- Increasing VAT could lower real incomes by 3%, the IFS suggests
The Chancellor has been warned that raising VAT in the Autumn Budget would have a more detrimental effect on the economy than income tax hikes.
Rachel Reeves has ruled out raising VAT in keeping with her manifesto pledge, but economists warn she may have little choice.
Increasing the main rate of VAT by 1 percentage point would raise £9.9billion a year by 2029-30, according to the Institute of Fiscal Studies.
But analysis by the National Institute of Economic and Social Research shows that raising VAT would lower real incomes by nearly three per cent – twice as much as raising income tax – and real GDP by 1 per cent.
Real income refers to household spending power, adjusted for inflation.
VAT is a lucrative revenue raiser, bringing the Treasury £222billion a year, behind National Insurance contributions (£226 billion) and income tax (£398billion).
Tax grab: Raising VAT would have a detrimental effect on the economy, experts warn
Reeves has to raise as much as £40 billion according to economists, and balance it with economic growth against a backdrop of sticky inflation and higher unemployment.
NIESR warns that increasing VAT would push inflation, interest rates and unemployment even higher than income or corporation tax.
Ed Cornforth, NIESR economist said: ‘VAT would put pressure on prices, an undesirable option given current inflation expectations, and additional business taxes would harm investment incentives, at a time when employer NICs have already dampened business confidence.
‘Although it is politically unsavoury, avoiding raising income tax will force the Chancellor’s hand into worse options; tinkering around the edges simply won’t shift the dial.’
The analysis shows that a rise in the rate of income tax ‘would appear to be the least economically damaging option available to the Chancellor at this time.’
However, higher income taxes come with their own issues, namely discouraging people from saving in taxed forms, like investing in companies or property. NIESR says it would also hurt labour supply or a larger-than-expected reduction in consumption.’
David Aikman, NIESR director, said: ‘The Chancellor’s priority should be to rebuild fiscal resilience by putting the public finances on a stable and sustainable path.
Doing so would also signal to markets that the Government is serious about restoring fiscal discipline – which could, in turn, help reduce borrowing costs. Achieving this will require either cuts to public spending or higher taxes.’
In its pre-Budget analysis this week, the IFS said Reeves could raise tens of billions of pounds in revenue without raising the ‘big three’ taxes.
However, it would require her to reform the tax system, as opposed to making what it calls a ‘half-baked dash for revenue’.
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