Taxation: the key to repairing the deficit?

Jul 14, 2020 | Tax Tuesday to As we start to move back to some kind of ‘normalcy’, Tax Tuesday ponders some of the macro-economics which we all potentially face now and poses an unanswerable question or two on the subject of taxation.

We understand that 2020 will be a year of extreme public sector deficit. There might be as much as £350 billion of “over-spend” this year. It is quite likely that 2021 will follow on with another year of very substantial deficit. The latter year is much harder to predict with the same degree of certainty, but prudent economists, in independent places, are warning of up to another £200 billion.

These are very big balances, of course. Too big to be supplied by private depositors looking for a triple A-rated government stock in which to house their funds (especially at a time when even nation states might be viewed by investors with some considerable caution). In truth, the vast majority of the debt instruments necessary are being bought by the Bank of England herself. Sounds like printing money to most, even to those of us with degrees in Economics, and we can surely be forgiven for daring to think, “If the Old Lady of Threadneedle Street can just bail us all out whenever there’s no money coming in, does there ever need to be a problem?”.

Well, the Head of the Institute for Fiscal Studies, Paul Johnson, last week confirmed what has probably been written a hundred times or more, already, by eminent professionals working in the field, this last quarter. It will probably take “decades” to recover the UK debt arising from this pandemic. That, itself, he says, will almost certainly rely upon taxation increases bringing in an extra £35-£40 billion per annum over and above pre-pandemic levels. Mr Johnson isn’t so naïve to imagine that taxation could be increased in 2020 or even in 2021. On the contrary, the Chancellor is currently easing various taxation burdens, albeit temporarily. Last week, for example, we saw a large increase in the threshold for SDLT on residential homes and an equally large reduction in VAT on hospitality business. Nevertheless, the medium term warning is clear: if we want to have a chance of balancing the government books, taxation looms large as the likely, if not inevitable, key source of potential repair and recovery.

The backdrop to taxation as an antidote to our extended public sector deficit is probably not terribly encouraging. However, for over 20 years now, I have been presenting and feeding back to clients immediately after the annual Budget Day speeches. Almost every single one of those Budgets has asked us to believe that, within the following five or six years, the plans would bring us back into surplus. Well, we have never achieved that mythical surplus, at least not since the end of Tony Blair’s first term when some modest surplus arose as his government followed through with pre-established Conservative austerity measures.

The Credit Crunch was partly responsible, of course, for the (seemingly perpetual) deficits, but there were plenty of years which preceded that upheaval and there has been a good decade of growth thereafter.

The year 2018/19 ended up with an official £41.5 billion deficit. That deficit arose in a period when taxation inflows amounted to £623 billion – a shortfall of 6.6%. This was all pre-pandemic of course, and all following a considerable period of economic growth.

In recent periods a total debt to GDP relationship of circa 80% has been considered tolerable – a new fiscal main-stay, it seemed. The pandemic measures have already blown that out of the water and we will see the relationship easily burst through the 100% mark this year – the combination of significant borrowing against significantly reduced economic activity presents a brutal double whammy for this statistic of course.

So what might this mean in practice?

The crude and all-too-obvious questions are these: have we ever been in control of our public sector budget in the 21st century? Are we kidding ourselves about the sustainability of the relationship between our expectations (of care, public services, rights, protections etc.) and our willingness to pay for these things?

And then along came Coronavirus to kick what was already looking like structural deficit into the stratosphere.

Before long (but not, at least, before the UK economy gets back on to its feet), there must surely have to be a significant adjustment to fiscal policy. That adjustment will surely need to change the landscape if it is to be effective. Coronavirus will provide government with the obvious electoral excuse to justify that change, of course. Whether government will be able or willing to go as far as their advisers might tell them is desirable, must be in doubt, but whatever the level of change adopted, it is likely to be significant.

It is no surprise, therefore, that we expect tax planning discussions with clients in the coming months to be set in the context of an assumed material adjustment to taxation in the medium term.

If you have immediate tax planning questions that you’d like to discuss, contact your usual relationship practitioner or email