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Why Britain’s Economic Recovery Does Not Imply a Reduction in Budget Deficit?

While most part of the European countries are passing a low growth path that almost seems a stagnation, Britain grew up 3,2% in the second quarter of this year (i.). In the last twelve months 774, 000 jobs were created, while the adult employment rate increased to 73%, its maximum since 1974. It seems that just the budget deficit is not benefiting with this economic acceleration, widening to £11,6 billion this August from £11 billion a year earlier. (ii.)

According to the Office for Budget Responsibility, this increase is primarily due to the decrease of income tax receipts (see the graph below). While employment grew up 5% in the last four years, income tax receipts have fallen 4%. The first reason for this is that at the start of the 2013-14 tax year, the top rate of tax was cut from 50% to 45%, consequently some high-earners shifted their bonus payments to that year, increasing tax receipts in the first months of last year and slowing the annual change now. A second reason is that wages are stagnating, low-paid part-time work, self-employment and zero-hours contracts substituted some full-time jobs, and those who earn less than £10,000 do not pay income taxes. (iii.)

Source The Economist

Source: The Economist

An income earner that earns £28,000 a year pays more than four times someone that earns £14,000. Also, when wages do not follow the increase in inflation, workers across the income scale are pulled into lower tax brackets. All this demonstrates the dependence that the Treasury has to high-income earners; in 2013-14 the top 1% of earners contributed 28% of all income taxes, while in 1979 just represented 11%, according to the Institute for Fiscal Studies; obviously this makes receipts more volatile. This is a consequence of the progressivity in taxes (tax where the tax rate increases as the taxable base amount increases), but it also shows an increasing inequality, making it inevitable that it must be the high earners to pay a growing share of the overall tax rate.

The narrowing of the tax base reflects two failures of tax policy. The first is the proliferation of exemptions and deductions that undermine the progressivity of the tax system. The second failure is how complicated it had become the UK tax code, one of the longest in the world with 11,000 pages, creating schemes where people avoid to pay taxes out of ignorance. For example, every time that someone donates to a charity and it claims gift aid, is involved in tax avoidance. (iv.)

So, how should the UK government solve the problem of its deficit? It should not use the easiest tool that is increase high income tax, because this will discourage entrepreneurship and force the high income earners to move their income to other countries in order to avoid paying the tax. What is necessary is that wages need to rise (output per hour is below its pre-crisis level), and hence tax income, UK needs to use more of its resources and getting more from them. But this solution tells us that the UK budget deficit will not immediately decrease and many policy reforms are needed.

Marli Fernandes


Author: studentnovasbe

Master student in Nova Sbe

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