantially lower in the longer term.
Between 2007–08 and 2015–16, there has been a fall in the share of the adult population who pay income tax (from 65.7% to 56.2%) and, for the remaining tax payers, an increase in the proportion of income tax paid by the top 1% (from 24.4% to 27.5%). This increased reliance on a small number of income tax payers follows a longer-run trend that was driven largely by above-average increases in top incomes. Since 2008, this increased reliance has been largely driven by the policy choices to increase the personal allowance, cut the higher-rate threshold, introduce the additional rate and cut pension tax relief.
Corporation tax always moves with the economic cycle, and since 2008 receipts have been substantially hit by weak profitability in the banking sector. There have also been many reforms in this area. Overall, corporation tax policies between 2010 and Budget 2016 (including those that are due to come in before the end of the parliament) have resulted in a revenue cost of £10.8 billion a year in 2015–16 terms. Moves to broaden the base and crack down on avoidance and new taxes on banks have not been sufficient to outweigh the cost of cutting the corporation tax rate from 28% to 17%. The overall trajectory of corporation tax receipts will continue to depend on the strength of growth in corporate profits and the extent to which lower rates boost activity. A permanent decline in onshore corporation tax revenues would mark a break with the previous trend which, despite continuous predictions to the contrary, was for onshore corporation tax receipts to be quite steady over time once cyclical effects were excluded.
Two new taxes on banks – the bank levy and bank surcharge – were introduced in response to the lower revenue stream coming from banks and, in part, to the view that banks should contribute to the public finance cost of the crisis. These measures have buoyed receipts, but they were not underpinned by a clear strategy. Notably, the bank levy was ratcheted up almost constantly in an attempt to squeeze more revenue out of banks before an abrupt about-face in response to concerns that it may be having undesirable effects, including increasing the likelihood that HSBC left the UK. More thought should be given to whether, and if so how, the banking sector should be taxed differently from other sectors.
More broadly, the new taxes, which also include a diverted profits tax, an apprenticeship levy and a sugar levy, have tended to be introduced hastily and without consideration of the full set of effects.
There is always uncertainty around forecast tax receipts. The risks to revenue streams are currently larger than usual: there is still uncertainty about the strength of the recovery, it is difficult to forecast the receipts from new taxes and there is policy risk in the sense that the government may choose to deviate from the assumptions embedded in forecasts. A long-term strategy for the tax system would help to alleviate some of these risks.