218. How Do We Get Off The Escalator Of Ever Rising Taxes?

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1:37Hello and welcome to The Rest is Money with me, Robert Paxton. Steph is away fighting crime as host of Crime Watch. We're already assured by that, but I'm delighted to be joined by Karen Ward, who is the chief strategist for J.P. Morgan Asset Management Europe, a regular on this programme. So much to talk to you about, Karen. How is the Chancellor going to fill the fiscal black hole? Is she rebuilding the lost confidence of lenders to the UK government? Are we facing a looming financial crisis? I thought we'd start, since we're recording as we've seen inflation figures a bit better than the Bank of England was expecting, a bit better than most forecasters were expecting.

2:17Markets have reacted in a positive sense, if you are a borrower, because before this morning's inflation figures, markets were broadly discounting no interest rate cut till next year by the Bank of England. There now appears to be, you know, a way better than evens chance markets think of Bank of England cutting interest rates in November. Do you think that's right? Do you think if somebody's got a bit of a debt in the UK, that they can be hopeful that the bank will cut another quarter point off the bank rate in November?

2:53Robert:It certainly could happen. I mean, the bank has been in this really tricky position where the growth side of the economy has been increasingly worrying, particularly the labour market, that companies aren't employing at the rate they were, if anything, returning towards some job cuts. And in normal times, that would be when the Bank of England would spring to action and provide those rate cuts and try and get some activity going and stop the decline. But the bank has been stuck because inflation has been so sticky, has been well above its target for some time. And I think the bank has become increasingly concerned that, you know, we've all got used to higher inflation.

3:34Robert:And I think there is an element of that. You know, I don't know about you, But every time I open a bill and my annual charge hasn't gone up by 10%, I feel quite chuffed. So we've all sort of got used to... I paid an insurance bill recently and my goodness, that was expensive. And I think that's a real problem for a central bank. When we all get used to, oh, well, two was the normal increase each year and we all get used to a number that's more like four or five. That's what economists call de-anchoring. We all just, we adjust to a higher level. And that's really dangerous territory for a central bank.

4:06Robert:So they've been getting very nervous, having to remain with interest rates quite high, talk quite hawkishly about their determination to bring it down. So this morning's news is helpful. Now, let's not forget, it's still 3.8, which is still almost twice their target. So those mortgage holders, I wouldn't sort of spend too much just yet because we're probably only talking about a quarter point if we do get one. and we need to see some signs that it's easing. But I think every step in the right direction is certainly very helpful. And before we get on to the nightmare for the Chancellor of a budget where she's going to have to raise taxes very significantly, where are you now on where interest rates in the UK will settle?

4:54Because there is definitely a disagreement, including, I think, between members of the Bank of England's Monetary Policy Committee, which is the body that set interest rates, about, you know, essentially where the neutral rate of interest, this is the sort of rate of interest that we can expect to prevail for years and years and years, the sort of non-inflationary interest rate. Do you think that's 3 % or do you think it's nearer 4 %?

5:20Robert:Probably somewhere between the two. I mean, the way we tend to think about that is to think, what is our inflation target? And then what is our potential rate of growth in the economy? So if we take the inflation target of two, our potential growth of probably one and a half, that's where nominal growth should settle. The therefore nominal interest rate should be somewhere around about there. So we're still some way above that. So we should still over time see those interest rates come down. But obviously, I built up that number starting with two and therefore for inflation. And the longer we stay with inflation proving sticky, then it's going to be much longer before we can actually get to that number of three and a half.

6:01And the important point, if you are a borrower in the UK, is those years that many people live through of almost 0 % interest rates, just forget them. They've gone forever.

6:09Robert:Oh, absolutely. And I think maybe for your listeners as well, the other really important thing is to remember to take inflation off of the interest rate you're getting from your bank when you're thinking about what to do with your money. We know we've got all these additional savings in the UK. We spoke about that the last time I was in. An awful lot of them are siding cash. And I think that's because people are going, oh, this interest rate's much higher than it's been before. Isn't that lovely? But they're forgetting to take inflation and the corrosive impact that has on purchasing power off of that interest rate, which is then what takes you down to about zero return on those cash savings.

