LTS Tax Writing Competition 2022 - Winners

These are the results of our second annual tax writing competition. Thank you to all the entrants for some excellent entries and to the judges – Andrew Hubbard and Allison Plager of Taxation magazine, Ximena Montes Manzano of Temple Tax Chambers and Mala Kapacee of London Tax Network Ltd – for taking the time to review the entries and provide feedback to entrants.

The topics this year were

• How has UK tax changed over the last few years and how do you expect it to change in future?
• Which one current UK tax would you abolish if you were chancellor – and which tax would you increase to make up the shortfall in revenue?

The winner was Henry Winterton and second place went to Edmund Paul. Edmund’s article is below.

Congratulations to them both!

Note that these articles were written while Liz Truss was Prime Minister.

Introduction

During the Conservative leadership election, promises of reduced taxation played a pivotal role in Elizabeth Truss winning the Conservative leadership election. The perception was that higher taxation was stifling economic growth and reducing taxation would boost productivity in the economy. Following market volatility, the tax-saving measures announced were reversed.

And so, here we are at a tax crossroad. To plot our potential course, this article looks at recent tax trends and what the future direction of travel may be.

A slowly increasing tax burden

There are many metrics that point to increasing tax burdens in the recent past. One of these is the annual tax receipts as a proportion of GDP (ATRPGDP), which per the Government’s statistics¹ of 21 October 2022 show that receipts have grown from 26.9% of GDP in 2002/2003 to 30.3% in 2021/2022.

This trend can also be seen when looking at the tax changes by individual chancellors. The IFS reported² that every chancellor from John Major onwards have announced permanent tax measures that increased tax take as a proportion of GDP. Interestingly, Rishi Sunak’s last budget was the largest single increase, resulting in taxes rising as a percentage of GDP by c.2%.

There have also been changes to who bears the greatest percentage burden of tax. Estimates for 2019/20³ suggest that the top 1% of income taxpayers contribute 29% of all income tax receipts, compared to only 21% in 1999/00. Further, the richest fifth quintile paid on average £39,800 in direct taxes in 2020/21, whereas the poorest fifth paid £2,800 in direct taxes. This has meant that the Government is now reliant on a smaller base of taxpayers for a greater portion of their revenue.

This is not to say that tax changes have been evenly distributed across taxes. Value Added Tax (VAT) has become a significant contributor to tax revenue in recent years, which per the IFS⁴, brings in around 18% of tax revenues today, roughly double the share it accounted for in 1978/79. Successive governments have increased the rate of VAT, with the largest single increase in 1979 from 8% to 15%, then rising slowly thereafter to our current 20% rate.

However, corporation tax has been a significant beneficiary of reduced taxation rates, with the 1984 budget reducing the headline rate from 52% to 35%, with subsequent Governments eventually reducing the rate to 19%. However, this trend has recently been reversed, with the rate increasing to 25% for certain businesses.

Tax burden should not be looked at by headline rates alone. There are also costs of compliance, for example the use of external advisors or the hiring of tax professionals within businesses. HMRC’s 2021/22 annual report⁵ states it made £30.8 billion through enforcement activities and opened 265,000 new civil compliance check interventions. Also, whilst there have been limited Government studies on the cost of employer PAYE compliance, when last measured in 1995/1996, costs are estimated to have been of the order of £1.3 billion⁶. Given the increase in number of employers and the volume of legislation, this figure is likely to be materially higher now.

What does the future look like?

The OBR forecast in its Economic and fiscal outlook⁷ (published October 2021), that ATRPGDP will rise to 36.2% by 2026/27, the highest level since the early 1950s. Whilst certain tax decisions have changed since publication, it does strongly demonstrate the upward trajectory of travel.

Despite the growing tax take, per the September 2022 public sector bulletin⁸, the state spent £79.3 billion in September 2022 compared to the £71.2 billion it received. This is illustrative, as whilst there are fluctuations in monthly tax receipts, monthly central government expenditure generally exceeds income. Often, the difference has been funded by Government borrowing.

As at September 2022, cumulative public sector debt equated to c. 98% of UK gross domestic product, a level last seen in the early 1960s. In the short term, increased debt results in higher government expenditure on interest repayments. With a significant portion of UK government debt paying an interest rate pegged to inflation, debt repayments are growing.

In addition to these medium-term trends, there are longer terms trends which will impact both productivity and expenditure, being population demographic changes and impacts of climate change.

Currently, the office for science suggested in its “future of an aging population” report, there are currently around 3.47 people in employment in 2020 for every person of state pension age but by 2041 this will have fallen to 2.65. Combined with this, The Office for Budget Responsibility (OBR) identifies health and long-term care as two of the “main drivers of the increase in non-interest spending… due mainly to the ageing population”. They project expenditure on health to grow from 7.3 to 8.3% of GDP and on long-term care from 1.1 to 2.2% of GDP. Furthermore, spending on the state pension is significant, in 2020-21 representing around 10% of total public spending and 5% of GDP. With an aging population, the number of individuals eligible for this benefit will increase.

