At this week’s Labour conference, the leadership injects some positivity about the country’s prospects having been criticised for its so far downbeat messaging that is not compatible with motivating the economic growth it seeks. 

The narrative of tough decisions needed in the upcoming budget persists. And maybe it’s good politics to get all the bad news out of the way as early as possible in a parliament. 

In that context we thought it appropriate this month to look again at the UK tax system – who does the money come from and where does it go?

Our chart of the month shows that the UK (and, maybe even more surprisingly, the US) does more redistribution than the nominally more social democratic European countries. It may be possible to tweak this to direct some more to the poorest 20%, but it is hard to argue that the UK tax and spend system needs more redistribution.

It is also the case that the UK tax system is more progressive than in other countries (figure). Who would have thought that in Germany, Denmark, France, Spain, etc., the richest 10% had a lower effective tax rate than the poorest 50% whereas in the UK the opposite is the case – and by a long way?

The UK tax take is therefore already highly concentrated on the wealthiest residents. As we covered in a previous chart of the month, the top 1% of UK earners pay 28% of all taxes collected and the top 10% of earners pay 60% of all taxes collected.

Favouring redistribution over public services

Compared to most but not all other European countries, the UK spends less on public services (figure). In other words, the UK favours using its tax take to redistribute money rather than to spend it on public services. Fair enough. That’s a choice. And it’s unlikely that any country can do both while remaining solvent.

That said, for a government focused on driving growth, it is worth wondering what effect such a choice has. Does a focus on more redistribution lead to less incentive for people to enter productive, paid employment (the UK has a relatively low employment ratio)? Would better public services be more of a spur to growth than more redistribution?

Yet, as the backlash over winter fuel payments has shown, redirecting funds away from redistribution is challenging. 

Where to tax

The government has laid the groundwork for tax rises in the upcoming budget. The question is where are they to fall. Here the Chancellor will be walking the same difficult tightrope as most Chancellors. 

Given the already high concentration of the UK tax system on higher earners – those that are most mobile and most able to exploit any loopholes – any further such concentration may make the tax system less resilient with a highly uncertain impact on tax revenues. Many also question the impact on investment and economic growth. Yet taxing on a broader, and therefore more reliable and resilient, basis is politically challenging at a time when people are having to cope with increases in the cost of living.

There is a lot of talk about pensions becoming ‘unaffordable’. Yet nothing is unaffordable – it’s simply a question of the choices we make within the available funds – prioritising health, education, defence, pensions…? Everyone will have their view.

As the figure below shows, UK public expenditures on pensions is relatively low and has barely increased compared to most other countries while UK demographic projections are not as dire as in many other countries.

Some are pushing for decreased tax expenditures on pensions – in other words paring down some of the tax reliefs around pension contributions and/or lump sum payments. As we argued in our recent paper on pensions: ‘investment behaviours by pension funds tend to lead successive governments to see increased tax-deductible pension contributions as a tangible fiscal cost rather than as another mechanism to boost the country’s economic performance.’  The anti-domestic and gilts biases of UK pension fund investments may, once again, come home to roost. 

The Office for Budget Responsibility has just issued a statement saying that the public finances are on an unsustainable path. It is clear to everyone that, long term, sustainability of the public finances can only be achieved through sustained economic growth. An ever-increasing tax burden on its own won’t cut it. The Chancellor therefore faces the same tightrope as previous chancellors – how to improve the state of the public finances while generating the space, confidence, enthusiasm and morale necessary to drive an economy that has flatlined since Labour took power. 

We shall see in a few weeks’ time how the Chancellor walks that difficult tightrope.