How high is UK taxation? Well, it seems to be elevated given media comments that it is at a 70-year high. But is it true? Not according to the Institute of Fiscal Studies.
On their calculations, tax as a percentage of GDP was higher in the 1960s and 1970s. It may be a quibble but it looks more like 40 years rather than 60.
So, how do we compare internationally? Our tax take is higher than in most other English-speaking developed economies (such as Australia, New Zealand, Ireland, and the United States) but lower than many EU countries. Overall, we appear to be broadly in line with the Organisation for Economic Co-operation and Development average. If we delve a bit deeper it seems that the income tax take is broadly in line with international norms – although well behind Scandinavian levels. We raise a bit more from value-added tax than the average (despite having a relative narrow base) and are broadly in line on indirect tax. Corporate taxes contribute a bit less, whilst building taxes raise more than in other countries. Where the UK gets less of its tax from, on a relative basis, is the taxation of employment. National Insurance contributions (from employees and employers) raised 6.6% of GDP in 2019, compared with 12.0% on average for the EU14 (EU members prior to 2004) – this explains most of the difference between UK and EU tax levels.
How will the Chancellor tighten fiscal policy on 17 November? Despite speculation over the weekend that spending cuts were going to represent a majority of the fiscal tightening, I don’t buy into that. I expect the balance between tax hikes (windfalls, National Insurance, fiscal drag, capital gains and dividend income etc.) and real spending cuts to be tilted towards the former. In the face of a recession, squeezing public expenditure will be a hard act to pull off. So high earners can expect to shoulder more of the fiscal shift. Interestingly however, when looked at from a global perspective, UK taxes rise more progressively than the European average. This is partly due to the relative low take from National Insurance – which is less progressive than income tax.
Interest rates increased…
No doubt there will be more clarity in a few weeks. In the meantime, we have seen a flurry of rate increases. The US Federal Reserve (Fed) implemented a widely expected 75bps hike, taking the federal funds target range to 3.75-4.00%. Despite the spin, this was not a dovish pivot. Whilst the Fed might hike less than 75bps in December, their forecast terminal rate looks to have risen. Overall, talk of a pause is premature given the Fed’s stance that reducing inflation is likely to require a sustained period of below-trend growth and a restrictive monetary policy.
In the UK, the Monetary Policy Committee also hiked rates by 75bps to 3%. However, it was not unanimous with one vote for 50bps and another for 25bps. Future rate rises were flagged but the Bank of England (BoE) was keen to stress that market expectations were too high. This actually did little to change yield curves with a bank rate priced between 4.5% and 4.75% in six months’ time. Admittedly, this is a long way from the 6% peak priced in during the Liz Truss period.
The UK rate hike was unusual as BoE forecasts for the economy remain very grim, with GDP growth expected to be negative in both 2023 and 2024, and with unemployment forecast to hit 6.5% by 2025. Where does this leave inflation? Below 1% in 2025 according to the BoE. But a lot can change by then.
…and markets reacted
In bond markets yields tended to rise a bit. US yields rose across the curve with two-year yields finishing above 4.7%. German and French 10-year rates rose 20bps and there was a general move up in real yields. Implied inflation was marginally higher in most areas. In currency markets sterling lost some ground following the BoE’s warning of a two-year recession, but against the US dollar is well above the September lows.
In credit markets, yield spreads were generally unchanged. We continue to see a trend towards better liquidity and there has been a small pick-up in sterling credit bond issuance. My central expectation, at the beginning of the year, for non–gilt sterling credit spreads was a high of 150bps. In my view, it feels unlikely we will see a 30bps rally in the next six weeks and I continue to believe that current spreads are attractive.
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