6:43So let's get straight on to the budget hull, which is anything between 30 billion and 50 billion pounds. It's an awful lot of money that the Chancellor has to find at the budget, which will be at the end of next month. The Treasury has made it clear that the lion's share of that will come from tax rises. We can talk about whether there is any scope to squeeze spending, but it's very difficult to see, given their political commitments, what they do on the spending side. we've seen a couple of stories which inevitably happen in the run-up to a budget about possible tax changes in the last couple of days so the FT did a story saying she's thinking of cutting the VAT imposed on our energy bills currently a five percent charge to nil because she's acutely aware of sort of cost of living pressures.

7:40To be clear, though, one of the things that is sort of slightly amusing about that story is, of course, that is cutting taxes, that's giving money away, that is not filling the sort of 30 to 50 billion hole. But let's just start with that. Obviously, there is an issue around people feeling that energy isn't affordable. It's a huge political issue. You know, one of the reasons why some would say, you know, reform have been doing quite well is because they've been running with this campaign for some time now that somehow the government's net zero policies is adding to people's bills in a completely unsustainable way.

8:18And plainly, we have a government that wants to respond to that. But if you are going to tackle cost of living issues, is that a rational way to do it? Abolish? I mean, you could argue, and I think most economists would argue, that one of the problems with our VAT system is that there are too many exemptions and energy is one of them. So would it be a good idea to reduce or to eliminate that 5 % VAT charge?

8:43Robert:Well, I think one of the broader points you make in this comment, Robert, is we have to think about whatever the tax or the spend move is, what are the ramifications of that that might make it helpful or actually counterproductive? Because if we reflect back on this time last year in the last autumn's budget you know the chancellor made a great effort to raise taxes of course very difficult decision to raise national insurance contributions and the hope was that that was going to be the once in a parliament tax rise the once in a parliament reset to balance the books but what we learned is even though she was raising taxes then it pushed up cost pressures for companies it raised inflationary pressures that's meant the bank of england's held interest rates higher that's fed through to her borrowing costs so her efforts to raise money as we look back probably look a little bit counterproductive so it can be the case sometimes that cutting taxes raises your overall tax revenue.

9:51Robert:And I think anything she can do to take the Bank of England out of this bind that we've just discussed, anything she can do to dislodge us from this three number back towards the two number. But I want to sort of slightly press you on that because the history of the Bank of England is it tends to look through, you know, whether it's a one-off rise or a one-off cut. And I think there will be members of the MPC who will say, okay, so, you know, in the short term, the inflation rate is coming down, but not in an underlying sense. I mean, that's just a one-off cut in prices. But in terms of inflation, I mean, you could argue, let's just say it increased confidence within the economy and spending went up against an economy where there isn't a lot of spare capacity, you know, there would be some who might argue doing that would actually be inflationary in the medium term.

10:48Robert:So I see that argument, but I do think the bank are just really concerned that people have just got so used to inflation being high. That's why they then go into their wage bargaining rounds every year and say, well, I need four because inflation's four. And so we're sort of locked in this high inflation world. So if you cut energy prices and people think, oh, that's good news, I've got more money to spend on other things, I don't need such a high pay rise, as it were, you think that's how the Bank of England would analyse it? So the Chancellor would be rational to do something like that? I absolutely think anything she can do to ease the inflationary pressure is going to free up the Bank of England to provide her a bit of help.

11:29So that is£2.5,£3 billion worth spending. All right, but we've still got to fill that hole, right? So at least that little hole might be filled by this other tax change, which has been floated. This one's in The Times. And I understand this is absolutely what the Treasury is looking at, which is to end the exemption on employers' national insurance contributions for trade setups, which are known as limited liability partnerships. So many law firms are limited liability partnerships. Hedge funds are. Private equity funds are. Quite a lot of accountancy firms are. And these consist of very highly paid people.