Climate change could also have a significant impact on the economy. Looking first at the net zero strategy, the Climate Change Committee reported that the annualised cost of reducing GHG emissions to Net Zero would be 0.6% of GDP by the early 2030s. However, many sources of revenue could be lost from the transition. Per the 2021 Net Zero review, this principally concerns revenues from Fuel Duty and Vehicle Excise Duty (VED), amounting to £37 billion in 2019/20 equivalent to 1.7% of GDP. It also stated, were the current tax system to remain unchanged across the transition period, tax receipts from most fossil fuel related activity will decline towards zero during the first 20 years of the transition, leaving receipts lower in the 2040s by up to 1.5% of GDP in each year. Therefore, either new taxes or increased tax rates would be needed to fund the transition.

However, if the world was unable to achieve net zero, unmitigated climate change would result in significant tax impacts. The OBR’s Financial risk report 2021 suggested that unmitigated global warming would cause debt to reach 289 per cent of GDP by the end of the century and net debt interest payments might have risen to around 10 per cent of GDP. It is likely that taxes would need to rise in order to fund this debt.

Taken together, the required expenditure of the state is likely to increase but there may be fewer taxpayers to bear this burden, potentially resulting in a higher per person tax rate.

What hope do we have?

So far, this article has depressingly charted rising taxation and the risk of potential increases. However, this writer has also considered whether this is inevitable.

The first argument is that taxation rates do not necessarily have to rise to increase Government revenue. This is a theory put forward by Arthur Laffer, which states that there is an optimum rate of taxation. Research suggested a reduction of 5% marginal income tax rate and average tax rates by 2.5% could increase GDP growth by 0.3%, albeit this was a US study. This higher growth could result in higher tax revenues in the longer term.

Secondly, there is increased focus on productivity in the economy, which can have a direct impact on taxation revenues. Historically, UK labour productivity grew around 2% per year⁹ but since the 2008/2009 recession has stagnated. From an international perspective, ranked on GDP per hour worked, the UK came fourth highest out of the G7 countries (being around 15% below the US and France) in 2019,.
A more productive economy is able to produce more goods and services with a given amount of inputs. Research suggest that workers who produce more for each hour they work are able to demand higher wages, a concept thoroughly explored by the NRER¹⁰. Higher incomes in turn lead to higher tax revenues. Finally, it is argued a more productive economy provides a larger economic base from which governments are able to extract revenues at lower tax rates than less productive economies with higher tax rates.

There have been a number of measures to boost productivity recently introduced including the introduction of R&D tax credits, accelerated reliefs for capital expenditure, the introduction of the apprenticeship levy as well as the capital allowance “super deduction”. Should these measures successfully increase productivity, we may see growing tax revenue requirements offset by higher growth.
Higher taxes may not be required if state expenditure decreases. The prospect of reduced Government expenditure has already been raised by Jeremy Hunt, who stated that government departments will be asked to find efficiencies within their budgets. However, two of the largest sources of Government expenditure are health spending and pensioner benefits, which are politically challenging to reduce. Therefore, it remains to be seen whether public expenditure can be significantly reduced.

Finally, HMRC suggests that there is a 5.1% tax gap, which equates to £32bn of revenue. By closing this potential tax gap, either by simplifying the tax system to mitigate unintended tax loss or increasing compliance activities, there can be increased revenues without increased tax rates.

Conclusion

It does appear that tax rates are likely to rise, mirroring the trends of the recent past. Whilst not inevitable, the increased costs arising from climate change and an aging population will likely lead to higher public expenditure and potentially increased taxation rates. The rate of increase can be offset, by for example reducing the tax gap or increasing productivity, but it is uncertain whether these measures will bear fruition. What is certain is that a more taxing time awaits.

Edmund is an in-house employment tax manager for a telecommunications business, with a keen interest in tax change and transformation. He previously worked in practice for a number of years across a range of clients.

1. HMRC tax receipts and National Insurance contributions for the UK (annual bulletin) – GOV.UK (www.gov.uk)
2. Boris Johnson and Rishi Sunak have announced tax rises worth 2% of GDP in just two years – the same as Tony Blair and Gordon Brown did in ten | Institute for Fiscal Studies (ifs.org.uk)
3. CBP-8513.pdf (parliament.uk)
4. How have government revenues changed over time? | Institute for Fiscal Studies (ifs.org.uk)
5. Annual Report and Accounts 2021 to 2022 (publishing.service.gov.uk)
6. Compliance costs for employers (core.ac.uk)
7. CP 545 – Office for Budget Responsibility – Economic and fiscal outlook – October 2021 (obr.uk)
8. Public sector finances, UK – Office for National Statistics (ons.gov.uk)
9. Productivity: Key Economic Indicators – House of Commons Library (parliament.uk)
10. Stansbury and Summers. Productivity and Pay. Final Version NBER.docx