The Telegraph reported this morning that the National Institute of Economic and Social Research (NIESR) has told Rachel Reeves that raising income tax would be the least damaging way to fill what it described as a £30 billion hole in the public finances. They note:
Adding 3p to the basic and higher rates of income tax would be less harmful than ramping up VAT, corporation tax, or a raft of smaller taxes, the institute said.
This is the route to even worse outcomes from Labour than anything they have tried before.
First, let me start with the obvious. There is no £30 billion hole in the public finances. The UK government is the issuer of the currency. It cannot run out of money. What it can run out of are real resources, whether they be labour, materials, skills, or the planet's capacity to sustain what we do. The constraint is physical, not financial. Talking about a hole in the public finances is a political choice, not an economic truth.
But then let's play along with the question NIESR has set. If Reeves believes she must raise taxes, and she clearly does, for political and institutional reasons, the real issue is not whether to raise them, but who should pay.
First, not all income tax rises are equal
Adding 3p to the basic rate would penalise millions of people already struggling with stagnating wages, stealth fiscal drag, and collapsing public services. This would be a tax rise on the lowest paid who already shoulder a disproportionate share of the burden in proportion to their real capacity to pay.
But there are alternatives within the income tax system itself. In the Taxing Wealth Report, I showed that almost all the real tax giveaways of recent decades have gone to the top few per cent of the population. That has not been through the headline rate of income tax, but through the myriad ways the wealthy convert income into something that is not taxed like income at all, or through which they can claim disproportionate tax allowances and reliefs. Not all taxes are equal in that case, and a rebalancing is required. The NIESR seem to be ignoring that, as if they are deliberately feeding the prejucies of The Telegraph
Second, tax wealth, not work
If Reeves wishes to make the tax system fairer and raise substantial revenue, she should begin where the money really is, which is in wealth, and not wages. Four straightforward reforms would achieve more than any blanket increase in income tax:
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An investment income surcharge. Apply an additional tax rate to income from interest, dividends, and rents, sources overwhelmingly concentrated among the wealthiest households, largely to address the fact that national insurance is not paid on these sources, and Reeves could find much of the tax she is supposedly looking for.
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Equalise capital gains tax with income tax. There is no moral or economic justification for favouring returns from ownership over returns from labour. These rates should be the same.
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Charge VAT on banking and financial services. These sectors are currently exempt, which favours the wealthy who are the predominant purchasers of their services.
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Restrict pension tax reliefs for high earners. The subsidies here are hugely regressive, turning pension contributions into tools of tax avoidance rather than social insurance.
Together, these measures could raise more than £50 billion in my estimate, while improving fairness and efficiency. They would also help to begin closing the yawning gap between earned and unearned income, which is a gap that distorts markets and erodes the legitimacy and social acceptability of the tax system in the eyes of most people, which matters when they are now very angry about that fact and are moving towards Reform as a result.
Third, stop pretending tax rises fund spending
Even if Reeves were to adopt all these proposals, the purpose of doing so should not be to plug a hole. Taxes do not fund spending. They serve to reclaim some of the money the government has already injected into the economy through its own expenditure, to manage inflation, shape behaviour, and express social priorities. The point of tax is to redistribute both income and power, not to fill imaginary fiscal gaps.
The real tragedy is that Labour still speaks as though it is constrained by some kind of household-sized budget. And Reeves insists that every pound of public investment must be fully funded as if she were managing a corner shop rather than steering a sovereign government with direct control over its own monetary operations.
What follows
If Reeves genuinely believes that Britain needs better public services, and she frequently says she does, then she must stop treating taxation as a penalty and start using it as an instrument of fairness.
Raise taxes, by all means, but only on those who can easily afford it. And do so for the right reason: not to balance the books in some mistaken way, but to rebalance the economy and restore legitimacy to public finance.
Taking further action
If you want to write a letter to your MP on the issues raised in this blog post, there is a ChatGPT prompt to assist you in doing so, with full instructions, here.
One word of warning, though: please ensure you have the correct MP. ChatGPT can get it wrong.
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Your clearest yet on tax. That’s omnibus-ready!
🙂
🙂
I agree with most of this but I think the government should tread cautiously around pension tax relief. I think it would be fine if the higher rate of tax still only applied to high earners but fiscal drag has pulled a lot of modest earners into the 40% tax bracket too.
I think it would be very dangerous of the government to say “hey Gen Z/millennials earning £55k. You know how your mum and dad bought houses much more cheaply than they sell for now and how they got to retire at 65 sometimes with defined benefit pensions? Well, guess what, we’re still terrified of them as a voting block, so we’re going to make it even harder for you to ever retire than it was already instead.”
I think the status quo of losing pension tax relief at around the £130k mark would be about right, not least because just before that people are paying a 60% marginal tax rate if they don’t save into a pension. It just doesn’t seem fair to me to take another relief from them when the rich are only paying 24% on their capital gains and those retirees who were luckier aren’t being asked for much from those four proposals (those examples above would see a pensioner in a £1m house but a modest income pay nothing extra whilst taking from people earning barely more tban £50k).
