David Willetts is President of the Resolution Foundation.
Conservatives don’t like putting up taxes and voters don’t like paying them. So it is not surprising there is an energetic campaign against the National Insurance increase. Should the Chancellor give ground to the critics?
One of the arguments, set out eloquently on ConservativeHome, is that we are having to pay higher taxes because the Government has decided to increase the size of the state, and it would be far better to shrink the state and abandon the tax rises.
But the main reason for the NI increase is to finance the cost of the NHS. That, in turn, is going up just because there are more old people, so public spending rises – even without any change in policy. Old people are heavy users of the NHS. It is very different from the demographic backdrop to the 1980s and 1990s when there were many fewer pensioners because of the low birth rates of the 1930s and the war years.
But now we are facing the healthcare and pensions costs of the post-war baby boom. And, however radically the Government reformed the NHS, it is hard to see pensioners being asked to pay for it, but that is what is driving the spending increases.
The Health Foundation estimates that funding for healthcare will have to rise in the next decade by over £60 billion just to maintain services in the face of these demographic pressures. We can try to offset these pressures by cutting other Government programmes; indeed, we have been doing that for a decade.
Whitehall-controlled day-to-day spending will have gone up by £111 billion between 2010 and 2024. An extraordinary £84 billion of that will have gone to the Department of Health and Social Care. We are reshaping the state so it is above all a mechanism for extracting money from young people to finance services and payment to older people who tend to vote – and vote Conservative.
This leads on to the objection that the levy is unfair on young taxpayers, especially as an increasing proportion of the money is to go to older people to protect more of their assets, and fund their health and social care. It is indeed a big problem that NI is not paid by pensioners, so if they are still working they take home more than a younger worker doing the same job.
The Treasury is very aware of his and for the first time extended this new supplementary rate of NI to pensioner earnings as well. It also covers income from dividends. But there are still other sources of income – from occupational pensions, for example – which do bear income tax but don’t pay this levy.
One obvious simplification of the tax system would be to merge NI with Income Tax, but the various exemptions from NI for pensioners have made this politically difficult. So I am relieved that at least the Chancellor has broadened the base of the new levy compared with traditional NI.
Even so there is still some validity in the argument that the Government is increasing taxes on earnings to protect old people’s assets. What we really need is a bold new Conservative programme for a property-owning democracy. We should reverse the decline in property ownership among young people. I hope to come back to this in a subsequent column.
As well as the generational problem, there is also the objection that the levy hits poor people, who are now facing the cost of living crisis. There is indeed a big hit to living standards looming. But the levy is a smaller part of this than the energy price rises. The NI rise will cost the average household £440. By contrast, average household energy bills are forecast to rise from £1,300 to £2,000. Moreover, the levy is not paid by the lowest income households. The Chancellor also increased the taper for Universal Credit so overall his budget boosted the incomes of many low income families whilst collecting more from the most affluent.
If the Chancellor has any fiscal room for manoeuvre now, he has much better means of easing the cost of living crisis than abandon the levy. Here it is. First introduce a radically improved Warm Homes Discount – increased by £300 and made available to 8.5 million families. Second, spread the costs of energy firm failure over a number of years. Third, temporarily transferring the social and environmental levies off energy bills. Combined this package would reduce energy bills by up to £545 a year at a cost of around £7.3 billion. This is much lower than the £12.7 billion cost from cancelling the rise in NI. It would also be much better targeted: more than half the benefits of postponing the NI levy accrue to the richest fifth of households.
Is it nevertheless the wrong time for any tax increases when the economy is still recovering from the enormous blow of the virus? But if anything it is bouncing back better than was feared. The better figures for public borrowing, which some are arguing show you don’t need the tax increase, are also evidence that the economy is growing fast enough to pay for this.
Borrowing is running rather lower than forecast – but it is still £147 billion this year so far and likely to come in at around £180 billion. With interest rates rising, the cost of this borrowing is going up. The Treasury always worries that if markets think the Government is never going to be able to raise taxes, the interest rates we pay would rise. There is some politics here as well – delay for a year or two and the hit is closer to the next election. Margaret Thatcher faced these arguments 40 years ago when the 364 economists warned against her tax rises in the 1981 budget, but that was the moment when the economy started to recover.
Then finally there is the most seductive argument of the lot – that tax rises actually cost revenues whereas tax cuts fund themselves by boosting economic growth and getting people to declare more of their income. It is true that there comes a point where increasing tax rates reduces totally revenues, but we are nowhere near that. The one apparent recent example is the increase in corporation tax revenues after the rate was cut, but this looks to have been driven more by the fall in business investment after the financial crash and then Brexit. The fall in investment boosted receipts as investment spend can be offset against corporation tax.
There is no prospect of funding today’s British state, shaped by Conservatives over the past decade or more, without increasing taxes. We can’t just keep on borrowing the money for our day-to-day spending on healthcare and pensions. We can certainly reform our taxes. We can also aim to reform the NHS to offset some of the costs from demographic pressures. But we cannot be the tax cutters we were in the 1980s because we are now an older country than we were then – and indeed it is older Tory voters who are the biggest beneficiaries of the reshaping of the state which has been the result.