Mind the (fiscal) gap

Reform has published new research on direct taxes, public debt and population ageing.

“Mind the (fiscal) gap”, argues that the UK’s dangerous level of public debt means new personal tax cuts must remain off the table. The report shows that even with the forecast average increase in taxes of £380 per family by 2033, debt will still be heading towards clearly unsustainable levels. This will make the economy vulnerable to interest rate rises and hurt economic growth.

In July, George Osborne told the Treasury Select Committee that taxes would not have to rise in the next Parliament to bring down the deficit. The Chancellor expects to eliminate the deficit around 2020 but according to the Office for Budget Responsibility the UK’s fiscal position will worsen after that as the population ages. As a result the report argues that there is “no fiscal headroom for large reductions in tax revenue.”

The authors warn that targeting tax increases on people of working age could “place a heavy burden on many people at the key productive stage of the life cycle and have serious effects on incentives and on economic growth.” Governments must avoid the temptation to raise tax burdens on working aged people through fiscal drag or higher National Insurance Contributions.

The report praises the Government for phasing out the higher personal allowances for pensioners (“age-related allowances”), but urges Ministers to go further and review the exemption from paying National Insurance Contributions above State Pension Age. This tax break does not reflect the modern labour market in which age is now a less reliable indicator of need. Ending the exemption would raise £735 million per year and only affect the richest (by income) 6.3 per cent of people aged over 65.

The report also questions the future of tax relief for pensions, on the grounds that it is “expensive, poorly targeted and fails to achieve its policy objectives.” The net cost of pension tax relief has been estimated at nearly £24 billion per year. Yet the authors calculate that any reform will impact on younger taxpayers. Most of the relief (61.2 per cent) is received by people aged 35 to 55 and nearly 20 per cent of the relief is received by people below 35.

The report warns that the Conservative and Liberal Democrat focus on increasing the personal allowance would fail to address concerns over living standards. An immediate increase in the allowance to £12,500 would cost £15.9 billion per year, but only 1.3 per cent of that would go to people who earn below the equivalent of the minimum wage for 35 hours a week. An immediate increase in the allowance of £500 would cost £2.5 billion, and only 4.9 per cent of that would go to minimum wage workers.