If you are only just in the higher tax rate so nearly all your income is taxed at basic rate, and make pension contributions you are getting an extra 15% of tax back that you were never going to pay. How is that fair?
As an example using pensionbee pension calculator, if you were earning £50,000 and decided to contribute £5,000 to your pension, you would pay £4000 and get £1000 basic rate relief from the Government as an auto-add to your pension pot.
If you earned £51,000 and wanted to contribute the same £5,000 to your pension, you would pay £4000, get £1000 basic rate relief, but you could also claim £146 back on your self-assessment tax return, so you actually only pay £3,854.
So you earn more and yet you pay less into your pension.
@ AW1983, please excuse me when I say this may be rather misguided.
Defined contribution pension schemes, which are all that are available to most young people, pump money into stocks and shares on the assumption that the value of those assets will grow over time, as they have in the past. As Richard has said previously, buying secondhand shares, does not invest in companies, which happened when the shares were first bought. Instead, it’s about speculative gains, i.e. gambling.
The financial industry is desperate for people to “invest” in shares, and pensions are a primary way to do this. If more and more people “invest” then the price of shares will increase. But that will not happen indefinitely. World population may plateau, then shrink, as early as 2050, well before many young people are set to retire. When that happens fewer people will be buying shares for pensions and more people will be trying to extract the money they have previously “invested”. Stock market valuations will reach a tipping point when values are no longer increasing. Then people will rush for the exit trying to extract their funds. This will create a vicious circle leading to a, permanent, stock market crash. Consequently young people who “invest” in a pension today are at serious risk of losing much of their “investments”. Basically, the defined contribution pension industry is a Ponzi scheme.
What pension tax relief is really about is providing higher earners (significantly more that the £55k you suggest) a way to avoid higher rate income tax and inheritance tax. If they earn more than £110k they can put £60k into a pension and not pay income tax. They then take money out at a lower tax rate and money left in the pension may also be shielded from inheritance tax.
So defined contribution schemes are a tax avoidance opportunity for the wealthy. Today’s young people are the unwitting pawns in a Ponzi scheme and risk losing their investment. I really doubt we should be encouraging young people to “invest” in defined contribution pension schemes, though they do need a fair alternative. Seen in this light reducing pension tax relief is a good thing.
I am not sure all your numbers are right – but the principle is, and I have not got time to check the limits which I no longer need to memorise as once I did.
I see where you are coming from but if you want you can invest in a SIPP, hold nothing but government bonds or even cash and you still get the tax relief.
I think what makes me uncomfortable is telling someone on £80k that their pension tax relief is being stopped but we’re still going to look the other way and ignore all the existing retirees who made 500% returns or more on homes the person on £80k has no prospect of buying.
I appreciate tax measures should come with a stronger safety net but I am also squeamish about a generation of renters having their pensions clipped to fund triple locked pensions for their homeowning parents (although granted I agree with Richard that the deficit doesn’t need closing anyway).
What I think would be fairer is charging NI on pension income (so it doesn’t penalise people based on age, we will all pay at retirement); abolishing the 25% tax free allowance and maybe capping tax relief at £25k of contributions per annum (including employer contributions). But I do think some relief should be available on the grounds people will pay the tax later anyway.
I also think as younger people will still be slightly worse off than retirees with these measures, for fairness they should be balanced with an LVT so retirees are paying their proper share too.
If Rachel Reeves is stupid enough to raise income tax rates by 3p, Labour could follow the Conservatives into electoral oblivion.
I already think Labour will lose a lot of councillors next year. A decision like this would make things worse in every possible way.
The UK economy needs more government spending to lift the economy.
If Rachel from accounts puts up basic income tax it will take money out of the system, resulting in more misery for the majority of the UK’s population, who will be disproportionally affected.
I don’t know how much it might raise, but I still think earned income by “pensioners” should be charged NIC.
I stress earned income.
My employer pays NIC. It seems inequitable that I don’t.
But maybe it would not bring in very much money so not worth the political cost to Labour.
I agree
Furthermore, since NI is simply another form of income tax, it should be combined with income tax (thereby abolishing employee NI). This would make the tax system simpler, hopefully more progressive, and avoid the nonsense about who does, and who doesn’t pay NI. In reality, it’s all income tax.
There are real difficulties
Pensioners would most definitely object
Yes, I agree, there are real difficulties.
Yes, pensioners would object.
Other changes would need to be made (e.g. raising the state pension to compensate pensioners).
No changes are easy but unless changes are made the tax system becomes more and more labyrinthine as it tries to absorb more and more historical baggage. And more and more loopholes for tax avoidance emerge (such as “salary sacrifice” for. Pension payments avoiding NI).
Yes, it’s not straight forward but nevertheless worth doing IMO.
It would solve the problem on investment income
If income tax and NI were combined, then eligibility for the state pension would of course no longer be based on NI contributions. In the short term pensioners who ‘paid into’ the old system might feel hard done by, but in the long term the whole population would benefit there being a non-contributions-based state pension that is effectively a UBI for pensioners.
