Tax revenues are below forecast despite the strong recovery in the economy. The result is a £30bn black hole in the finances and the need for yet more austerity
The strength of Britain’s economic recovery has surprised everyone. So rapid has been the upswing that Bank of England governor Mark Carney is now telling households to prepare for an early rise in interest rates.
For all the good news, though, there are concerns we are not experiencing the ‘right’ sort of growth. Chancellor George Osborne has warned that Britain’s housing market poses an ‘old and familiar’ risk. Carney has added that the trade position is another fundamental vulnerability. ‘Borrowing from abroad to consume at home is hardly a recipe for a balanced and sustainable expansion,’ he said in his recent Mansion House speech.
And when the International Monetary Fund gave its annual assessment of Britain’s economy, its staff said ‘growth will eventually stall’ if the terrible productivity performance of the past six years fails to improve.
None of these assessments mentioned another serious threat to household prosperity and happiness: that the tax system is not collecting enough revenues.
Tax revenues have consistently fallen short of expectations in this recovery – unlike public spending, which has been close to the chancellor’s targets set in the June 2010 ‘emergency’ Budget. For the 2013/14 financial year, this year’s Budget estimated public sector net revenues of £607.7bn, more than 8% (or £54bn) lower than the £661.9bn expected back in 2010.
Of course, most of this shortfall was caused by the economic weakness of 2011/12. Economic stagnation is a necessary, but not sufficient, explanation.
In 2010, the Office for Budget Responsibility expected the tax system to be able to collect 38.7% of national income in tax revenues. In fact, this year’s Budget documents show revenues accounting for only 37%. It means that 1.7% of gross domestic product – almost £30bn a year – has gone missing. That is a lot of money.
The trends are no better, even in the most recent year of rapid economic recovery. Taking real growth and inflation into account, the size of the economy grew 4.7% in 2013/14, but revenues rose only 3.5%. Normally, revenues grow faster than nominal GDP.
Weakness in revenue growth matters because if it continues, the shortfall will eventually be recovered through painful tax rate increases or further public spending cuts, meaning the grind of ever-harsher austerity will continue for longer.
A disappointing tax-to-national income ratio is a problem for the acceptability of taxation, since it suggests Britain’s tax system is more leaky – either domestically or internationally – than we thought. If the trend continues, those paying taxes will face a greater burden in years ahead.
If you talk to Treasury officials about the missing tax revenues, you get one of two responses. In public, there are many explanations for weak revenue: more low-paid jobs have been created that are not so tax-rich because the government has increased the income tax personal allowance; housing transactions remain weak, leading to shortfalls in stamp duties; oil revenues have taken a hammering from the slump in North Sea production; and financial companies are still offsetting past losses against current profits, hampering the growth of corporate tax revenues.
In private, there is greater concern that the structure of the economy and the UK tax system no longer easily generate tax revenues. There must also be a concern that tax avoidance is beginning to make a serious dent in the nation’s resources.
We have been here before. In 1995, the Treasury was concerned about a value-added tax hole and set up an investigation into lost revenues in the 1990s recovery. Just as it reported – with rather inconclusive results – the revenues came flooding back. There is no guarantee of another happy ending 20 years later.
Chris Giles is the economics editor of the Financial Times. He will be speaking at the CIPFA annual conference in London, 1–3 July 2014
This opinion piece was first published in the JulyAugust edition of Public Finance magazine
