The Challenge of Balancing Fiscal Responsibility and Economic Growth
Chancellor Rachel Reeves is under pressure to address the government’s financial challenges in the upcoming Budget. A leading think tank, the Institute for Fiscal Studies (IFS), has warned against hasty or poorly thought-out tax increases that could harm the economy. The IFS emphasized the need for a careful approach, highlighting that some tax rises might have negative consequences.
The Budget is expected to include tax increases as the government seeks to meet its financial targets. These targets include not borrowing for day-to-day public spending by the end of this parliament and reducing government debt as a share of national income. Analysts believe that the chancellor may need to raise tens of billions of pounds through tax hikes or spending cuts to meet these goals.
Key Financial Rules
The two main financial rules set by the government are:
- Not to borrow for day-to-day public spending by the end of this parliament.
- To reduce government debt as a percentage of national income by the end of this parliament.
Before the 2024 general election, Labour promised not to increase income tax, National Insurance, or VAT for working people. However, the IFS suggests that it is possible to increase tax revenue without breaking these promises. This would require navigating several constraints on major taxes such as corporation tax, council tax, business rates, and fuel duties.
Tax System Reforms
The IFS report calls for broader reforms to the tax system, aiming to make it “fairer and more growth-friendly.” It suggests aligning overall tax rates across different forms of income. Helen Miller, director of the IFS, stated that there is an opportunity to implement changes that support economic growth while being fairer for all.
Reforms to property tax and capital gains tax are highlighted as good starting points. The report also discusses potential trade-offs the government could consider to generate more revenue.
Wealth Tax and Other Considerations
The IFS warns against implementing a wealth tax, citing practical challenges and potential negative impacts on savings and the movement of wealthy individuals. Instead, it recommends fixing existing wealth-related taxes, such as capital gains tax.
Property taxation is identified as an area needing urgent reform. The current council tax system, which uses property values from 1991, is criticized as outdated. The IFS proposes a reformed council tax based on current property values.
Extending the freeze on income tax thresholds, which is due to end in 2028, could generate significant revenue. Chancellor Rachel Reeves has not ruled out this option. However, restricting income tax relief for pension contributions could be unfair and distortive. The IFS suggests alternative ways to increase tax on pensions, such as reforming the tax-free element.
Government Response
A Treasury spokesperson stated that the chancellor aims to strike the right balance between funding public services and encouraging growth and investment. This approach is crucial for maintaining economic stability and supporting long-term development.
When is the Budget and What Might Be in It?
While the exact date of the Budget has not been specified, it is anticipated that the announcement will outline the government’s plans for addressing fiscal challenges. The focus will likely be on balancing tax increases with economic growth and ensuring that public services remain adequately funded. The IFS’s recommendations highlight the complexity of this task and the need for thoughtful, strategic decision-making.