Unpleasant choices redux

As expected, the UK government did indeed announce the widely trailed rise in NICs that I looked at in my previous post. The package of measures represented a budget in all but name and will take the tax burden relative to GDP to its highest since 1950 (chart). If nothing else, this highlights that the era of low taxation is over. This is a reflection of the reality that the UK cannot continue to cut taxes whilst simultaneously meeting the electorate’s demand for better public services. It is also a reflection of demographic reality. The tax cuts of the 1980s were possible because the last of the baby boomers were still entering the workforce. But over the last four decades, the population share of those aged 65-plus has risen by four percentage points to 19% and is set to rise to 25% by 2050. Some thoughts on these issues below.

What was announced?

Dealing first with the package of measures, both employer and employee NIC rates will rise by 1.25 percentage points (a touch more than anticipated) from April 2022 and the rate of dividend taxation will rise by a similar amount. All told, this is expected to generate £12 billion pa of funds for health and social care (0.5% of GDP). From April 2023, underlying NICs rates will return to their previous level and a formal legal surcharge of 1.25% will be levied on wages which will be ringfenced only for health and social care purposes. Another important part of the package is that the government plans to introduce a cap of £86,000 on the amount that households (in England) will need to spend on personal care over their lifetime. This is designed to reduce the problem that individuals will be subject to high and unpredictable long-term care costs (an issue I looked at ahead of the 2017 election).

What is it likely to mean in practice?

The tax hikes come on top of the £25 billion (1.1% of GDP) of medium-term tax raising measures announced in March. It is notable that the UK is the one major developed economy to raise taxes in the wake of the pandemic – which, by the way, is not yet necessarily behind us. It may be that this will prove to be a tax hike too soon. Moreover, contrary to previous expectations, the funds raised by what the government calls a Health and Social Care Levy will be used largely to fund the NHS rather than fix the problems in the social care system. Over the next three years the social care programme will receive just £1.8bn in additional revenues (15% of the total raised by the Levy). The government has taken the (probably well-founded) view that voters are not going to be too exercised by whether the funds are used for the NHS or for social care – at least in the short-term. This might change if the government is forced to come back for more money in a few years’ time.

A deeper dive into the details

Although the government is using the Levy as a way to find sorely needed funds for the health system rather than primarily to fund social care, this is not necessarily unwelcome – after all, many of us have pointed out that the pressures on the NHS arising from demographic change meant that it has been underfunded over the last decade. But those of you with long memories might recall that the Brexit campaign, backed by Boris Johnson, promised that leaving the EU would generate savings of £350 million per week (£18.2 billion per year) which could be used to fund the NHS. That being the case, you may wonder why workers are being hit with additional taxes to do exactly that.

There is also some confusion regarding the impact of the lifetime social care spending cap. The £86,000 lifetime limit refers only to how much individuals pay for care. It does not include daily living costs which are incurred by living in a care home, such as food, energy bills and the accommodation itself. The average costs associated with living in an old age care home are currently £36k per person per year. Daily living costs are estimated to account for one-third of that. It would thus take the average person 3½ years to run up £86k of health costs (3.5*(36-12) = 84) – but 75% of those admitted to care homes do not live longer than three years, suggesting that the £86k limit is (a) not very generous and (b) still leaves residents having to use an additional £40k of their own money to cover daily living costs before they hit the limit.

The macroeconomics of the tax hike

Whilst there was much criticism about the generational aspects of the plan, some of this is to miss the point that there is always a transitional element in tax policy. Admittedly, today’s retirees do benefit at the expense of younger workers but assuming no changes to policy in future, today’s young workers can be expected to benefit from similar funding when they eventually retire. There is no doubt, however, that those in the early stages of their career and those on low to middle incomes will bear a considerable part of the load. At the younger end of the age spectrum graduates already face significant costs as a result of having to pay back their student debt. New graduates with an average debt of £47k and earning an average salary of £30k per year are subject to a debt repayment charge equivalent to 1% of gross income, and are now being asked to contribute an additional 1.25% to fund the health levy. As an inter-generational move, this is not a vote winner.

In any case, many were left wondering why there is any need to raise taxes at all in this fragile stage of the economic cycle. The UK is coming off its biggest peacetime recession in history and is responding by tightening the fiscal stance. It is unlikely that the impact on growth will be significant but on the basis that the government will almost certainly need to tap taxpayers for additional funds for social care, this tax hike may have political repercussions.

Nor has the government had any problem raising funds in the bond market. It could quite easily have kicked this can down the road for a year had it wished in order to assess the longer-term effects of the pandemic. Chancellor Rishi Sunak argued that to continue borrowing would be “irresponsible at a time when our national debt is already the highest it has been in peacetime.” But this is misleading. The BoE owns almost 40% of the debt – a significant proportion is thus held by the one institution that is not about to get cold feet and demand a higher risk premium.

What to make of it all?

We should not be overly critical of efforts to try and secure more funding for the NHS. However, we can be more critical of the way the government has gone about it with too much emphasis on taxing the incomes of working people (not to mention the additional costs to employers) whilst not enough of the burden falls on those who derive income from non-labour sources.

Two final thoughts spring to mind: First, the Chancellor has announced a spending envelope which is unchanged overall. Thus although health spending will rise and some areas of spending will be ringfenced (e.g. schools) this implies real spending cuts for unprotected departments. It also implies that future Covid-related spending will not be funded by borrowing (e.g. to cope with the effects of scarring) but must be met from taxation. This leads us to the second point: Over the past decade, spending on health has risen from 30% of total outlays to 38% today (even after taking out Covid effects). This squeeze is likely to continue as demographic pressures intensify, suggesting that if the state is to remain the primary provider of health and social care, more tax rises are likely before the decade is out. 

And to think that Boris Johnson wrote in the Conservative manifesto in 2019: “the Labour Party … would raise taxes so wantonly.” Life comes at you fast.