12:13These are mostly people who work for these firms, particularly if they're senior, in the sort of top 1%, sometimes in the top 0.1 % of earners in the UK. And, you know, for some time, sort of tax experts have said this is an anomaly. It's ridiculous that we get effectively less tax from these people because they do not pay employers national insurance simply because of what is effectively a corporate structure. The thing that makes this complicated politically for the government, most GPs are in partnerships and some are in limited liability partnerships. But as I understand it, and this is certainly what the Treasury seems to believe, most are in general partnerships.

13:00And as I understand it, what the Treasury is looking at is somehow imposing national insurance for employers on limited liability partnerships, but not on general partnerships. because, first of all, there are quite a lot of firms where the individuals are paid an enormous amount of money that are general partnerships. So, for example, Slaughter's, which is, some would say, the leading UK magic circle law firm. That is a general partnership. Is it fair that it would continue not to pay employers' national insurance just because it happens to be a general partnership rather than a limited liability partnership?

13:38But there is another point. I am reliably told by a guest on this programme, Dan Needle, a great tax expert. He says that if they just do limited liability partnerships and not general partnerships, all that will happen is all the limited liability partnerships will convert to general partnerships and they won't raise any additional national insurance. But the general point, which certainly somebody like Dan Needle has been arguing for ages, is it is a crazy anomaly that these very highly paid people, basically their firms, avoid paying a very significant chunk of tax simply because of the structure.

14:14Robert:Well, this is sort of taking me back to my very brief stint in government when I was supporting Philip Hammond, because, of course, then we tried in one budget to adjust the tax system. This was with regards to self-employed and this issue as well, making sure that national insurance was paid by a broader swathe of the population. Of course, it was politically very challenging. Was this the white van man? Then there was a climb down. Yes. I should remember the front page of at least one tabloid had white vans on it. Yes. Possibly the longest 48 hours of my life, I should say. Talk me through that.

14:56Robert:So, I mean, basically the argument around, you're absolutely right. In the big picture sense, we have a tax system that makes it beneficial to structure yourself in a different way. Now, that might be via these partnerships and it might be perhaps via a self-employed mechanism or employing people on a self-employed basis when they are actually really employed by one employer, for example. Now, the argument that's always used is one of two things. Either these are risk takers in the economy. These are the people who create jobs in the economy and therefore they should get a sort of subsidy for doing so.

15:39Robert:Or alternatively, well, you know, maybe these individuals don't get, let's say, sickness pay or maternity leave or things that employed in regular structures that they get. And for that reason, they should therefore pay lower taxes. I don't find either argument compelling, to be honest, Robert. If you're a risk taker and risk generator, wonderful. Thank you for doing that service in our economy. But your profitability that the nation affords you as you're taking that risk and growing your business should be how you're rewarded. And in terms of, well, if you don't get the sick pay or the maternity pay, yes, again, absolutely right.

16:21Robert:You should be rewarded for that. But it should come from the person who's paying for your services, your contractor, rather than the state. The state's relationship with everybody should be, what are you going to take out of the state? Are your children going to go to school? Are you going to get a state pension? Are you going to use the NHS? And I believe that every individual on the same playing field, if you're taking out of the state on the basic public services and provision, which we all do, then you should be contributing the same. So you're basically saying there should be fewer exemptions and a simpler system.

17:01Yes. Now, let's go, though, away from the micro, because let's be frank, you know, we're really only talking about two to three billion from what may turn out to be a very controversial tax reform to the bigger picture, which is if she's got a raise between 30 and 50 billion, can she do it from other taxes without actually ending up damaging quite important bits of the economy?

17:24Robert:Well, that is the risk, isn't it? I mean, when you're constantly sort of fiddling, if we think effectively, it's a little bit like if you go to the smaller taxes, you have to lean on them all the harder in order to squeeze the same juice out of them. and therefore the damage you can potentially do via that is, I think, where we run into real problems. I mean, we've seen, for example, ahead of the last budget and happening as well today, people desperately worried about wealth taxes and capital gains and therefore, right, let me liquidate all of my assets so that I can't be subject to these taxes.

