Manifesto Check: Labour's tax plan may fail to raise revenue

The Labour Party manifesto makes the promise of fairer taxes. There are income tax changes with a new 10p starting rate and the top rate of tax will be increased from 45p to 50p for people earning over £150,000. There will be no increases in VAT or national insurance, and core tax rates and tax credits will remain fixed. For businesses, there are a series of measures to reform corporate taxes to help small businesses grow and to tackle tax avoidance to fund some of their policies.

10p tax side-effects

The party’s plan to introduce a lower 10p starting rate of income tax is geared toward reducing the amount of tax paid by the lowest earners in society. Labour has said it will paid for it by abolishing the Marriage Allowance.

This proposal poses a serious concern for much-needed productivity in the economy. A lower income tax rate will only benefit the least productive workers (or those who want to remain at the bottom of the productivity and effort scale), and not the ones who are continuously trying to improve productivity (taxpayers with partners and families). Abolishing the marriage allowance may also distort the economic incentive to live in a marriage or civil partnership. However, it will remove the disincentive for married couples to move to the top income tax threshold, or for the other half of the couple to start working.

While it is understandable that Labour is trying to propose a redistribution of wealth across two groups of taxpayers, the fairness of the proposal is not adequately addressed in the manifesto, and no details are provided on how much redistribution is projected and how it will affect the disposable income and standard of living of the two groups of taxpayers.

Incentive problems

The top rate of tax will also be increased from 45p to 50p for people earning over £150,000. Again, the idea is that the tax burden will be shifted to wealthier sections of society. Research shows this reform could create serious problems of incentive and tax avoidance.

Increases in tax for top earners mean that taxpayers who have the highest productivity will be hurt, and will see no incentive to remain at the highest productivity level. It will also destroy the incentive for others to be more productive and move to higher income levels.

The highest earners also have the best ability to afford tax avoidance, and therefore this may add to the worries of tax collection and tax compliance Britain already has. Overall, this reform therefore is unlikely to boost growth in government revenue.

Similarly, the party’s plans to abolish the tax breaks used by hedge funds and abolish non-dom status are geared toward raising revenue and paying for various policies. But their ability to raise the amount they hope from these measures is uncertain. The removal of the tax breaks for hedge funds and the bank bonus tax will put banks into more financial stress and it is likely that banks will either find ways to avoid their new tax liabilities or increase their fees – either will incur additional costs for the economy. Similarly, reaping the benefits of abolishing non-dom status is questionable.

Mixed benefits for business

For businesses, Labour proposes to keep the corporate tax rate for larger firms unchanged and aims to foster the growth of small businesses by cutting the current business rate, so they can commit to longer term investment. The promise to freeze the lower business rate is likely to remove any uncertainties small business might have before committing to any new investment plans, which is important for encouraging growth.

The reduction in business rates will mean a loss of revenue, however, which the party does not make clear how they plan to recover. If the projection is that the new business rate will encourage more people to start new business, the incentive does not appear to be sufficient, because little detail is provided on how the party wants to help new starters with the funding for initial investment.

Betting on the long game

Labour’s plan to cut the deficit and boost productivity-led growth in Britain require a huge amount of resources to be allocated with immediate effect. But some of its tax reforms are slow yielding, while the revenue potential of the others cannot be assessed without further details. And the manifesto does not present sufficient details on how Labour wants to tackle the problems of tax avoidance and tax evasion.

With no major changes in the income tax system, and with more VAT exemption and cuts in business rates, it remains unclear how the government can finance its proposed expensive long-yielding projects. These uncertainties pose serious questions on the feasibility of Labour’s plans and open the possibility of larger public debt in near future for the UK. Given the current debt burden and the associated deficit in public budget, any further debt for the UK can be lethal.

Sheikh Selim does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.