Could we see a U-turn on 'no new taxes'?

05 October 2022

The chancellor Kwasi Kwarteng may still be nursing his wounds following the about-turn on his pledge to scrap the 45% rate of income tax, but his respite may be short lived as there remain unanswered questions on how he plans to balance the UK’s books.

The Treasury is due to publish the Office of Budget Responsibility’s (OBR) forecasts, potentially later this month rather than on 23 November 2022 as originally planned, alongside the chancellor’s medium-term fiscal plan. The chancellor is going to get his work marked and will no doubt want the anticipated announcements on deregulation to be taken into account first which was the initial justification given for the delay.

The details of these deregulation measures largely remain to be seen and it may prove challenging for the OBR to confidently confirm the scale and timing of any resulting economic growth benefits.

If the chancellor cannot rely on growth to get him out of a funding hole, the options left open to him appear to be to cut spending or raise taxes. When challenged in a radio interview on whether the country may be looking at more austerity measures, Mr Kwarteng said, “I don’t think so at all, I think what we’re trying to focus on is growing the pie”. Perhaps not the most convincing rebuttal but he is likely to be wary of wandering into an austerity minefield and potential backlash.

The last obvious lever is to raise taxes. It might seem unrealistic given the recent rhetoric of further tax cuts, but politics may back the prime minister and her chancellor into an economic corner. So, if their backs were to end up against the wall, what tax rises might be considered?

It’s a challenging conundrum, particularly given the public commitments made to date by the prime minister on what she will not do. Typically, the obvious targets for a tax rise would be focused on income tax, national insurance and VAT, as these are comfortably the largest revenue generators for the Treasury. All three were subject to the 2019 manifesto pledge of not being raised, albeit that pledge has already been broken. Given the flagship tax cuts introduced in the mini-Budget that require funding relate to income tax, national insurance and corporation tax, it seems unlikely that these would be subject to increases.

From the revenue raising big-hitters, that leaves a potential increase in VAT. Statistics published in June 2022 suggest that a 1% increase in the standard rate of VAT could generate £7.5bn a year for the exchequer. The political challenge is that such an increase in VAT could prove to be regressive, putting more pressure on lower-income households that are already struggling with bills.

If a VAT hike could cause further controversy, a windfall tax might prove to be the most politically pain-free option. An advantage of windfall taxes generally are that they are often one-off measures that can be difficult to avoid, with the potential to generate significant tax revenues. Various flavours of windfall taxes have been suggested in recent months and years. The most obvious of these that might be explored as a political measure of last resort by the current administration is to extend the windfall tax on energy companies.

A U-turn of that magnitude could lead to further economic turbulence, causing uncertainty on tax policy, but it might also resolve the funding issues for the growth plans in one fell-swoop. The damage from more U-turns may not be as severe as some might think. A recent YouGov poll suggests 42% of people consider it a good thing and a sign that the government is listening. It seems unlikely that the chancellor can afford another serious misstep and his next throw of the dice needs to be a good one, or it could be his last.