18:02Robert:And then we have all these people starting cash. So are people actually doing that now, increasing their cash? We've seen this as a problem for the last year, this fear of capital gains taxes, wealth taxes. Quick, I need to store my money under the mattress. Now, that's the worst thing we can do because, of course, not only are those individuals harming their retirement prospects and making them even more dependent on the state, we're not providing the lifeblood to the economy. So I think it's absolutely true. If we're going to do this sensibly, it has to be a recognition. It's got to be a small amount on a broad based tax.

18:35Robert:But Robert, I wouldn't mind sort of just because I'm increasingly frustrated with this fixation on the correction has to come from tax. And this is what's frustrating me about this broad conversation and lack of conversation in the nation, actually, because so some numbers for you. Spending, so government spending as a percent of GDP in 2000 was 35 percent. So of all the income the UK economy generates, the government would take some of that and spend 35 % of it. Today, that number has climbed up to 44 % of GDP. Let's fast forward 50 years and that number has reached almost 60 % of GDP. And that's largely because of the ageing of the population, that forecast of 60%.

19:26Robert:That is. The growth up to now is really not being helped, of course, by the number of people that are not working because they are long term sick. So we've got this real problem structurally here in the UK between the number of people taking out of the public purse is growing much more rapidly than the number of people paying into it. And until we're willing to really have that conversation about how do we stop spending rising to 58 % of GDP? How are we going to keep a lid on our pension bill that we need to talk about the triple lock, which is grossly inequitable? How are we going to make sure that our NHS provides some productivity improvements so that we're not just adding tens of billions to the pot every single year?

20:17Robert:How are we going to make sure the long term sick are back in employment? Until we're really willing to say, let's get spending under control, we are going to be stuck year after year of having a conversation about which tax goes up this year. And that's where I'm immensely frustrated about the current dialogue. We're not having the conversation about how are we going to get spending under control? And in fairness to the front bench, in fairness to Prime Minister Keir Starmer, in fairness to Chancellor Rachel Reeves, they've had a bit of a go at this. You know, they've said, look, our welfare system really needs some reform.

20:52Robert:The backbench have not supported them. So I don't think this is just that the government are burying their head in the sand. I think they've had a go at this. They can't get the party behind them. But this is where I become worried about the outlook for the UK, because until as a nation, we're willing to have a conversation about how we're going to get spending under control, we're going to keep coming back to what tax this time. And I genuinely believe, you know, the tax burden. So let's, you know, it's 37%. So I gave you the numbers on spending now on the tax receipts. At the beginning of this century, we withdrew 37 % of all the income from the economy in tax.

21:32Robert:That number has now risen to 41%. And I believe where the economy is already showing tax exhaustion. You know, we saw, for example, when George Osborne took the higher rate of income tax, he took it down, even though he was conducting a period of significant austerity. And when he took that top rate of tax down, the actual tax take went up because more people came to the UK and paid those higher rates of tax. I'm really worried that until we can have a better conversation about getting spending under control, I think it's going to be an annual discussion on which taxes. And that makes me, I think, deeply pessimistic.

22:14So I should point out to listeners that actually, as luck would have it, our next episode will be a chat with Art Laffer, who is the economist most closely associated with the idea that when you push tax rates above a certain level, you actually get less tax revenue. And there are times when you cut taxes that you can actually generate increasing revenue. For now, let's go to a quick break. And after it can, what I want to ask you about is this whole issue of how much the Chancellor's hands are tied by the growing unease among the big investors who lend to the UK. Big stuff to talk about after the break.

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24:33Robert:There are two types of business owners, those who are busy and those who want to be busy. Toast is designed for both, with tools to keep you humming and help turn grind into growth. That's how you turn busy into business. Toast. Built for busy. One of the things that I have been struck by in recent weeks is the extent to which the scope for manoeuvre that the Treasury has to make, whether it's rational tax reforms, because quite a lot of rational tax reforms would cost you money in the short term, even if it increases revenue over the long term. And they are terrified of increasing the deficit in the short term.