The two main political parties are in a bidding war over which can promise to increase taxes the least. Each accuses the other of harbouring a desire to push up taxes to support a growing list of spending pledges.
The Conservatives say there is a £38.5bn funding gap in Labour’s spending promises over the next five years and that to cover it, “Labour will increase your taxes by £2,094”. Labour claim unfunded Tory spending pledges add up to £71bn, or 2% of GDP.
Amid the claims and counterclaims, one thing is certain: in order to stay within self-imposed fiscal rules – adopted by the Conservatives, and matched by Labour – the next government will either have to cut spending on already creaking public services or raise more money through tax. Experts say economic growth won’t be enough to increase government revenues, and that higher tax rates, or new taxes, will be needed.
But the room for manoeuvre is narrowing. Labour’s shadow chancellor, Rachel Reeves, has pledged not to increase income tax, national insurance or VAT rates, matching Jeremy Hunt’s stance.
Here we assess the remaining options open to the next government to raise more funds:
Income Tax
Fiscal drag is set to continue and it will raise large sums. The Tories imposed a freeze on income thresholds in 2021, to help pay for the pandemic and then the energy crisis, and on Thursday Hunt confirmed he would keep it in place until 2028-29.
The Office for Budget Responsibility (OBR) has pencilled in a 20% rise in income tax receipts from £310bn in 2024-25 rising to £371bn in 2028-29, mainly driven by the freeze on tax thresholds. On its own, maintaining tax thresholds from 2021 is expected to benefit public finances by about £50bn. Hunt has promised to raise the threshold for pensioners to make sure the state pension remains untaxed, but otherwise the freeze will remain in place for another three years.
Reeves is expected to make a similar commitment, keeping in place the 20p rate on incomes between £12,571 to £50,270, the 40p higher rate from £50,271 to £125,140 and additional 45p rate on incomes over £125,140.
VAT
Both parties have promised not to increase VAT, which would meanleave the standard 20% rate in place. But there are ways more could be raised from the sales tax.
There is a long list of exemptions, which limit the impact of the tax on low- and middle-income families. Most food escapes VAT and so do children’s clothes. More controversially, financial and property transactions and private schools are also exempt.
In its latest assessment of the UK economy, the International Monetary Fund (IMF) said the government should look to abolish the exemptions to widen the scope of the tax and bring in more revenue. Reeves has started that process. She expects to generate £900m a year from applying VAT to private school fees for the first time, while keeping the headline rate.
Capital gains tax
Neither Hunt nor Reeves have said they will freeze the overall rates of capital gains tax, so this option remains open, for now.
The International Monetary Fund also said ministers should consider raising more money from the sale of assets such as shares and property by wealthy people via capital gains tax (CGT), which last year generated £15bn.
The rates are much lower than the tax on wages: 24% on gains from a residential property, 28% on gains made by partners in private equity firms and other investment funds, known as carried interest, and 20% on gains from the sale of other assets, such as shares and non-residential property.
Reeves is sticking to her pledge to increase taxes on carried interest, which is likely to mean raising the rate to 45%, to match the additional rate of income tax. While the measure redresses inequalities in the tax system, it is expected to raise only between £400m and £500m a year.
Dividend tax
More could be raised if dividends on shares were taxed more heavily. As with capital gains, the rates are far lower than taxes on wages. Critics say this is unfair, as capital gains and dividends are forms of earnings usually only available to the wealthy.
At the moment, standard rate taxpayers are charged 8.75%, higher rate taxpayers 33.75% and additional rate taxpayers 39.35%, up from 7.5%, 32.5%, and 38.1% respectively in 2022.
The next government could equalise the rates with the income tax rates, generating several hundred million pounds in revenue. However, neither Hunt nor Reeves have had much to say on dividends.
Council tax
Several years of near 5% increases in council tax pushed up receipts to £44.5bn last year – double the figure in 2006-07. It is on course to rise to £57.5bn by 2028-29 if left unchecked, according to the OBR. A review is long overdue of thresholds and rates dating back more than 30 years, but Labour and the Conservatives have dodged the issue.
Tax relief
In a report earlier this year, the National Audit Office calculated that the government offered tax breaks and relief worth more than £400bn. The estimated £40bn cost of subsidising pension savings mostly benefits higher-rate taxpayers.
Reeves plans to review tax reliefs should she become chancellor. She has a plan to tackle tax evasion and avoidance that secures £700m in the first year, rising to 3.9bn in 2028-29 – more than £10bn overall.
Hunt estimates that he will secure £6bn a year from tackling tax avoidance and evasion. He has yet to say whether he thinks a review is needed.
Climate change levy
The Climate Change Levy (CCL) is paid by businesses on the energy they use. It aims to reduce the overall emissions that businesses produce and, if successful, shouldin theorytheoretically spur change rather than higher tax receipts.
But critics say the levy is set so low that it has little effect. They say it should be increased and its scope widened as a deterrent against fossil fuels. It raised £1.9bn last year and this figure is expected to drop to £1.8bn in 2028-29.
Tax receipts from the UK’s emissions trading scheme is likewise falling, from £5.8bn a year to £1.6bn over the same timescale, and will be only partially offset under Labour’s plans by a new energy profits levy on the big energy firms that will add £1.3bn a year to Treasury coffers.
