Philip Aldrick: If done right, tax rises can bring the economy back faster and greener

The Times

If there is one principle guiding fiscal policy right now, it is “forget about tomorrow”. Tomorrow will take care of itself. Until then, it’s all hands to the pump, bailing out the economic ship as the virus punches fresh holes in its hull. The public finances have become an afterthought, albeit one we are reminded of every month as the national debt hits new highs. The next update is on Friday, when we will learn that the government borrowed between £30 billion and £40 billion in December alone, roughly as much as the 2018-19 financial year as a whole.

Everyone — from Labour to Boris Johnson to the former deficit purists at the International Monetary Fund and the Organisation for Economic Co-operation and Development — agrees that the best way to deal with the debt is by growing the economy. Yet Rishi Sunak is reported to be planning tax rises in his March budget. Corporation tax and council tax reforms first, apparently. Predictably, the backlash was quick. “A hike would slow economic growth,” the Institute for Economic Affairs said. But would it?

Tax rises don’t have to slow the economy if they are carefully targeted. It is true that the last thing Britain needs at present is a squeeze on household or business spending. Raising VAT or income tax, for example, would stall the recovery by taking money out of people’s pockets and higher business taxes would drain away vital investment.

But what if a corporation tax increase was accompanied by a large, temporary uplift in investment and R&D relief that, for many companies, more than offset the tax rise? By making the trade-off more valuable, there would be an even greater incentive to invest. Companies with dry powder, and there are many, would have a time-limited tax break so long as they invested to drive the recovery. Higher corporation tax might not raise revenue in the first few years, as companies used the relief, but towards the end of the parliament it would bring down borrowing. Joe Biden plans something similar, a rise in corporation tax from 21 per cent to 28 per cent, combined with a 10 per cent “Made in America” credit for investment that supports domestic manufacturing. With a rate of 19 per cent, the UK has room for manoeuvre. At 25 per cent, it would still be the lowest in the G7.

Another beneficial levy would be a carbon border tax, as the European Union plans, to ensure that the carbon price on imports matches the carbon price in the UK. Brussels is pitching it both as a “level playing field” issue, to prevent dirty Chinese imports undercutting clean local producers, and a green initiative, to stop domestic companies exporting emissions.

Given that the UK is both hosting the COP26 climate summit this year and trying to rebuild relations with the EU, the policy has clear attractions. Pre-announcing the tax could bring forward investment in domestic production to replace Chinese imports. The cost of carbon tariffs, a cost that business inevitably faces if Britain is to hit net zero by 2050, would be borne later in the parliament, once the recovery is established.

Council tax reform might even stimulate spending. As a paper this week by the Onward think tank set out, cutting council tax rates in the lowest band and raising it for the highest would give poorer households, with a higher propensity to consume, more spending power. Rich households can absorb higher council rates. Residents in Kensington and Westminster in London are already making voluntary top-ups.

While tax rises in general are contractionary, tax policy does not have to be. The Treasury, which is bursting with big brains, can be clever about it. The chancellor is right to consider tax rises in his budget. They could stimulate growth and, from the public finances point of view, at some point tomorrow will become today.

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