MNI INTERVIEW2: UK Tax Hikes Before Fiscal Rule Change - NIESR

UK Chancellor of the Exchequer Rachel Reeves will have to hike taxes in the autumn to demonstrate to markets that she is serious about sustainable government finances, though there would be a compelling case for her to then consider reform of the fiscal framework, NIESR Deputy Director Stephen Millard told MNI.

The National Institute of Economic and Social Research, an independent think-tank, made headlines with its projection that current spending and taxation plans point to a gap of GBP41 billion pounds, equivalent to about 1.3% of GDP, with Reeves' current budget balance fiscal rule. The chancellor cannot stick to her fiscal rules as well as her spending commitments and also keep her pledge not to hike taxes on working people, Millard said, arguing that tax hikes should take precedence. 

"I think we have got to revamp the fiscal framework ... but I don't think we live in an ideal world ... If she were to do that, the markets would say, 'Oh, you're only doing that to get out of the fact that ... you don't have a credible plan at the minute," he said in an interview.

While NIESR and others have criticised the current fiscal framework for tying current policy to uncertain five-year forecasts of revenue and expenditure, Millard said markets will demand action in the autumn budget. (See MNI INTERVIEW: Ex-OBR's King See Productivity Cut, Loan Boost)

"I think a tax rise in October is inevitable, because it's only if there is a tax rise that's announced straight away that the markets are going to believe she's serious about fiscal sustainability," Millard said.

"One possibility is that she raises taxes, but that she doesn't necessarily fill all of the gap in one go," he said, adding that she could  promise some further tax hikes and flag up "some kind of plan around a fiscal framework that is possibly a little bit more sensible than what we have at the moment.”

HIT TO ECONOMIC ACTIVITY

Academic research suggests that income tax hikes would be preferable to measures such as Reeves’s previous increase in the employee payroll tax (NICS), which was liable to affect demand for labour as well as to feed inflation, Millard said. (See MNI INTERVIEW: UK Employment Law Tightens As Jobs Data Ease)

"Income tax is probably the one to go for, because that way you can raise the most amount of revenue while doing the least damage to GDP. Economists like me love VAT rises, because that isn't distortionary, it doesn't distort any spending decisions, if anything, it encourages people to save more, which is kind of good. But the big problem with VAT is, of course, it is very, very, very regressive," Millard said, noting that this would be highly problematic for a Labour government.

"I think, realistically she's going to look to raise the upper rates of income tax, and then she will, I think certainly have to raise the basic rate as well, just by one or two percentage points. And it really is as much about convincing the markets that she is serious about addressing the fiscal issues as it is necessarily about filling the entire hole in one go," he said.

The Bank of England followed convention in its August Monetary Policy Report by not factoring in any unannounced changes in fiscal policy, so its growth projections are likely to prove optimistic once the budget’s measures take effect.