UK Election Watch: Taxes in the spotlight

The polls

The polls have changed very little in the ten days since the General Election was called by Rishi Sunak: individual polls are telling slightly different stories, with some pointing to further gains for Labour, while others have the gap between the two major parties narrowing slightly. But even taking the variation into account, Labour have a minimum lead of around 11 points. Sunak’s gamble on the timing of the election does not appear to be paying off, particularly in terms of the smaller parties where the picture is also pretty much unchanged and notably the Reform party are still polling around 11%, even following last week’s announcement that Nigel Farage would not be standing. The picture may change as more policies are announced and parties face increased scrutiny, but for now a Labour majority still looks the most likely outcome. 

The Taxes

The news this week has centred less around what the parties intend to do if they were to gain office, but what they intend not to do. In this regard, taxes were firmly in the spotlight. Indeed, both parties have ruled out hiking three key tax rates, including income tax, National Insurance and VAT, with the Shadow Chancellor, Rachel Reeves, confirming that Labour would not announce any additional tax rises. Both Labour and the Conservatives intend to attempt to close the so-called “tax gap” – the difference between what HMRC expect to get in tax revenue vs. what comes in – though only Labour have put any money towards such a crackdown. And to be clear, both have committed to keeping income tax thresholds frozen for the next three years, which increases the tax burden significantly as more people are dragged into higher tax bands. Labour also intends to revoke the charitable status of fee-paying schools, which means they will no longer be exempt from paying VAT, enact another windfall tax on energy companies, reintroduce the lifetime allowance on pension savings and increase taxes on non-doms and private equity bonuses.

The public finances

The big picture, though, is that further tax increases are probably going to be necessary, given the state of the public finances. Indeed, recent upward revisions means government borrowing overshot the OBR’s March forecasts by £7.3bn in 2023/24. And the overshoot continued into April, with spending exceeding the OBR’s projection, as the Chancellor’s, National Insurance cut and benefit increases – which are linked to inflation – kicked in. In addition, the infected blood scandal looks set to cost the government an additional £10bn. The public finances data are prone to large revisions, so the picture could change, but it seems that much of the already tiny £8.9bn headroom around the current fiscal rules forecast by the OBR in March has probably been wiped out.

Any incoming government will face the same constraints given that the major parties have committed to maintaining the current fiscal rules – which include both debt falling as a share of GDP and public sector borrowing not exceeding 3% in five years’ time. Currently, sharp spending cuts are needed over the forecast period to remain within the fiscal rules, without any major boost to growth. Indeed, the IFS estimates that unprotected departments, including local authorities, HMRC and the criminal justice system, face somewhere in the region of £10bn to £20bn worth of cuts with a similar level of cuts pencilled-in to public investment. We think it is unlikely that a Labour government would want to push through these cuts in full, given its commitment to improve public services.  Moreover, the current fiscal rules are already the weakest in the UK’s 27-year history. There is a strong case for a further fiscal adjustment with taxes, therefore, most likely having to rise at some point over the next parliament, under any government, the question is when and what. We continue to think that a Labour government with a comfortable majority would push through temporary fiscal tightening, to allow for affordable fiscal loosening after further repair to the public finances in time for the next election. However, a Conservative government would probably hold off for as long as possible, given the rhetoric around lowering the tax burden.