313. Ruth Curtice: middle earners need to be taxed more

0:00How much headroom is there really? What kind of taxes might we need to put up? Do mid-learners need to pay more tax? To answer those questions, we've got one of the UK's great experts, Ruth Curtice. She used to be at the Treasury. She now runs the Influential Resolution Foundation. And the big question I want to ask her is, how does the UK stop being the ugliest in the ugly contest when it comes to borrowing money from the world's big investors? We're proud to say that the rest is money is powered by Octopus Energy this year and Greg Jackson, the founder and CEO is with us. Greg, I wanted to ask you about heat pumps.

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2:23Ruth, thanks for coming back in again. Thanks for having me. You guys have been busy doing lots of analysis and some new calculations on the fiscal headroom as well. We've been talking about it, obviously, under pressure from what's going on globally with inflation and the potential interest rates going up and everything else. Do you want to tell us where we're at with it? Yeah, so if you remember back in March, Rachel Reeves had£24 billion of what we call headroom. So that was the amount compared to her aim to balance day-to-day spending and taxes, the amount she had. She was sort of overachieving.

2:53Now, we've had these huge moves in the cost of borrowing for all governments. And it looks like that will add about 11 or maybe 12 billion to that debt interest bill. But there will be lots else going on in the OBR forecast. I would expect growth to be a bit lower given the war in Iran, inflation a little bit higher. there will be some good news. Equity prices are up a bit and you get some tax receipts from that. Now, what we try to do is look at how all of that might shake out. And I think it will be a bit worse than that 11 to 12 billion hit. So it could be as low as five billion pounds, the headroom that the Chancellor is left with.

3:31That number also accounts for the fact that there have actually been some policies announced since March as well that the government hasn't yet paid for, not least the defence investment plan that Keir Starmer announced. So that's your worst case scenario? Well, you can't do a worst case scenario at this point, Steph, because we've got a new chairman of the Office for Budget Responsibility. He might just disagree about some of the judgments that they made before. And, you know, I think the forecast is still being prepared. Those bond markets are still moving. So it's your central case is really what you're saying.

4:03Now, this is a very difficult judgment to make. But Rachel Reeves, in her last budget, took the view, which Steph and I, I think, absolutely agreed with, that her previous headroom of 10 billion was too low because that put her too much at risk of it just being totally wiped out by the normal swings in the economy. and therefore probably meant that interest rates that lenders to the UK were demanding were higher than they needed to be because they thought there was a bit too much risk lending to the UK. That's why she built it up to 24 billion. And actually, it was quite interesting. After the last budget a year ago, when, you know, headroom was increased to more than 20 billion, actually, she got a bit of a bounce in the gilt market.

4:55Actually, you know, gilt prices rose, interest rates came down a little bit. Now, she's now in this awful position where interest rates have surged even more than in other countries. What do you think a central amount of headroom now should be? How much essentially money does she need to raise to reassure lenders to the UK? So, look, I think first of all, we should give Rachel Reeves some credit. Like you say, Lots of us said she should increase her headroom. And she did. And if she hadn't, we would be sat here saying the fiscal rules are about to be broken and we're not. We're saying the headroom's reduced.

5:34So in a way, we're seeing in practice. And, you know, I think there's a case to be made on the one hand that a war has broken out since that last forecast, a war with big effects on the UK economy. And so, you know, what's headroom for if not for a war? I mean, look, we've got Trump in the White House. It could be another war for all we know, because, you know, it's his war. He's unpredictable. You'd simply, I don't think any lender to the UK would think the headroom of five billion provided enough protection. So John Healy is going to have to build it up. What does he need to build it up to? So I agree, just to finish, that he does need to build it up and not least when the bond markets are where they are.

6:16right that's that's the counter argument um i think we should say that the rule will be three years away at this budget last last time it was four years away and actually headroom in three years time is is worth more than headroom in four years time right if what we actually care about is will we achieve this target a three-year target so i do think there um uh are reasons to think a bit carefully about whether you need to get all the way to 24 billion but big picture look robert but you're absolutely right. The bond markets are still seeing the UK as kind of worst in class in the G7. And that is not where we want to be.

