Spending cuts not enough: middle class tax is needed

Filed under: Tax

A leading think tank has warned that George Osborne is not going to be able to cut the deficit to meet his targets by simply slashing spending. At a presentation in London, it outlined the reasons why taxes are going to have to go up too - and why the middle classes are going to bear the brunt of these rises.

So will it hurt you?

Not enough

The Institute for Fiscal Studies analysed Osborne's latest spending announcements, and concluded that the measures he has planned are not enough to meet his targets for the deficit. Paul Johnson, the Director of the IFS, said: "At some point we are going to have to have a serious debate about whether all of the rest of the fiscal consolidation is really going to happen through spending cuts alone."

He revealed that the spending cuts announced so far would not cut the deficit far enough. The IFS announced that if the government stopped cutting departmental budgets, taxation would have to rise £25 billion. If it continued to cut them at the same rate, taxes would have to rise £10 billion.

Johnson also highlighted that Osborne has strayed from the 80:20 rule that he initially said he would stick to - where 80% of the savings would be made through cuts and 20% through additional taxation. Currently we are on course for an 85:15 split. He added: "Returning to an 80:20 split for the consolidation as a whole would mean a £6 billion tax increase in the next parliament. Coincidentally this is pretty close to the average tax increase seen in post election budgets in recent decades."

So will it hurt you?

It depends how Osborne decides to raise taxes. He could unfreeze council tax. The IFS is against the freeze in the first place, which it says has lost the government £3 billion already. It added that now the freeze is in place, it will be hard to unfreeze it at all, let alone use it to generate higher tax revenues.

Alternatively, Osborne could push up VAT to 21p, but VAT has already proven to be a political hot potato, earning Labour no friends when it was reduced and then subsequently increased again.

Alternatively there could be a 1p rise in income tax, but given that the government's biggest success story so far has been to increase the personal allowance to help the less-well-off, to push up the tax they pay as soon as they are over this threshold would be politically unpopular.

Middle classes

It's for this reason that the IFS suggested that Osborne is likely to squeeze higher rate taxpayers. He won't do this by increasing higher rate tax, but by failing to increase the threshold for higher rate tax in line with inflation - so over time more and more people end up paying the 40% rate.

This is already his plan. In the Budget in March he announced a cut in the band in April, and then a 1% rise in the subsequent two years. This will take the band to £41,865 next year and £42,285 the year after that.

The initial drop brought 400,000 more people into paying high rate tax, so that now one in six people pay 40%. Over the next two years, as wages are expected to rise faster than 1%, more people will be drawn into paying the higher rate.

The IFS suggested that Osborne may choose to freeze the rate rather than stick with his 1% rise, which would mean that in five years' time five million people will pay the higher rate.

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