Tax policy will remain in the headlines in the run-up to the next general election. But how does the UK compare internationally on tax and what might the political parties learn from looking to their international counterparts?
The Institute of Fiscal Studies states that, based on current forecasts, by the time of the next election in 2024, UK tax revenues will amount to around 37% of GDP compared with 33% at the time of the last general election.
However, the UK is not alone in this upward trend. A recent report from the OECD looking at historic data noted that 2021 marked the second successive year that the OECD average tax-to-GDP ratio rose, continuing the general trend of small rises in the tax-to-GDP ratio.
Looking at the trendlines for the G7 countries and the OECD average, the tax revenue to GDP trendline for the UK had held relatively steady over the 20-year period to 2021. It generally tracked close to the OECD average. The OECD data is backward-looking, so it cannot be said whether the UK has remained on trend or become an outlier.
The composition of tax revenues
OECD global revenue data uses broad data categories. Taxes on income, profits and capital gains includes taxes on individuals and corporates. Social security encompasses contributions paid by employees, employers, the self-employed and non-employed individuals. Taxes on property include recurrent taxes on immovable property (eg, business rates and council tax), wealth taxes, inheritance taxes, and transaction taxes (such as stamp taxes). Taxes on goods and services include VAT and duties.
The UK generally raises a greater proportion of its tax revenues from income, profits and gains; and taxes on goods and services, but revenue from social security has grown over time.
The Office for Budget Responsibility also publishes data. This includes forecast receipts based on current policy. These figures show a recent increase in taxes on income, profits and capital gains.
Tax policy trends
The UK is not alone in having a challenging economic environment. The OECD states that tax policy decisions in 2022 reflected policy makers’ challenging task of responding to the short-term needs of a macroeconomic environment dominated by elevated inflation levels, the long-run pressure of ongoing structural changes, and country-specific circumstances.
In response to the cost-of-living crisis, many countries indexed personal income tax thresholds, allowances, and credits for inflation. However, some jurisdictions balanced this narrowing of their tax base by increasing their top tax rates to raise revenue and support progressivity of taxes on personal income.
The UK might appear to be an outlier as it has frozen its income tax allowances and bands until 5 April 2028. The stated policy objective for this is to support the government’s objective of putting the public finances on a sustainable path in a way that is fair.
Not all jurisdictions adopted the same approach of indexing bands for social security contributions, citing the need to promote the sustainable financing of their social security systems.
A combination of wage inflation being outpaced by price increases and increases in nominal incomes pushing taxpayers into higher tax brackets have led to a loss of purchasing power.
The OECD uses a measure known as the tax wedge. The tax wedge measures the difference between the labour costs to the employer and the corresponding net take-home pay of the employee.
In its report Taxing Wages 2023: Indexation of Labour Taxation and Benefits in OECD Countries, the OECD noted that the average tax wedge increased in 23 OECD countries, and declined in 11. The largest increase was reported in the US. This was attributed to the withdrawal of COVID-19 support measures. The largest decline was reported in Türkiye, due to the introduction of a minimum wage tax exemption.
Trends in corporate income taxes
The OECD notes that the downward trend in corporation tax rates is moderating. More countries are favouring measures that narrow the tax base over further rate decreases.
Tax incentives to encourage greater investment in innovative technologies and research and development were common in 2022.
To address high profits in certain sectors – particularly the energy sector – windfall taxes, levies or other measures on companies that generated extraordinary profits were introduced in many jurisdictions. The UK’s energy profits levy is an example of this.
Taxes on goods and services
Most European countries used temporary VAT rate reductions to cushion the impact of rising energy prices. A number of jurisdictions also lowered VAT rates on food and other basic items to support households with cost-of-living increases. The OECD observed that these measures dampened incentives to lower energy consumption.
The OECD noted a trend in jurisdictions to use their VAT systems to encourage the transition to lower carbon economies. However, countries with mature low-emission car markets are introducing more stringent conditions to qualify for reduced VAT rates to address concerns over equity and foregone revenue.
The OECD also highlighted the body of empirical evidence that using reduced VAT rates to address equity, environmental, and other policy goals is questionable. This is on the basis that richer households benefit more from reduced VAT rates for necessities in absolute terms and the overall distributional effect of reduced VAT rates on non-essential items is regressive in relative and absolute terms.
Incentivising the transition to a low carbon economy
High energy prices led many countries, especially in Europe, to cut environmental taxes such as fuel duty to support households and businesses. Despite that, several high-income countries implemented or increased emissions trading systems (ETS) and carbon taxes. The EU announced a carbon border adjustment mechanism (CBAM) that entered its transitional phase on 1 October 2023. The phasing in of the CBAM will work in parallel with the phasing out of free allowances under the ETS.
Using tax incentives to encourage adoption of low-emitting vehicles is becoming more widespread in low- and middle-income countries. By contrast, some high-income countries have announced plans to remove or limit their long-running tax incentives to encourage the ownership of electric and hybrid vehicles.
The US Inflation Reduction Act was a prime example of using tax incentives to support investment in more environmentally friendly technologies and a reduction in carbon emissions. There are a range of measures across both personal and corporate taxes.
Some countries introduced tax exemptions for earnings from renewable energy.
Twice as many property tax reforms were recorded in 2022 than 2021. These include taxes on net wealth, vacant property and crypto transactions and gains. The OECD cites the pressures on governments to raise revenue, address housing affordability issues and combat inequality as the reasons for driving this trend.
Lindsey Wicks, Senior Technical Manager, Tax Policy
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