6:51It's an extremely expensive place to be. I think the headroom number does depend on whether this is a budget that addresses some of the big spending pressures that we know are coming or doesn't, right? So a headroom of 10 billion, but with a budget that said, I know we need to spend more on defence. I know I've got these ambitions on social care and council house building, and I'm going to tell you how I'm going to pay for them, that might actually be more credible than a budget that says, I've got headroom of 20 billion, but I'm not going to tell you my plans on defence. I'm not going to tell you how I'm going to pay for all the ambitions that the new prime minister has set.

7:28So I think we can just get, look, I think he needs more than 5 billion of headroom. You know, the lowest we've had was Jeremy Hunt at six, normally at the start of a parliament, and we've got a new prime minister, you want more headroom because you probably want to have a few budgets where you're not raising taxes. So we should get as close to 20 billion as we can. But more importantly, we just have to address what we're sort of hiding from, which is these huge pressures that we're not talking about. So, and as you point out, obviously we've heard a lot about plans they want to do, which cost money.

7:59And as you just talked about, the headroom shrunk. So have we got any idea on how much John Healy's going to need to raise in this budget. So look, let's say he wanted to get back to 15 billion of headroom on our numbers. That's raising, say, 10 billion of tax. I think the indications are that he's not going to go further than that. He's not going to say, actually, this is my plan for defence spending. What that means, I think, is we've got to have a spending review next year. They will have to set out at that point what their plans for defence spending are. Maybe this means this is actually less of an event this autumn, but we will have to have another one before we get to that spending review.

8:39The penny doesn't seem to have dropped quite for him or for the Treasury, that if they were in a position to set out more concretely, that they would reform the triple lock, for example, or this is the kind of quantum we're looking at in terms of welfare savings, if they did that earlier, Yeah. Our view is they would be massively rewarded by lenders to the UK. Yeah. What we'd see at that point would be a significant rise in the price of government debt and therefore a very significant rise in the interest rate that he would pay. And that would just create a sort of following wind that could not only give him more room for manoeuvre in terms of his ambitions, but also be a following wind for the for the whole economy.

9:29Is it just that the politics are just too difficult for this government to do it as quickly as that? Is that what's holding them back in your view? So, look, I don't know what's holding them back on the triple lock, for example. I mean, they're obviously trying to stick to everything that they said in the manifesto. But I think even saying that we would move off the triple lock beyond this parliament is something, you know, that's a thing that just costs the UK a huge amount in the long run. It's not necessarily something that raises you lots of money in a forecast, but in terms of credibility with the bond markets, there's almost this direct contradiction between the kind of politics and the bond markets.

10:06What the bond markets, I think, partly want to see is that this is a government prepared to do uncomfortable, difficult things in order to balance the public finances. And so indicating that that is something that they will take on and that they will deliver, I think, would be rewarded. Yeah. So in the meantime, it means a lot of people like us are all trying to guess what might happen next. And we alluded to this earlier, but you've done some really interesting work around the tax burden, haven't you? And in particular, the tax wedge. So this difference between what an employer pays to an employer worker and what actually they take home and pay.

10:41So tell us what your headline findings are. Yeah, so we've had a look at, as you say, this tax wedge. So how much that someone keeps both from the taxes that are paid by them and their employer, but also kind of net of any benefits like child benefits. So that if we're taking away with one hand and giving away with the other, that's sort of accounted for. That has risen a lot in the UK. So what we've done is look compared to 33 kind of comparable OECD countries. And we see that last year that rose more in the UK than in any other country. But what I think people will less expect is that we started very, very low.

11:17We started lower than the G7. We've overtaken countries like the United States that are not thought of as low countries. And we're still in that kind of bottom third of OECD countries. There's eight countries with a lower tax wedge than us on average earners. So while the tax take to GDP is at a record high, it is not the case that median earners in the UK pay a kind of unusually high rate of tax. So just to put this into the kind of language that most people understand, what your analysis shows is that relative to the public services that we receive and we think we deserve to receive, people on, I don't know whether, sorry, is this the median or the average?

