Why UK taxes should be higher


Discussion of taxation in the UK is
bedevilled by two problems: one familiar and one less obvious. The
familiar one is to imagine the level of taxation is separate from the
level of public services and welfare. Most voters and much of the
media understand the two are connected, which is why the Tory attack
on Labour’s ‘tax bombshell’ is so misplaced. A majority want
public services to improve, and know that requires higher taxes [1],
so all the Conservatives are doing is reminding voters that Labour is
more likely of the two parties to improve public services.

Yet this familiar point gets forgotten
when we come to the less familiar problem, which is historical
comparison. It is now well known that UK taxes as a share of GDP, as
measured by the OBR, are currently higher than they have been since
1948 (see
Ed Conway here for example
). This sounds bad, until
you remember the first problem, which is that it is pointless to
discuss taxes without also discussing public services and welfare
payments. The elephant in the room here is health spending. Below is
on total health spending as a share of GDP in
each of the G7 countries, with the UK in red.

Health spending as a share of GDP in
the G7

Health spending as a share of GDP has
been trending upwards in all the major economies since at least 1970,
for familiar reasons like longer life expectancy and advances in what
medicine can do. If health spending is mainly paid for through taxes,
then unless some other large item of government spending is trending
in the opposite direction, taxes are bound to be at historic highs.
For some time in the UK there was such an item, defence spending, but
once that peace dividend ended there has been nothing to take its
place. Of course if health spending is not paid for by taxes citizens
have to pay for it by some other means. The top line in the chart
above is the US, where spending is so high in part because it is a
very inefficient insurance based system.

I have heard journalists in the media
say that UK taxes are at record levels countless times, but I have
never heard them also say: ‘but of course this reflects the steady
increase in health spending as a share of GDP’. The more general
point is that talking about tax without discussing what it pays for
is just uninformative. [2]

International comparisons of taxation
are better, because advanced economies have similar structures to
their public sectors. Here is the same chart as above for total tax
as a share of GDP (source).

Total tax as a share of GDP in the G7

Note the definition used here is a
little different from the national accounts total the OBR uses, so
using this measure UK taxes in 2022 are similar as a share of GDP to
taxes in the early 80s. France has the highest tax share in 2022,
followed by Italy and then Germany. Indeed most major European
countries have a higher tax share than the UK, as
Chu shows here
. The UK share is similar to Canada and
Japan, while the US has the lowest tax share. (Will Dunn shows an
international comparison for taxes on wage income

Although more informative than
historical comparisons, looking at other countries has obvious
pitfalls. The US tax share is so low mainly because most US citizens
pay via their employers for health cover through insurance companies.
It doesn’t mean that US citizens are better off because taxes are
low, because their wages are lower so firms can afford to pay for
health insurance. If we ignore the US for this reason, then the UK
has amongst the lowest tax take among the G7, and also the lower than
most major European countries.

While international comparisons of
taxes are better than looking at historical trends, they are not
ideal because – as the US shows – the structures of the public
sectors are not identical. Partly for this reason, the OECD compiles
an analysis of total public and private spending on what it calls
“social expenditure”, which is mainly health and welfare. I
discussed this data in
this post
. However, even if we restrict ourselves to
total public spending on social expenditure, the OECD
that the UK has the lowest spending in the
G7 (at 22% of GDP), even just below the US (at 23%). France tops the
table at 32%, followed by Italy (30%), Germany (27%) with Japan and
Canada both on 25%.

This suggests that public spending in
the UK is unusually low compared to other major countries, and as a
result taxes are unusually low. This should come as no surprise,
because public spending excluding health has been cut back sharply
since 2010, as this
chart from the Resolution Foundation

What international comparisons tell us
is that these cuts in public spending have moved the UK to the bottom
of the G7 in terms of spending and taxation. UK public services are
in crisis not because they are unusually inefficient, but simply
because the Conservative government has chosen to spend far too
little on them in order to get taxes unusually low compared to other
G7 and major European countries. The Conservatives are going to lose
this election badly in part because they continue to prioritise tax
cuts over improving public services.

Which means UK taxes are too low, and a
Labour government is going to have to raise taxes to meet both its
pledges and expectations about public spending. (The National
Institute comes to similar conclusions here.)
The question Rachel Reeves and the Treasury will have to answer is
they can raise enough using the taxes left after you exclude those
they have promised to keep at existing planned levels
If not, will they break these election pledges, or will the public
sector remain underfunded and the UK remain under taxed?

Even if Labour can raise enough taxes
without breaking its election pledges to get public spending to
levels similar to other European countries, this may pose
macroeconomic issues. Higher public spending matched by higher taxes
on companies or the better off may end up increasing aggregate
demand, because higher taxes will not be matched by lower private
spending. Together with higher public investment, this will put
upward pressure on interest rates. [3]

However this will be a price worth
paying, in part because public spending at close to current levels is
having a negative impact on economic performance. In particular ever
growing NHS waiting lists are restricting labour supply

and therefore UK output and incomes. If the Labour government is to
be successful in ending a period of very weak growth in living
standards, one of the things it will have to do is increase levels of
public spending and taxes closer to other major
European countries.

[1] To preempt the tweets from MMTers,
even if you believe that the level of taxes is just what is required
to keep inflation constant, that in turn will depend on the impact of
the public sector on overall demand. For this to be roughly neutral
over the medium term, what the public sector adds to demand with
higher spending it needs to roughly subtract from demand with higher
taxes, so spending and taxes will across countries and over time tend
to move together.

[2] Discussing the composition of total
tax, and how it has changed over time, is more interesting. The
Resolution Foundation has an excellent account here.

[3] Whether this means higher interest
rates, or just rates coming down more slowly than they otherwise
would have done, will of course depend on other influences on
aggregate demand.

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