What the spending review means for the future of UK tax

25 November 2020

As expected, today’s statement by the Chancellor of the Exchequer setting out his spending plans for the next year did not specifically address tax policy. Nonetheless, the forecasts by the Office for Budget Responsibility (OBR) underline that the UK faces long term fiscal challenges and that, at some point, taxes will rise in order to address this.

The OBR expects Government borrowing to be £390bn this year. The real problem, however, is that even by 2025/26, borrowing will still be approximately 4% of GDP or £100bn and debt as a proportion of GDP will continue to rise. Such a situation is unlikely to be seen to be sustainable and action at some point to fill in a permanent hole in the public finances of £40-60bn will be necessary.

On the plans set out today, it looks likely that spending will play a part. Compared to the spending plans set out in March, public spending on non-Covid matters is set to be £10-12bn per annum lower than was anticipated (the Chancellor announced additional spending to address Covid but such spending is temporary). Ensuring that spending does not exceed these numbers will not be without difficulty but the partial freeze in public sector pay and the cut in overseas aid (if sustained) will make a contribution.

This will leave a further £30-50bn which will need to be found from higher tax revenues. Again, the Government’s focus is likely to be on the level of borrowing in two or three years’ time which may suggest that tax rises could be delayed for a while. However, taxes in aggregate rarely rise in the second half of a Parliament and the Chancellor may consider moving earlier, perhaps with some temporary off-setting tax cuts or spending increases. For example, he might consider a permanent increase in corporation tax rates combined with a temporary increase in the generosity of capital allowances. Another option might be to increase capital gains tax rates to fund a further short term boost to Universal Credit rates.

We are likely to know more at the time of the next Budget, expected in March. Rapid progress in rolling out the vaccine is likely to improve economic forecasts but accelerate the timing of any tax rises; conversely, a less than smooth ending of the Brexit transition period would worsen economic forecasts but likely delay any such measures. Nonetheless, even though there remains uncertainty over timing, the Chancellor’s statement and OBR forecast confirms that the Treasury is looking to raise taxes at some point in the next few years.

UK borrowing is due to hit a peacetime record of £394bn this year as the government grapples with the cost of the coronavirus pandemic, with chancellor Rishi Sunak admitting that “the economic emergency has only just begun”.

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