Mending the UK public finances: a Sisyphean task

Tom Traill - 19 October 2017

The UK public finances enjoyed a welcome reprieve recently, recording the first July surplus since 2002 and the best August outturn for a decade. These positive outturns follow poor June data, meaning that the cumulative deficit for the current financial year is virtually the same as at the same stage last for 2015-16. Philip Hammond’s forthcoming Budget on 22 November is already throwing a spotlight on the public finances, with mounting speculation that the Chancellor will have little room for manoeuvre. The implication of productivity downgrades may be no more than a nuisance but the underperformance of tax revenues is altogether serious: the task of bringing in the grain has been getting progressively harder for the exchequer.

The largest sources of UK government receipts are income tax (around 25 per cent) and National Insurance contributions (18 per cent). The disintegration of work contracts, allowing work to become more and more divisible, is a major headache for the tax authorities. As a growing proportion of the workforce is part-time, self-employed or engaged in piece-work, the tax yield per person is under threat. The rise of non-traditional employment has weakened the relationship between total hours worked and aggregate revenue from income taxes. At the turn of the millennium 66 per cent of those with permanent jobs (ie not on temporary contracts) were full-time employees, but this has fallen to 63 per cent.

The figure below shows the tax generated in four circumstances: the traditional, full-time employee, assumed in this case to earn £50,000 per annum; two part-time employees, both assumed to earn £25,000 per annum; a full time self-employed person, also earning £50,000 per annum, and two part-time, self-employed people, both earning £25,000 per annum.

Firms such as Uber, Taskrabbit (recently acquired by Ikea), Deliveroo, and eBay are making it easier for people to work to a schedule that suits them. These workers are often nominally self-employed (though this classification is the subject of a legal challenge by the government), and in many cases they are working part-time.

The structure of the personal allowance for in income tax and national insurance means that two part-time workers are entitled to two personal allowances and thus contribute less tax. The problem is compounded by the shift to self-employment. Not only do self-employed people pay a lower rate of National Insurance, but they do not accrue an employer’s National Insurance liability either.

There has been a substantial increase in the numbers of workers aged over 65, some returning to work out of boredom and others out of economic necessity. Regardless of the reason, those who are above the state pension age are not required to make National Insurance contributions.

George Osborne’s first budget (in 2010) set out to eliminate the budget deficit by the end of the parliament (2015/16). Theresa May recently extended that ambition to around 2025 – a decade behind the original schedule. If there are no radical proposals in store to overhaul the tax system, then the government must fight an uphill battle to preserve tax revenues, even in a growing economy. The task of stabilising the public finances and eliminating the deficit seems ever more daunting, particularly for a slowing economy.

Figure 1

Data source: EP calculations

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