Taxing the wealthy won't solve Rachel Reeves's problems

Telegraph

6 hours ago

For a moment, the mask seemed to slip. While repeating Labour's manifesto pledge not to raise taxes on working people, Heidi Alexander, the Transport Secretary, went off-script.
'We made a commitment in our manifesto not to be putting up taxes on people on modest incomes, working people. We have stuck to that,' she told Trevor Phillips on Sky News.
It is the first time modest earners have been singled out.
'When it comes to taxation, fairness will be our guiding principle,' she added.
Alexander also failed to deny that ministers had discussed a wealth tax at a Cabinet away day, saying only 'not directly' when asked if it had been mentioned.
Her remarks are a signal of what is to come. Rachel Reeves is faced with a fiscal black hole that could be as large as £30bn come the autumn Budget.
With gilt markets on edge and attempts by Sir Keir Starmer to curb public spending ending in tears, it can only mean one thing: big tax rises.
Alexander's comments suggest it will be the middle class who are targeted. But economists are warning that there are limits to how much Reeves can raise from higher earners.
'We can have bigger state and more tax on average earners. We can have smaller state and real cuts in public services and benefits. That's it. The choice,' Paul Johnson, the former Institute of Fiscal Studies (IFS) head, warned last week.
David Miles, a member of the Office for Budget Responsibility's (OBR) committee that scrutinises the Government's spending plans, was even more outspoken in his warning to the Chancellor.
'If you try and keep increasing the ratio of taxes to GDP, and look for more and more taxes wherever you can find them, it's very likely that at some point you start creating so many disincentives – to save, invest, work – that you start doing some serious damage to the growth potential of the economy, and it backfires on you,' Miles told CNBC on Friday.
'The ratio of taxes to GDP in the UK is now getting to levels that we really haven't seen since the Second World War. The scope to simply just raise more and more tax revenue is definitely limited.'
Over the past 15 years, Britain's high earners have seen their taxes rise significantly, while those on low and middle incomes have been granted big cuts.
This means that as Britain's tax burden has risen towards a post-war high, those on modest incomes have escaped the direct hit.
Average earners – typically on around £35,000 – are taxed less than at any point in the last 50 years, the IFS noted in 2024. Their tax bill was actually £2,000 lower last year than in 2010.
They can in part thank George Osborne, the former chancellor, who raised the tax-free allowance from £6,475 in spring 2011, gradually taking it to £11,500 in 2016-17. It has since risen further to £12,500.
The gap between how average and higher income workers are treated by the tax system makes the UK stand out internationally. It ranked 32nd for how much middle earners are taxed among 38 mostly rich countries last year, OECD data shows.
Meanwhile, high earners have been hit with several blows over the past 15 years.
Their wages have barely risen in real terms, while paying much more in taxes than previously. Anyone fortunate enough to make £200,000 last year was taxed £10,000 more than they would have been in 2009, according to the IFS.
As a result, the Treasury has come to rely more on its golden geese. At the turn of the millennium, the top 1pc of earners paid just over 21pc of all income tax receipts. This year they're projected to pay almost 27pc, HMRC figures show.
In contrast, the bottom half of all workers contribute just 10pc of all income tax receipts – down from 11.6pc.
The lack of appetite for spending cuts suggests the UK is poised to become more like continental Europe. This would mean tax rates would have to rise for both middle and high earners. But the jump would be far bigger for those on middle incomes, according to research.
While internationally comparative analysis is hard to come by, one paper from 2019 found that the UK already ranked lowest for taxes on average earners when comparing with 10 wealthy European countries. However, when looking at taxes on the very highest earners, the UK ranked sixth – only a nudge below the famously high-tax Denmark.
'Henrys' have 'reached their limit'
The fact that the highest earners are yet again being eyed up after welfare about-turns by revenue-hungry officials has not gone unnoticed. One disgruntled so-called 'Henry', an abbreviation for high earners who are not yet rich yet, was quick to ask for recommendations for where to relocate to, declaring on a Reddit forum: 'I've reached my limit for sucking up tax rises.'
'Can't wait for them to spout the 'those with the broadest shoulders' sh--e again, only to wring pensions, Isas, and PAYE. Why is it always working people that get screwed?', another chimed in.
Such complaints were foreshadowed by the OBR at the October Budget. The watchdog warned that Reeves was hitting a small group of people with several overlapping policies – such as VAT on school fees, changes to inheritance tax and higher capital gains levies.
This makes the behavioural response more difficult to predict, raising the risk of the disincentives that Miles at the OBR warned of.
The response to such concerns from many on the Labour Left has been to suggest a wealth tax – ignoring that Britain already taxes wealth in many different ways such as through stamp duty, inheritance tax and capital gains levies.
Stuart Adam at the IFS says: 'An annual wealth tax would need to apply broadly to all assets to ensure that it was not easy to avoid. Such a tax could raise significant revenue if it applied to the bulk of the UK's wealth – that would include the homes and pensions of the middle class.'
What most people think of when they talk of wealth taxes is probably not their own pension or house.
All of this leaves few good options for Reeves. Finding up to £30bn while sparing workers on 'modest' incomes may prove her toughest challenge yet.