True
But the tax rate on pensioners would rise and politicians would hear that
NI is paid at 8% by employees earning less than £50k and at only 2% if you are earning more than £50k. Why do wealthy employees get this reduced rate? Further it is called National Insurance and at age 66 people stop paying, yet they go on to receive benefits for the rest of their lives. I wish my home and car insurance worked on the same principle.
People living off rental income and all other (non employment) income will be able to access some welfare benefits but they are not making any contribution to the NI component of tax.
Couldn’t the Chancellor eliminate the NI 8% charge over her remaining 4 year term by 2% per annum and increase income tax rates by 2 % per annum. Then everybody could be paying for welfare, whether retired, employee or other investment income. She should also increase tax free allowance each year so that employees on less than £50k do not notice any change in total take home pay.
See my work on an investment income surcharge in the Taxing Wealth Report 2024
Letter to MP sent. Previous one end of September, awaiting reply….
Thanks
I’ve sent a few MMT-related letters to my MP and I’m now not getting replies or even acknowledgements. My letters were polite and reasoned. The replies I did get varied between pretty useless and appalling. Lib Dem MP. I had hoped for better, but they seem to be just as caught up in the neoliberal myths.
@Anne S – unfortunately many people in this constituency (High Peak) do not think that ‘our*’ MP can either read or write – he does not seem to answer correspondence. The asterisk (or when referring to politicians should it be Asterix?) in re ‘our*’ being a joke because he is not in it for ‘us’ (his constituents), purely for himself. Writing to him is pointless – the only reply I have ever seen from him was a ‘copy and paste’ extract directly from the Liebour playbook. Maybe your MP is of the same ilk?
Having watched the Green Party election broadcast, and reflected on some of Gary Stevenson’s videos, in addition to your report and videos, might a slight tweak in the slogan be helpful so that “Tax Wealth, Not Work” becomes “Tax the Wealthy, Not the Workers”? Just a thought. It may seem an almost irrelevant change but to me changing the emphasis from “wealth” in itself (which is fraught with technical problems which you have highlighted and Gary Stevenson now appears to be accepting) to the owners of that wealth (however obtained). It could also undermine those, like the multi-millionaires and billionaires, who might try to argue that they actively “work”. And why is not possessing obscene wealth not questioned as an issue of morality?
I like that suggestion
Re-label National Insurance as Income Tax and remedy the unfairness this exposes
But they are different
My own thoughts is that everyone needs to pay more tax, but we can rejigg the current tax system to be fairer. For example, without the freeze on personal tax allowance, it would stand around £17k.
So I would proposed, raising the PTA to £20k but at the same time, raising income tax by 5p across the board at current thresholds.
This would basically mean, people in the bottom income distribution pay less, middle break even, top pay more. This raises much more revenue, but you can seel it to the top like this, ‘after the threshold, you won’t lose your PTA and we will make childcare universal.’
The only real losers with this would be childless people on higher incomes.
It really is not quite that simple
I’m aware that it’s not that simple.
I think there have to be a raft new tax measures, that redistributes income in fairer and more productive ways.
This was a specific comment on income tax that is fairer to almost everyone on the income distribution.
All I am saying is that simple solutions on tax rarely work in a decidedly complex world. Sorry, but that’s a fact.
I fully agree with all the points you make Richard. Re taxing the wealthy, HMRC is now being aggressive re ‘tax havens’ and there is now ‘data exchange’ between some authorities. But if an investment income surcharge were levied, I hope that this would not affect many less wealthy (frugal) savers as they would (hopefully) have their savings in ISA products, and this will not amount to large amounts of savings – just frugal savings for a rainy day. The wealthy will certainly hold ISA products, so will still receive some income and gains tax free – surely the wealthy cannot complain at that? As for rental income by the wealthy, those who can afford to purchase property at speed are frequently preventing a young person from buying their first property, albeit that wealthy individual on occasion offering that property for (ever increasing) rental income, but far too often placing that property onto the holiday let market when we have a housing shortage.
Thanks
Of course it’s not that simple, but nothing ever is.
You can propose many new tax changes but you don’t know what behaviour results from said changes.
You can try to predict, but fundamentally, in economics, you would have to run the world twice to know if you were right.
But your article specifically focused on income tax, so my comment was focused on income tax.
Noted
Richard please send that very cogent post to NIESR cc Reeves and Telegraph. And/or offer it as a piece to the Guardian
The Guardian always says no.
And of late, Rachel is not a fan of me.
From the main post: “What it can run out of are real resources, whether they be labour, materials, skills, or the planet’s capacity to sustain what we do.”
… Got me thinking along a tangent which I’d be interested see a blog post on sometime. The tangent starts with the observation that in May the UK passes its annual resource use limit and goes into ecological debt to the planet. https://overshoot.footprintnetwork.org/ presumably we’re ‘borrowing’ from others. ‘Borrowing is a euphemism.
So how do we handle this from a sovereign currency powers (per MMT) pov?
I will look at doing a video on this. Thanks.
Would you still expect people to pay tax on pension income if they paid tax on what they saved? Or indeed wait until they are 55.
Often ‘free money’ is a good enticement for people to not opt out.
If a pension justify becomes some locked away savings then I think it will cause bigger societal problems longer term.
I do not understand your question, so I can’t answer it.