From Crisis to Crisis – the results of not listening
In October I wrote A word to the Treasury Wise, highlighting the growing cost burden of ever-increasing tax and regulation, effectively making the UK economy less competitive.
So let’s look at this over half a year on, from three perspectives: the point of view of professionals in economics, the point of view of you and me, the average Briton, and what the data is actually saying.
Point of view of professionals in economics
The Laffer curve is a graphical representation of the relationship between tax rates and government revenue. It suggests there is an optimal tax rate that maximises revenue without discouraging productivity and economic growth.
Starting from a low tax base, a marginal increase in tax increases revenues and enables governments to provide more services. However, when taxes become too high, human behaviour kicks in – and further increases can have the opposite effect, reducing tax revenues and creating wider economic consequences.
We’ve seen this in practice. The previous UK government significantly increased the tax burden on private landlords by restricting mortgage interest relief. The consequence has been a steady exit from the market, particularly among more responsible landlords, reducing both tax receipts and the supply of rental housing. The result? Rising rents across the country, especially in major urban centres.
Point of view of the average Briton
As it turns out, Britons largely agree with the professional view, and it isn’t difficult to understand why.
An Ipsos survey in January found that 77% of Britons believe the economy is in a poor state, and this is well before the consequences of the Iran war kicked in. Importantly, those who view the economy negatively largely blame decisions made by the UK government – both current and previous administrations.
The same survey highlights a growing preference for tax cuts. And as conditions have continued to tighten, with persistent inflation and delayed interest rate reductions, this sentiment is only becoming more pronounced.
What the data is saying
The data tells a very similar story.
Business Matters reported in March that the UK economy flatlined in January, before any escalation in geopolitical tensions. This leaves very little room to manoeuvre or absorb unexpected shocks.
Inflation is not yet under control, pay growth is at its slowest rate in more than five years, as reported by BBC News on 19th March, and as Sky News also highlighted, unemployment remains at a five-year high, with youth rates continuing to climb.
This means fewer people are producing and paying taxes, more people are relying on social security (increasing the tax burden), and those who are working are seeing inflation eat into any pay increases.
The implications are straightforward: fewer people working means lower tax receipts, while greater reliance on social support increases pressure on public finances. Those still in work are seeing any pay increases eroded by inflation.
So, the data aligns closely with both economic theory and public sentiment.
Consequences
More tax and more regulation mean less money in people’s and businesses’ pockets.
That applies to spending today (income tax, National Insurance), in the future (inheritance tax, capital gains), or both (pensions, energy levies and related taxes). The result is reduced spending and investment, which ultimately leads to lower tax revenues and higher borrowing, creating pressure for further tax increases.
And so the cycle continues.
This is not unlike a business increasing prices to compensate for falling revenue, only to see demand fall further. Over time, this erodes resilience and increases risk.
The UK, even as a G7 nation, is not immune to such consequences.
The UK left the EU, whether one agrees with the move or not, on the promise of less red tape and a more flexible economy. Instead red tape is increasing as are taxes, making the UK less nimble in responding to changes in the economy and international arena.
Reality will hit
Great leaders are not those who simply steady the ship today. They are those who understand the destination and bring people with them to reach it.
And when a storm comes, they know how to steer around it, or at least minimise the damage.
It is not too late (just yet) to change course. But the urgency is increasing. Rising geopolitical tensions are already pushing fuel prices higher, which will inevitably feed into inflation and put further pressure on interest rates.
Higher interest rates mean more of the UK budget is spent on debt repayments. At the same time, households and businesses face higher borrowing costs, leaving less money in the economy and reducing tax receipts further.
With limited financial headroom, and continued borrowing to fund day-to-day spending, the UK is in a fragile position. If the next shock is significant, the impact will be felt quickly.
We understand the economic consequences of rising fuel prices. So why is the equally well-established impact of rising taxes and regulation being overlooked?
If this is not addressed, we risk moving from one crisis to the next. And a leader focused only on the next storm will eventually run out of the resources needed to reach their destination.
