Austerity is going to be hard for everyone – is it time to reform our tax system?
It is widely anticipated that today’s Autumn Budget Statement will entail a reduction in spending and rises in taxes in the range of £50bn.
Austerity is never easy and reducing spending and increasing taxes is going to be harder for everyone now given the cost of living crisis and the slowing economy facing the country today.
We argue that the economy is at a tipping point and the Chancellor’s design of this austerity package is crucial not just for public finances but also for United Kingdom’s future growth potential and productivity.
This budget will be costly, not just for our back pockets but also on the next ballot paper
The government have had to play a monumental balancing act, with the need to reduce its debt as quickly as possible, to do this as painlessly as possible while trying it’s hardest to not exacerbate inequalities. Our research suggests that the need to reduce debt and minimise negative impact on the economy inevitably creates greater income inequality.
So, what is the trade off? If the Chancellor announces spending cuts, income inequality is likely to be exacerbated and societies most vulnerable will be disproportionately affected in a worsening cost of living crisis. In the short term, these cuts will drive down labour income, redistributing income from the poor to the rich. Naturally, this is a politically costly move.
Alternatively, the Chancellor could raise taxes which would have a greater negative impact on the UK’s long-term GDP. Further consequences to the raising of taxes vary by tax type, for example: higher income tax or VAT is likely to hurt poorer households more, whereas raising corporate tax is likely to discourage investment, further affecting the UK’s economic productivity and GDP in the long term. This may be particularly damaging given that the UK economy has been suffering from low productivity at least since the global financial crisis.
As we brace for austerity, Richard McManus, Dawid Trzeciakiewicz and I indicate that it may be time to reform the UK tax structure. Their research indicates there is a further balancing act when it comes to taxes, as tax hikes raise taxes on the rich raise less revenue as they further increase the disincentive for high-income earners, likely to result in lower tax revenues. A rise in VAT, on the other hand, is bad for both economic activity and income inequality.
What is more, the current UK tax system is highly regressive, with low-income households paying similar proportions of their income in taxes as high-income households, just that they pay it through taxes on their consumption, not their income.
Ultimately, several policy trade-offs need to be balanced delicately for austerity to have any realistic chance of success. This budget will be costly, not just for our back pockets but also on the next ballot paper.
Professor Gulcin Ozkan, professor of finance at King's College London.
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