S2E9: Where your taxes actually go and why you’ll need to pay more | Director of the IFS Paul Johnson
It feels like we pay a lot of tax in the UK but is that really true? Where do our taxes actually go? Are they wasted? And are we going to have to pay more in the future? Paul Johnson is the Director of the insanely well respected Institute for Fiscal Studies and in this episode he explains how we’ve got into this pickle, how we can get out of it - and why our feelings about paying too much tax might not be rooted in reality.
Things to remember from this episode
Paul Johnson is the Director of the Institute for Fiscal Studies (IFS) and the author of Follow The Money.
He argues that numbers should be put into context, e.g. £1 billion could be a lot but it isn’t in the context of an NHS budget of £180 billion.
Income tax was first introduced to fund the Napoleonic wars. Go figure.
If you look at tax as a fraction of national income, it’s been steady at a 1/3 since WWII, but it’s jumped by 3% - 4% in the last few years, by about £100 billion.
It held steady for decades despite the increase in public spending on stuff like health because it was offset by massive cuts in defence spending.
The reality today is we’re spending more on health, there are more people over the pension age and that’s only increasing, growth has been very poor for 15 years - and we’re spending vast amounts on debt interest payments.
Even though we’re facing the highest tax level ever in the UK, we’re still doing better than most of Western Europe - as in, they generally pay more tax than we do. Globally we’re in about the middle.
You can’t have a low tax system like America and have European public services.
Unfortunately UK taxes are high by historic standards and public services appear worse, like NHS wait times - despite us spending a bigger fraction of public money on health than ever before.
Paul says it’s a mystery why the NHS hasn’t performed better since 2019 because we’ve been employing more doctors and nurses - we just haven’t been seeing the results.
Why Paul thinks we’ll need to pay more tax:
Population is getting older (older people cost the state more/don’t earn).
Climate change - we’ve got a target of getting to net zero by 2050 which will cost the state to get there.
Against this backdrop we’re also going to raise defence spending for the first time in years because of geopolitical events.
Unless we really ration the NHS, then taxes need to increase to meet these demands placed on the state.
Paul says it always seems to be an emergency with the NHS. This means the urgent stuff gets dealt with and sucks up the money but this also means investment isn’t made for the long term, which keeps it in a perpetual state of emergency.
When it comes to problems with tax, there are often solutions but any changes will result in some people being worse off. Very few changes will make everyone better off. So this leads to huge resistance to tax changes. Even little changes are unpopular.
He thinks we need governments to make brave, unpopular long-term decisions.
We raise about £1 trillion a year in taxes in the UK. About 2/3 of that massive number comes from three taxes: income tax, national insurance and VAT (then corporation tax is the next biggest).
Income tax is going up by the most it’s ever gone up (the amount the government collects) because tax bands are being held where they are despite inflation and rising salaries. This will raise an extra £50 billion a year for the government but people don’t notice it as they’re just holding taxes where they are (rather than increasing the tax bands).
You need 2.1 children per woman to maintain the population. If it drops below that then the population will decline. We’re only having 1.6 right now which is the lowest ever. The reason the population has remained fairly stable is it’s been propped up by immigration.
The top 1% of people in the UK (by earnings) pay 30% of income tax, which is more than most European countries.
The top 0.1% of earners (income is over £650k) which is about 50,000 people in the UK, are paying 6% - 7% of all income tax.
About 1/3 of this group were born abroad, so they could leave and that would be expensive for us.
People who earn a lot are more likely to earn their money from sources which aren’t highly taxed.
Paul thinks we could look at wealth to raise taxes. The older generation is sitting on a lot of wealth and wealth is much more unevenly distributed than income. We don’t have a wealth tax per se. We have inheritance tax but it’s not very effective because if you have a lot of wealth, it’s easy to avoid it. The average level of tax paid on inheritance of £2m is double the amount paid on £10m .
Council tax is based on the value of your property that you live in - but the value it was in 1991, which is bizarre when you think about it.
He thinks council tax is a regressive tax because the wealthier you are the less you pay, as a fraction of your wealth.
Collecting corporation tax from global companies is complicated because corporation tax is a tax on profits and it’s difficult to pinpoint where profits are made (unlike revenue) for global companies. The rules for corporation tax were made 100 years ago and aren’t really fit for purpose any more. You could tax based on revenue in theory, but that would need international agreement - and because there would be winners and losers there is resistance.
In countries like Denmark where people pay more tax, they are generally pretty happy - i.e. more tax doesn’t necessarily mean you’ll be worse off or unhappier (as long as public services improve). The problem we have in the UK is we’ve got high taxes that don’t seem to be funding better public services - and there’s anger at the lack of fairness in the tax system.
The last 15 years have been the worst for income growth since the Napoleonic Wars. Wow.
Paul says there’s a dirty little secret in government - they know how to deliver growth, but only in the long term so they don’t do it because they need to get reelected in a shorter timeframe. He says the government can’t do stuff that delivers growth this year but they could do things over the next three years which would deliver growth in 10 years plus
So how can we get back to growth? Paul suggests the following:
Reform the planning system so we can build houses and infrastructure where it’s needed.
Invest more in education. Our 15 year olds compare quite favourably internationally but by the time they’re 21 years they’re way behind.
Reforming the tax system.
Increasing trade with Europe.
Improving regulations.
There are always trade offs.
We’re probably 3% or 4% worse off because of Brexit, Paul says, but now we can control our immigration which we couldn’t do when we were in the EU. This is a clear example of a trade off but these choices are often presented as binary because politicians are invariably pushing one side.
We need stable politics to drive growth. Stable politics isn’t enough on its own but it is a prerequisite.
