• C. Peters

How HM Treasury Works - Part 3

A Very Taxing Blog

HM Treasury’s Tax Policy Group is the part of the Treasury that… you guessed it, sets tax policy and oversees the tax collector HMRC. It again has one simple goal similar to the Public Spending group: Ensure the UK government can raise as much revenue as it can practically and politically get away with.

Now, you’re probably thinking, if one part of the Treasury is so obsessed with keeping spending low, surely this is because another part of the Treasury wants to get tax and revenue raising low… Sort of – but this is what I mean by the politically and practically get away with trade-off; the Treasury will try to raise as much revenue as it can get away with, but under most government’s – including the most recent Labour government – it has been extremely politically difficult to raise tax.

And despite that, UK tax is relatively high – not compared to Europe, but certainly compared to the rest of the English speaking world. At least tax on people and goods is high. On companies tax is relatively low against the rest of the world, which I’ll go into later in this series. But let’s focus on the great revenue raiser for the Treasury - you and I.

The evidence that the Treasury aims to raise as much revenue as it can politically and practically get away with is that we as a country put up with some extremely regressive, political inconvenient, but extremely efficient tax policies:

Top of that list is VAT, which adds 20% to the majority of goods and services aside from baby clothes and food. That is a tax on spending, adding as much as a fifth to prices, creating a disincentive for people to spend, which is bad for the economy… it's far more than a fifth when it comes to fuel, alcohol and tobacco. This means that the poorer in society spend far more of their income on taxable goods, that VAT disproportionately hits those on lower incomes. It is a highly regressive, very high tax.

In Australia VAT is 10%, in Canada it’s 5%, in the USA it practically doesn't exist (although most states do add a few percent to most goods). Even in France and Germany where there is a 20% rate, it is lower on many common purchases, including restaurants and fuel, where they fall to 10% (France) and 5% (Germany). It is remarkable that amid the cost of living crisis discussions, reducing VAT to levels across the rest of the English speaking world is considered something of a fringe position. It is difficult to perceive a more popular policy than reducing VAT to 10%, arguably it would be a boon to the economy and it would disproportionately relieve the burden on the poorest. VAT is proof that HMT taxes as much as it can get away with…

It is not the only proof. We’ve also historically bizarrely excepted the most regressive tax of all. National Insurance (NI) is a flat 12% tax on everybody’s income with very few exceptions (only those earning less than £6,500 a year don’t pay). Employers also pay NI too on everyone they employ. So it is a double tax on jobs – for employer and employee. This provides a disincentive to hire and a disincentive to work, again arguably it is not good for the economy, and because it is pretty much a flat tax it is disproportionately paid by low earners. But it is also an extremely efficient tax; both NI and VAT are the great revenue raisers for the government. Yet, until the recent rise, nobody has questioned the basis of National Insurance because it has been around so long.

[Source: https://www.statista.com/statistics/1172872/government-income-in-the-uk/]

The UK government has been run by a political party that prides itself on tax cutting for over thirty of the last fifty years, including the last twelve years, yet this tax on spending (VAT) and this tax on jobs (NI) have only gone up over this period. Before Margaret Thatcher, the greatest tax cutter of them all, came into power in 1979, VAT stood at 8% and only the high tax Labour government did not raise it on their watch since…

The Treasury has an iron grasp over tax policy no matter who is in power. Treasury Ministers are stewards rather than decision makers. If they were, then the Treasury would surely not have avoided fairer taxes or increased taxes on ordinary working people over the last fifty years under various guises of government. Income tax over the last fifty years or more has been targeted at middle and upper middle income earners, those earning £40-100k a year, rather than those on six figure salaries. This is because it is more efficient to tax the middle classes who have steady incomes and can’t afford accountants to get around taxes by using off-shore banks or other loopholes. A tax that would be both a high revenue generator and politically popular would be windfall taxes on millionaires or on profits from major companies, banks, energy providers etc, but they have never been deployed. This is because windfall taxes can’t guarantee stable revenues year on year – and millionaires and companies are effective lobbyists. It is also because the Treasury dare not upset the part of the economy I will go on to discuss in part 4.

The Treasury will avoid any taxes that it considers as either less efficient, less stable, or too politically controversial. For instance, one of the few things most economists agree on is that the fairest form of tax would be a land tax, as it would be disproportionately paid by the wealthy. But because the British public are more worried about rising housing costs than rising wages, land is oddly far more politically controversial than taxes on income, jobs or goods. It is remarkable that in our culture that stamp duty survives, given it is effectively a land tax and an extremely unpopular tax, but it is also a highly efficient tax and - rarely - a fair tax as it disproportionately is paid by the wealthy. Although of course populist Chancellors often can’t resist occasional stamp duty holidays, which the Treasury tolerates because it can always raise revenue by squeezing lower earners with VAT, NI and PAYE (income tax).

The last thing to say on taxes is a reminder that Treasury taxation policy is not subject to the hallowed “write round” process and Cabinet Collective Agreement… well, aside from the Chancellor letting the rest of Cabinet know what is broadly in the Budget on the morning of. The Treasury is the most powerful department in government, it decides every other department's spending, and in tax policy it has the most consequential policy lever government has… yet it can do this without any collective agreement from the rest of government. Did I mention that Cabinet Government is a sham?

An interesting thought experiment would be what has a greater influence on Treasury tax policy, a chief executive of an offshore bank or a Minister sitting next to the Chancellor… Before you answer, see Part Four on the third priority of the Treasury - the finance sector.

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How HM Treasury works, part 4 - Finance sector = sum of all other sectors combined, squared (or Square Miled)