The Office for Budget Responsibility produces a fiscal risks report to identify specific shocks or pressures that could push the public finances away from the OBR’s latest medium-term forecast or threaten fiscal sustainability over the longer term. With taxes amounting to some £674bn and the tax-to-GDP ratio currently running at around 37 per cent of GDP, the report published earlier this month comes at a sensitive time.
It’s not surprising to see the OBR identifying the financial sector as being relatively tax-rich. The report warns that the uncertainties surrounding the impact of Brexit pose a particular risk to the level of taxes paid by the financial sector.
However, the financial sector is by no means the only cause for concern. There are risks to a number of ‘tax bases’ which may grow more slowly than the economy as a whole.
For example, improvements in vehicle efficiency and the move to hybrid or electric vehicles mean that fuel duty receipts are likely to drop from 1.4 per cent of GDP in 2017/18 (£27.5bn) to just 1.1 per cent in 2030.
As more people kick the smoking habit, tobacco duty receipts will decline, potentially halving by 2030. And in a phrase which could only come from an economic report, the OBR notes that ‘the key downside risk for alcohol receipts is lower alcohol consumption’. The prospect that declining air pollution, smoking and drinking might reduce the strain on the NHS is very attractive. But the reduced contribution of these taxes to public expenditure will have to be made up from other sources.
This brings us to the tax gap. While the OBR predicts that the continuing attack on tax avoidance will produce declining returns as taxpayer behaviour changes, we are disappointed that the report does not challenge the government over the adequacy of its funding for HMRC to tackle tax evasion and the shadow economy.
The OBR report brings out some interesting points in connection with the operation of PAYE in respect of employment income (where the tax gap is 1.1 per cent) and those who complete self-assessment returns, which includes the self-employed (where the tax gap is 19.2 per cent). The Taylor Review on the categorisation of workers will be important in resolving these tax tensions. Incorporations are also seen as a threat to the tax base, costing £3.5bn in 2021/22.
Importantly, the OBR identifies self-inflicted government failures as a significant risk factor in the tax system. It is critical of the way in which default assumptions for the indexation of some taxes have not been implemented consistently. For example, if the indexation of fuel duty had not been cancelled, receipts would have been around £8.5bn higher in 2017/18. For alcohol duty, the equivalent figure is £1bn.
To put it another way, taxpayer behaviours are not the only risk to the tax system. Politicians themselves have a lot to answer for.
So, if the UK tax yield is at risk, how will the shortfall be made up?
Here, the OBR is equally candid, expressing concerns that tax receipts depend on too few taxpayers. For example, capital gains tax is typically paid by around 150,000 – 300,000 people each year. In the event of a recession or financial crisis, gains could plummet and so would the tax yield.
Similar comments apply to stamp duty land tax: in 2015/16, just 9,250 residential transactions in Westminster, Kensington and Chelsea accounted for £1bn, or 14 per cent, of total residential SDLT receipts.
When it comes to income tax, the figures are even more stark. The top 1 per cent of earners are expected to pay 27.7 per cent of all income tax in 2017/18. This is up from 24.4 per cent in 2007/08. This increase in tax contribution does not reflect an increase in incomes: during the same period the share of pre-tax income received by top earners fell from 13.4 per cent to 12.0 per cent. As the report notes, individuals who feel over-taxed can choose to work less, engage in tax avoidance schemes or simply leave the country.
With only 56.5 per cent of adults forecast to pay income tax in 2017/18 (down from 65.6 per cent in 2007/08) it would be dangerous for the government to try to cover the tax risks identified by the OBR simply by imposing more taxes on high-earners. If, as politicians are fond of saying, ‘we are all in this together’, then the tax base must be widened. Tax evaders and the shadow economy must also be brought within the tax system.