the UK needs to raise taxes, not cut them – here’s why

Taxation has proven to be the main issue dividing the two candidates in the current Conservative Party leadership race. While Rishi Sunak wants to delay tax cuts until the cost of living crisis is resolved, Liz Truss wants immediate cuts. She believes that the tax cut will not cause further increases in inflation for consumers.

But setting aside fears that tax cuts could accelerate price rises by giving individuals and businesses more money to spend, these strategies also ignore the need to deal with current crises facing the UK. Along with an underfunded health service, households need more help to cope with soaring energy costs this winter. This will require large increases in public spending in the immediate future. Britain will have to pay for it either by borrowing more or by raising taxes, not lowering them.

There is a pervasive myth regarding the effects of taxation on a country’s economic growth, namely that higher taxes mean less growth. It’s one of those ideas that may seem plausible at first glance, but is actually quite wrong. One source of this myth is the idea that raising taxes reduces the incentive to work. Simply put, people will refuse to take a new job or take a raise because it means paying more taxes. However, economists have found this idea difficult to prove.

Furthermore, various income support experiments around the world show that increasing social benefits has no effect on the willingness to work. And research also shows that corporate tax cuts in US states have no effect on economic growth.

It is also possible to challenge the myth that higher taxes prevent economic growth by examining the relationship between tax levels and economic growth in the world’s most advanced industrial economies – the 38 member states of the Organization for Economic Co-operation and Development (OECD) – over a long period.

1. Taxes in OECD countries rise with GDP growth

The correlation between taxation and GDP.
Author’s graph using OECD figures.

The chart above shows tax levels (from all sources) and gross domestic product (GDP) per capita among OECD members over the 50 years since 1970. GDP (which shows the size and health of an economy) and tax revenues these countries have increased over time, with the former growing faster than the latter. This produces a strong positive correlation between the two, indicating that higher taxes are associated with increased prosperity, rather than the reverse.

For example, in 2019, the last year before COVID hit the global economy, GDP per capita figures in Germany, Sweden and Denmark were respectively 13%, 11% and 17% higher than the Great Britain – although all three countries have significantly higher tax rates. .

The simple explanation is based on the interaction between growth and taxation. As countries get richer, they can raise taxes and spend more on education, health, social protection and other public services. At the same time, it stimulates growth because investment in infrastructure and a healthier, more educated workforce increase productivity.

In contrast, reduced spending means less investment and ultimately lower productivity and growth. The way to stimulate growth is to invest in both private and public assets, rather than depleting public investment in the mistaken belief that this will stimulate private investment.

While the vast majority of OECD members have raised taxes over the past 50 years, Britain has not. This can be seen in the graph below, which shows taxation as a percentage of GDP in Britain since the start of Harold Wilson’s Labor government in 1965. Britain’s current tax levies are essentially the same as more than half a century ago, while taxes increased by around 25% in the rest of the OECD.

2. UK taxes as a percentage of GDP

Bar chart showing taxes as a percentage of GDP and number of parties in Britain, 1965 to 2019
Taxes as a percentage of GDP over each UK government from 1965 to 2019.
Author’s graph using OECD figures

The graph also shows that there is little difference between successive UK governments and the size of the tax levied over time. There were fluctuations, but they were quite small and unrelated to the ruling party. It highlights Britain’s collective problem with ‘cakeism’ – that is, wanting decent public services but not wanting to pay for them. Part of the reason is that both major parties seem unwilling to tell the public the truth: We can’t cut taxes and solve the current cost of living and utility crises without borrowing more.

Dealing with Crises While Avoiding a Crash

Many of our public services are currently in crisis – whether it’s crumbling hospitals, a chronic shortage of NHS staff, the risk of the welfare system collapsing or even roads full of potholes. In the end, it all comes down to a lack of spending and investment.

Increased borrowing is not a long-term solution to this problem. In recent years, Britain’s international borrowing has increased. In March 2022 it was £2.365 billion, just under 100% of GDP – a much higher proportion than in the past, and an indication that the UK may already be struggling to repay its debts. debts. The pandemic, the war in Ukraine and Brexit have all contributed to this.

Interest payments on these loans are now rising quite rapidly as central banks around the world raise rates to fight inflation. This means that a government that finances tax cuts by borrowing more will risk higher inflation and therefore an acceleration of the deficit. This is the recipe for an economic crash. Additional expenses must be financed. To do this, Britain needs higher taxes, not tax cuts.

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