19 July 2019

The new OBR report echoes the risks to tax revenues highlighted in the Institute for Government’s Taxing Times report – and the need for the Government to do more to put the UK tax system on a sustainable footing, argues Joe Marshall

It is two years since the Office for Budget Responsibility (OBR) first set out its assessment of the UK’s medium- to long-term fiscal risks. In response, the Government acknowledged the challenges and made some welcome steps to address them. However, less progress has been made on revenue risks. While the OBR notes that the Government is actively trying to mitigate the revenue risks from digitalisation – including the announcement of a new digital services tax – it concludes that most revenue risks remain unchanged and unmitigated since its last report.

Two years’ ago, the Government response was heavy on rhetoric. This time around, however, it needs to respond with more concrete action.

The Government’s actions are making things worse in some areas

The OBR highlights tax reliefs as a key area of concern. Tax reliefs can be a legitimate means of addressing market failures or pursuing specific policy objectives, but they can also complicate the tax system and prove far harder to remove than they are to introduce – locking in potentially unsustainable tax breaks.

Despite Government commitments to simplify the tax system and ensure tax reliefs are ‘fiscally sustainable and represent value for money for the taxpayer’, the OBR highlights that ‘few reliefs have been evaluated – either in terms of cost or of effectiveness in meeting stated objectives.’ This gap is worrying; tax reliefs are often used as an alternative to conventional public spending, and they should receive greater scrutiny – as the Institute for Government and NAO have argued. Over the past two years alone, however, the Government has added over 100 new tax reliefs.

There is a real risk to tax revenues

Declining revenues from fuel duties also pose a challenge to the public finances. To some extent, this is driven by increasing fuel efficiency and the electrification of vehicles. But successive failures to implement the Government’s stated policy of increasing fuel duties in line with inflation are also hitting revenues – costing the Government around £10 billion a year since 2010.

The continued trend towards greater self-employment also threatens future tax revenues, given the favourable tax treatment of the self-employed and company owner-managers over employees.Policy changes since 2017 have slightly increased the tax incentive to work for your own company rather than as an employee, though some options have been closed down by rules on off-payroll working (known as IR35). In the long term, these trends pose a real risk to tax revenues.

The Government needs to meaningfully address risks to tax revenues

The OBR highlights a tendency for Governments to cut taxes in high profile ways – with relatively certain costs – while trying to raise revenues in less visible and more uncertain ways. Put simply, it is clear how much tax cuts will cost, but harder to know how much revenue-raising policies will bring in – particularly when uncertain behavioural changes are considered. With no money available to pay off any losers from reforms, governments have resorted to stealth or imprecise tax avoidance measures in an attempt to raise revenues without attracting opposition. While this approach may be politically more straightforward, it could prove less sustainable in the long term and doesn’t remove the need for structural tax reform.

The latest OBR report makes clear that there has been no change to many of the risks to tax revenues which it previously highlighted and, in some areas, these risks have been made worse by Government policy. Its response to the previous Fiscal Risks Report did little to reduce, manage or mitigate the risks to revenue. This time, however, the Government must start to meaningfully address the threats to revenues and chart a course for a more sustainable tax system.