A report by the Institute of Fiscal Studies (IFS) published on the eve of the Conservative Party conference caused shockwaves, with headlines reporting that UK tax revenues are at historically high levels. In this article we take a look at what is happening with UK tax levels, why they are so high and what might happen next. 

Putting it in context 

The IFS report shows that, by the next general election, tax revenues are forecast to account for 37% of national income - the highest level since records began in the 1940s.   

At the last general election tax revenues accounted for 33% of national income – and the IFS estimates that the subsequent 4% rise represents over £100bn a year more in tax revenue, or £3,500 more per household on average.  

However, despite this record high, tax levels in the UK remain about the average for developed countries. Out of the G7 countries, Germany, Italy and France all have higher tax levels than the UK, with only the USA having a significantly lower level. 

What’s the cause? 

The recent rise in UK tax levels is down to a number of factors. 

These include the corporation tax rise introduced this April, when the main rate paid by companies increased from 19% to 25%. Alongside this, we have also had new taxes introduced such as the electricity generator levy. 

However, a significant, and perhaps less obvious cause, is the freezing of various tax thresholds and allowances. In something often referred to as ‘fiscal drag’, freezing thresholds and allowances in a time of high inflation can lead to more people paying tax, and at higher rates. 

For income tax, the tax free personal allowance and the thresholds at which the higher and additional rates become payable have been frozen since April 2021.  In the past, these were normally increased in line with inflation each year, or sometimes even more generously.  As average earnings rise due to inflation, more and more individuals will find their income exceeds the personal allowance, meaning they now have to pay income tax, or that they are subject to the higher and additional rates.  

Similarly, the VAT registration threshold has been frozen at £85,000 since April 2017.  Rising prices mean more businesses may tip over this threshold, and therefore have to start charging their customers VAT.  

Whilst these freezes may be less headline grabbing than a rate rise or new tax, they can actually bring in significant extra tax revenues over time.  

What happens next? 

The IFS predict that the current high levels of tax are unlikely to come down at any time in the future. This is due to expected increases in Government spending, as an ageing population means more needs to be spent on pensions and healthcare.   

Even if we see a change in Government next year, large scale tax cuts are unlikely, with Labour ruling out unfunded tax cuts if they were to gain power.  

The Chancellor appears to agree, having said recently that tax cuts ‘were virtually impossible’ at the present time, stoking discontent amongst other factions of his party.  All eyes will be on the Autumn Statement on 22 November 2023 to see whether they have managed to change his mind.   

 

This article reflects the position at the date of publication (18 October 2023). If you are reading this at a later date you are advised to check that that position has not changed in the time since.    

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