12:01So this is actually a great question. I'm so pleased you asked, Robert. So this is what the OECD call average earnings. And that is actually quite high. It's about£56 ,000. But what you can also do is look at a number closer to the median, kind of two thirds of the OECD number. And what we're saying still holds for those people. So it holds for people on£38 ,000. It holds for people on higher numbers like£56 ,000. So let's just break down what we're saying holds. It is that if you look, as I say, at the kind of public services that we both have and think we deserve, right, what the typical household would pay in tax, net of the benefits and credits they receive, is not high by international standards.

12:49That sort of two thirds of the countries in the world that we would regard as somehow comparable countries, those people would actually be paying more. Exactly. So it's slightly stronger than that. It's that just looking at all countries, regardless of what public services they provide, two thirds would charge more for that average earner. And then if you look at countries with higher levels of public spending, if we thought that that was something we might head towards because, for example, of these pressures on defence, no other country achieves a higher tax ratio without placing more of the burden on those average earners.

13:25And there's a huge amount wrong with our tax system. There's lots of places I would look to raise tax before I would ask average earners to pay more because they have had these very steep rises. But I think when we're having a big picture conversation about where the country might end up, we have to be honest that actually probably most people will need to be asked to pay more. And on those steep rises we have had on average earners, because, you know, the whole Labour Manifesto is not to tax working people. And so this has come from the national insurance employer contributions. And the freezing of the thresholds in income tax.

13:59So it does also come somewhat from individuals paying more too. But yes, a lot of it is the employer national insurance. This is a horrible question to ask you. Obviously, we have, you know, the most astonishingly complicated tax system in this country. Right. Do you think broadly we just need to have a more honest debate that, you know, all of us, basically, if we if we want a certain kind of public sector provision, whether it's schools, hospitals, defence, we're just all going to have to pay some more. Yeah, I think in the end that's true. And particularly if the pressure is something like defending all of our safety and security, we have to be honest that that will probably require a bit more from everyone.

14:48And let's look back at just what's happened since the pandemic, right? The debt interest costs, even before these latest rises, are about 2 % of GDP higher. We're spending about 1 % more on health. And then we think we might need to spend, say, 1 % more of GDP on defence, right? I think quite quickly I've got to 4 % of GDP where very few politicians would demur from the idea that we need to pay that bill. But that's£120 billion, a bit more, right? I don't remember having a conversation over the last five years about, look, we need to find£120 billion. Where are we going to find it? And so it doesn't feel like it's been an honest debate.

15:28And hopefully we could have a more honest one going into the next period of time. One of the things we pointed out in the last episode was an incredibly wealthy, high earning person, a HR manager called Chris Rockus has just left the country and he pays quite a lot of tax in this country. He's going to stop paying tax in that country. There are a lot of people here who say the wealthy just don't pay enough. And that may well be true on their wealth. But it is also the case, isn't it, that the top 1 % of earners pay surprisingly large amounts of the total income tax bill. What is it like? I think it's something like 30%, isn't it?

16:12Yeah, it's the top 10 % pay 60 % and then it goes up from there. When you don't spread the tax burden across everybody and you are dependent on a relatively small number of high earners, If a significant number of those high earners, and they tend to be more mobile people, just decide they don't want to live here anymore, that's a problem, isn't it? Yeah. I mean, look, I think when we think about employment, one thing we should say is that although we have these low effective tax rates, kind of total tax paid, we do have some very high marginal tax rates. So that's one problem in the tax system, particularly those people between£100 ,000 and£125 ,000.

16:49and we do have, as you say, a large proportion of income tax, unusually large, collected from the top income taxpayers. That is not just because of the structure of the tax system, that's also because we're a relatively unequal country and so it reflects that too. I mean, I think we should say when we look at the very wealthiest who tend to be more mobile, it is also about the taxation of wealth and actually it is true that the evidence shows that kind of top 1 % tend to pay lower tax rates because they do get more of their income from these kinds of income, like wealth and investment and savings that are actually taxed less than hard work.

