With the government running out of financial options and a European economic crisis imminent, ministers have to start thinking the unthinkable
The latest global economic and financial crisis is often described as a ‘perfect storm’, combining, as it does, severe debt crises in the USA and the Eurozone with stagnant (or declining) economic performance in Western economies.
Whatever the outcomes of this crisis, one thing is certain: it will not pass the UK by as a consequence of us not being in the Eurozone. These crises always have a negative effect on the UK’s already fragile economy and this one may tip us back into recession.
Even if recession can be avoided, it seems likely that the coalition’s current fiscal consolidation plan will be thrown significantly off course causing the government to, once again, reconsider its approach. The danger is that ministers will introduce a further round of spending cuts (on top of those contained in the 2010 Spending Review) thereby delivering another downward kick to the economy.
The alternative is to raise taxes, but the impact on retail sales of the VAT increase in January suggests this would also not be good for the economy. In terms of direct taxes, the government is set on making the UK more business friendly and so would not want to increase corporation tax. This leads us on to the question: what about income tax?
Income tax was first implemented in 1799 by Prime Minister William Pitt the Younger as an emergency measure in order to pay for weapons and equipment in preparation for the Napoleonic wars. It was vigorously resisted in many quarters.
However, income tax was supposed to be a temporary measure. In fact it is still a ‘temporary’ tax in that it expires each year on 5 April, and Parliament has to reapply it by an annual Finance Act. For up to four months until the Finance Act becomes law, the Provisional Collection of Taxes Act 1913 ensures that taxes can still be demanded.
Over the last three decades, UK governments of all parties have been unwilling to increase the basic rates of income tax, although they have increased the tax take by fiddling with higher rates of tax and tax allowances. In the current fiscal and economic crisis that we face, perhaps now is the time to avoid all this ‘smoke and mirrors’ and consider raising the basic rate of income tax.
This would have the advantage of raising large amounts of money and would not bear down on consumption in the same way as an increase in VAT. There may be some negative effects such as the impact on work effort and the loss of certain types of employee overseas but this is an emergency and emergency measures are needed as they were in 1799.
It would surely be possible to build into the annual tax legislation a clause that says that the basic rate will only be raised for, say, 2-3 years and would then automatically lapse back to the previous rate. Hopefully, by that time the economy would have recovered enough to be able to retain the basic rate at the lower level.
Malcolm Prowle is the co-author of Planning and Managing Public Services: Getting out of the hole due to be published in September
