Where will the tax rises fall?

As we assess the election results, the big question still to answer is where
will the cuts or the tax rises fall?

Last week a report from the Institute of Fiscal Studies (IFS) revealed that
each of the three main parties had gaping holes in their economic plans
amounting to tens of billions of pounds worth of, as yet, unexplained savings.

The IFS concluded that the size of these holes was a indication that, whoever
forms the next government, there would have to be “greater reliance on tax
increases and welfare cuts after the election than the parties are willing to
admit to beforehand”.

Given that the IFS identified holes of £52bn in Tory plans, £44bn for Labour
and £34bn for the Liberal Democrats, it is beyond doubt that the so far
unplanned or unarticulated actions to fill them will have to be significant.

Even though the last Prime Ministerial debate followed the IFS report all
three candidates failed to address what these undeclared rises or cuts might be.
As one expert told Accountancy Age: “None of the parties came clean about where
the bulk of their tax rises need to come from.” But, if it is to be tax rises,
which ones will go up?

Experts and observers believe a big hit to VAT rates is on the way.

Tom Scott, UK chairman of the International Fiscal Association, said: “It’s
got to be an increase in indirect taxes. It’s VAT and employment taxes that
attract the most revenue earnings.”

Scott is right. If the new government wants to raise money fast the clear
option is to hike the rates on income tax, national insurance or VAT. For
2008/09, VAT raised £78bn for the exchequer, down on the previous year’s £80bn
but still higher than anything previously.

Yet the parties have avoided any real comment on VAT.

Anne Redston, visiting profession of tax law at Kings College London,
anticipates a rise to 20% from the current 17.5%. That may not be all at once
however. Some see the rise coming in stages, up to 19% this year and another
rise the year after.

A modest rise would bring in large sums immediately but VAT is also seen as
target because the rate is low compared to Europe – Germany charges 19%, France
19.6% and in Sweden the rate is 25%.

Some however believe the reduced rate of 5% might also see change. More
revenue could be raised by restricting its use or hiking up the rate. This could
potentially hit domestic fuel consumption heavily.

Bill Dodwell, tax partner at Deloitte, warned against rushing in the change
this year for fear of derailing recovery.

Perhaps the most likely tax change would be another hike in the National
Insurance rate. Both employers and employees will see the rate rise next year
(described as a tax on jobs by the Conservatives), but because it raises so much
revenue, £97bn for 2008/09, a further rise would also bring in significant sums.

Some experts see this as a possibility, despite controversy over National
Insurance during the election campaign.

The Lib Dems, in particular, have ruled nothing in or out, leaving room for
another hike, if they get into power.

Chas Roy-Chowdhury, tax director at ACCA, suggests that the 1% band for
earnings above £844 a week could be targeted. This would be another blow to the
better-off because it translates into salaries of £43,000, though it only
affects the margin.

Another tax in line for change is likely to be capital gains tax. The Lib
Dems have committed themselves to a hike in their manifesto, but it would not be
a stretch to see the other parties ensure they capitalise on reform.

The issue is the differential between CGT at 18% and the higher rate of
income tax at 50%. Experts believe the gap has to close or the 50% rate for
those earning more than £150,000 will drive more people to convert income into
capital to avoid the bigger hit.

But capital gains tax raises roughly £7.8bn per year. A rise to 25% would
increase the take but will do little to reduce the deficit.

One area advisers believe large sums will fail to be recovered from is
through an attack on tax avoidance. Labour Budget’s from 2008/10 estimated
anti-avoidance measures would bring in £4.5bn over five years.

The Lib Dems believe they can recoup £4.6bn through closing down schemes in
their first year in office.

Bill Dodwell said: “It’s not realistic to raise that amount of money in a
year. If you look at the history of tax avoidance, there’s never been anything
like that figure made in a year.”

He also casts doubt on the Lib Dem pledge to bring in a general
anti-avoidance measure suggesting that it would provoke so much legal action
that the chances of recouping funds quickly would be undermined.

Further reading:

Leader: the election is just
the first step in sorting out the economy

General election: the party’s
over