The embedded structural cost of tax cuts

Official forecasts in 2017 implied that lower tax rates for the self-employed and company owner managers relative to employees will cost about 15 billion in 2021-22. Therefore, if there are tax cuts, that cost will rise. Independently, and in parallel, the cost of government borrowing may increase. UK general government gross debt exceeds £2,365.4 billion (Quarter 1 – Jan to Mar 2022), equivalent to 99.6% of gross domestic product (GDP), see my previous blog ‘What is the economic impact of Brexit on the cost of living crisis?’ 

In the UK tax liabilities on income from work depend on legal form.

‘The way different incomes are treated for tax purposes is a problem. The system is unfair, complicated and economically inefficient. These problems are not new and not unforeseen. Researchers have been highlighting the problems and predicting that they would grow, including as a result of changing work patterns that blur the lines between employment and self-employment, for more than two decades. As the problems have grown, so too have the costs, including the revenue cost to the government.
 … [P]art of the reason that the current system persists is a widespread belief that the system is justified – ie, that there are benefits that offset the costs imposed by differentiating tax by legal form. … None of the common arguments holds up. Levying lower taxes on the self-employed cannot be justified by differences in publicly funded benefits (the differences are far smaller than the tax advantages) or by differences in employment rights (which do not act to skew the labour market toward employment). Lower tax rates are also poorly targeted at boosting entrepreneurship. It has long been recognized that there is a great deal of heterogeneity within the small business population and that not all are entrepreneurial. The latest research using HMRC tax records is allowing the population of the self-employed and company owner managers to be described in much more detail. The research highlights that most business owners, while conducting perfectly respectable trades, are not employing others, investing or growing – let alone doing anything that produces positive ‘spill-overs’ to wider society and that will, therefore be under provided by the market. This serves to demonstrate how poorly targeted the tax breaks are.
… Given that the problems with taxing legal forms in very different ways are large, long-running, well-known and growing and that no one seems happy with the current system, it is perhaps surprising that so little progress has been made in fixing the system.’
 (‘Principles and Practice of Taxing Small Business’, by Stuart Adam and Helen Miller, Chapter 5 of ‘The Dynamics of Taxation – Essays in Honour of Judith Freedman’, edited by Glen Loutzenhiser and Rita de la Feria).

£50bn (not taking any account of the £15bn I mentioned) will increase GND by 2.1%. The Observer view on Liz Truss and Rishi Sunak’s tax cut promises (see the link below) states, ‘Truss, … has gone much further, pledging tax cuts she claims will cost £38bn annually, but which economists believe could actually cost more than £50bn a year. She claims this will promote growth, but these kinds of tax cuts will do nothing to address the real reasons for Britain’s dire productivity growth – a lack of investment in infrastructure, skills and other forms of capital – while significantly reducing the resources available for public services at a time when inflation is eroding the real value of budgets in hospitals, schools and care homes. Most of the conversation about the cost of living crisis has, understandably, been framed through the lens of household budgets. But it will have just as damaging an impact on Britain’s public services. … Inflationary pressures, including higher wage bills and energy costs, are predicted to cost the NHS billions this year.’

If this economic analysis proves to be correct, then:

(i) tax cuts will not increase economic growth; and

(ii) the economic cost of cuts will be GND = 101.71% of GDP.

That is an economic tipping point.

See:

The Observer view on Liz Truss and Rishi Sunak’s tax cut promises | Observer editorial | The Guardian

Tory leadership: Do Liz Truss and Rishi Sunak’s tax pledges add up? – BBC News

https://www.bbc.co.uk/news/business-62168489