17:27So then if we come back to the manifesto of not taxing working people, and obviously, as you've just pointed out, with the income tax freezes, that is inevitably a tax rise for working people. And again, with the national insurance employer contributions indirectly becomes a tax on them. Where's the room for manoeuvre? Are there other little things they can do like that, which doesn't break the manifesto, but does actually increase the tax burden on the workers? So I think there are lots of places they could look. I think there are loopholes in our wealth taxes that they could still try and fix.

18:04What in particular? So in particular on capital gains tax, if you are a very wealthy person who leaves the country, all of that capital gains tax is lost or forgiven. Other countries don't do that when you leave the country. You kind of pay the gains that you've had on exit. Obviously, the issue about that is if you were going to do that, you would have to literally just announce it and do it. Yes. Because otherwise everybody would leave if there was any delay. Exactly, exactly. Funnily enough, Gordon Brown was having this conversation with us yesterday about that very point about how now that you cannot, it's impossible to just announce something and do it straight away.

18:41Why? Why does he say that? Well, because we were talking about how back in the day, you know, you didn't have social media, you didn't have all you journalists constantly ear-wigging on conversations. That's why there'd actually be a leak, essentially. Well, I mean, you know, I mean, look, the fact is one of the reasons it's thought that this bloke, Chris Rockos, left is because he thinks there will be a rule of that sort introduced. Well, maybe we should just get on and have one and then we'd get everyone who hasn't left yet. Yes, because now all this uncertainty again means people are questioning what are going to be the tax rises and then go, sack it, I can't cope with any more uncertainty, let's go.

19:16We end up with these, frankly, silly commitments to not change the rate. And then we kind of distort and think about exactly how you could kind of get around that commitment. I think actually what people want to know is, will they pay more tax or not? And so that's another way in which the debate has probably been unhelpful. But it is the case that workers pay more in tax than other forms of income. And there are things you could do to address that. So we suggested last year putting up income tax and cutting national insurance. We have a record high gap, for example, on the taxes paid by the employed versus the self-employed.

19:56We have a relatively high income pensioner population compared to history. they are the generation that have also benefited from the peace dividend when defence spending was lower. And so to the extent we're asking everyone to pay more, while the analysis does show that I think in the end median earners might need to be asked to pay more, I think there's lots of other people that should ask to be paid more too. Ruth, there's always more we want to ask you, but we're going to go to a quick break.

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22:32and just therefore going back to the proposal that you put last year which from memory was you would cut the employee national insurance rate by two percentage points and put up the income tax rates by two percentage points and that I think would have raised a net $6 billion or so because people would pay it on their pensions. People would pay a bit more tax on their pensions. They would pay a bit more if they had rental income, if they were property owners. And at the time, many people thought that was very fair. And actually, literally within days of the budget, that was something that Rachel Reeves was planning to do.

23:19You had a big influence. That was something that the Treasury and Rachel Reeves was going to announce in the budget. And then they had a terrible wobble. They had a panic attack. They thought that they'd be accused of breaching their manifesto. And they backed off. And as you said, they froze rates, I think, for another, sorry, thresholds, excuse me, the thresholds for another three years, which is a sort of hidden, some would say a slightly dishonest way of raising more income tax. Broadly, on your analysis, it is unfair that people don't pay a higher rate of tax on their pensions and on rental income.

23:58Many would say there's definitely a case for doing precisely what she was too scared to do last year. Now, any sense that the Treasury might pick that plan up again? Look, I honestly don't know. I think in the end, the judgment was, as you say, a political one about whether the kind of money raised was worth what would have been a change in the rate, but actually not an increase in the taxes on working people to the extent that that is employment. So I don't know whether they will look back at it. I have to say that the indications, I think, publicly are that they will not address things like the pressures on defence spending.

24:40So my impression is that perhaps they're hoping that they won't need to reach for quite such big levers as that one. But that will mean a collection of smaller tax rises. And as you know, Robert, sometimes those can actually also create quite big political trouble. Yeah, because if you've got something like you mentioned about rental income, there's already been so much going on in the rental market with the Renters' Rights Act. That's meant a lot of landlords have pulled out of the market. So it also what often gets neglected is the context in which these tax rises happen, you know, with the national insurance contributions.