The regressive evolution of the UK tax base

The declining significance of progressive and business taxation demonstrates the character of ‘austerity’

bailey_berryIn a recent SPERI paper, Jeremy Green and Scott Lavery argued that the economic recovery has been secured through processes of ‘regressive redistribution’, as quantitative easing and the suppression of wages represent a striking redistribution of wealth to asset holders and businesses, and away from low and median earners. This post presents evidence on a further dimension to the regressive response to financial crisis and recession, that is, the transformation of the UK tax base.

Our SPERI British Political Economy Brief, ‘The Evolution of the UK Tax Base’, published today, demonstrates that in the period since the financial crash, regressive forms of taxation have come to constitute a growing share in the overall tax base, as regressive taxation is deemed pivotal to delivering deficit reduction. In contrast, however, progressive taxation and business taxes have been relaxed – demonstrating the nature of the coalition government’s understanding of how economic recovery can be achieved.

In short, the evolution of the UK tax base since the financial crisis shows that ‘trickle down economics’ is alive and well, as policy-makers seek to unleash the wealth-creating potential of already affluent groups. The perceived need to reduce the budget deficit, in the name of austerity, is left to regressive taxes such as VAT (in addition to public spending cuts), which are disproportionately paid by the poorest members of society.

As detailed in the table below, the proportion of taxes we have categorised as ‘progressive’ (which are levied either  variably according to income, or targeted on significant wealth transfers) consumed 57.9 per cent of the total tax take in 2007/08 – the year immediately before the financial crisis – with business taxes (principally corporation tax) making up 13.6 per cent. Since then, however, these sources of revenue have declined, respectively, to 53.8 per cent and 12.3 per cent in 2012/13.

The taxes we have defined as ‘regressive’ (levied on individuals at the same rate, irrespective of income or wealth), conversely, have become a more prominent component of the tax take, increasing from 25.4 per cent in 2007/08 to 28.4 per cent in 2012/13. The rise in the VAT rate to 20 per cent has played a major role in this particular escalation; a change to the tax system implemented at a time when living standards were already falling dramatically.

The graph below indexes the revenue from the UK’s major taxes (those accruing over £40 billion in the 2012/13 financial year) against its 2007/08 value, to demonstrate this transformation quite dramatically.

The taxes on businesses are particularly noteworthy here. The incremental reduction in corporation tax (it is due to reach 20 per cent by April 2015) has seen a gradual decline in the share of business taxes. Interestingly, the OBR project that this trend is likely to continue in spite of forecasted economic growth, meaning that the Exchequer is unlikely to directly be a significant beneficiary of the rise in corporate profits in the next five years. If the coalition gets its way, we are witnessing the beginning of a substantial and potentially enduring shift in the UK tax base away from taxing profits.

However, it should be noted that the OBR also forecasts that the progressive/regressive taxation balance will partially revert to pre-crisis conditions as the recovery takes hold, meaning that progressive taxation will again come to make up a greater share of the tax take. It is worth remembering, however, that income tax – the key mode of progressive taxation – is no longer as progressive as it was when the coalition government came into office in 2010, due to the fall in the top rate of income tax from 50 to 45 per cent

Moreover, this forecast is based on projections of strong earnings growth – previous OBR projections of earnings growth have proven overly optimistic. The same cannot be said about consumption, from which regressive taxes are levied.

Even if this projected reversal is realised in practice, which is far from certain, the evidence we present here helps to demonstrate, at the very least, one of the main characteristics of how the UK state, and especially the coalition government, has sought to achieve deficit reduction since the financial crisis.