Valentin Boboc is Chief Economist at the Institute of Economic Affairs
One of the most enjoyable things about working on the Alternative Budget was that even when you think you have a reasonable idea of how fiscal dynamics work, there is always room for surprise.
Of course, surprises occur when you do research in preparation for the work itself, but one of the most valuable things about the Alternative Budget was the opportunity to share it with the world and get questions from the audience. Depending on your audience, questions can be quite brutal, but they are useful because people often point out things you didn’t necessarily think about or didn’t think about addressing separately in the first instance.
So I thought I’d share some of the surprising and interesting things I’ve learned along the way as I wrote the Alternative Budget and received feedback from experts and from members of the general public.
It takes surprisingly little to balance the books. This is perhaps because even experts who read obsessively about government spending every day have a slightly warped view of what the everyday role of the state is. Things most people would describe as core functions of the state, such as defence, policing and the courts, account for a relatively small share of spending. Given the sheer size of the welfare budget, which has been growing rapidly in recent years and is projected to continue growing, freezing it in cash terms and then making small cuts of 0.85% a year until the end of the current Parliament would, alongside the tax proposals in the Alternative Budget, be sufficient to bring Britain’s current budget into surplus.
Britain raises a larger share of its tax revenue from personal income taxes than the OECD average. This isn’t surprising to anyone who studies the British tax system, but what surprises me time and again is the extent of that reliance. In 2023, the British Government collected 30.2% of its tax revenue from personal income taxes and 30.2% from taxes on consumption, compared with OECD averages of 23.7% and 31.3% (see e.g. OECD Revenue Statistics). High marginal income tax rates can discourage work and deter people from pursuing higher incomes, and earning more is one of the most important ways to improve one’s quality of life.
People seem to believe that change is a means of punishment. The overall perception is usually that taxes are designed to ‘punish’ someone and exemptions are designed to ‘reward’ someone else. Whilst that can be true in the sense that governments occasionally attempt to reward their political constituencies through subsidies and tax exemptions, there seems to be an inherent belief that any tax is a form of targeted punishment. And perhaps, to some extent, people are right. Income taxes ‘punish’ people who pursue higher incomes at the margin. Stamp duty ‘punishes’ people who want to move house. The great thing about the Alternative Budget is that all the proposals are focused on creating a broader and lighter tax burden. In other words, the Alternative Budget wants to make sure that we ask a lot less from a lot more people, so that everyone feels as ‘unpunished’ as possible.
VAT rises don’t have to lead to persistent inflation. A rise in VAT can increase the prices people pay, but it does not follow that those prices will keep rising faster. In fact, if VAT is increased and firms choose to pass it all on to consumers, then after a year the inflation rate will be the same as it would have been if VAT had not risen. The Bank of England explained this ahead of the VAT rise in 2011. Moreover, VAT changes are not necessarily passed on to consumers in full. Research by the IMF suggests that the impact of VAT changes on prices differs between changes in the standard VAT rate, lower VAT rates and changes in the classification of goods. It’s quite likely the proposed changes could alter the prices of some goods and services without causing persistently higher inflation.
If you want to stop spending money, you have to start spending political capital. Most people seem to agree it’s a no-brainer that the Government should reduce its spending and address the debt and deficit issues. However, everyone would prefer it if the spending cuts could begin somewhere else. The issue with Britain’s complex tax system is that taxes, exemptions and subsidies have grown ever more specific, creating very clearly delineated political constituencies. And so making the Government less costly is incredibly politically costly.
The main point about the Alternative Budget is that Britain has choices. If we simply wanted a budget surplus, the changes required would be surprisingly small. If we could combine these changes with a better tax system and sensible pro-growth measures, we could achieve a better economic trajectory with somewhat stronger growth and healthy public finances.