Another nice mess

In 1993, I started my secondary education at the grammar school in Guildford. The fees cost my parents £5109 each year. In today’s terms (factoring in inflation in the intervening period) that is £11,060 annually. The actual cost of sending a child to the same school today is £26,370. A single example of the costs of middle-class life increasing well above the prevailing rate of either inflation or wages over the last 30 years, but one that seems typical.

Over the next two instalments of Money and Other Things, we will look forward to the budget in November and have a think about pensions and tax policy. We will look at what changes could be made. We will also have a look at some of the personalities involved. But to start things off, we are going to look at why increasing taxes seems so likely.

There are two key long-term trends that are worth highlighting. The first is high budget deficits in developed economies. All the largest developed economies have spent much more than they collect in tax for a long time. The days of very low interest rates seem to be behind us for now, so the interest payments are starting to really bite. The result is constant pressure to reduce spending and increase taxes.

A second trend is the squeezing of middle-class lifestyles in the same economies. In 2019, the OECD released research suggesting that millennial individuals typically had lower living standards than their baby boomer forebears. As we’ve seen, you have to have a much more elite income today to afford to send your child to the school my parents sent me to in 1993.  

The result is the strong impression that previously very comfortable levels of income will not support an affluent lifestyle. This feeling has been written into the current zeitgeist under the demographic moniker ‘HENRY’. The term, standing for ‘High-Income Not Rich Yet’ was coined by Shawn Tully, an American business journalist, in 2003. In the intervening years, globalisation and extreme monetary policy have exacerbated the existing pressure on a traditional middle-class life. They have also assaulted our sense of progress; newer generations are supposed to do better than their forebears.  

If you read the HENRYUK Reddit forum, the complaints about the iniquities of tax policy are legion. It is particularly bad if you want to have children. The loss of child benefit, tax-free childcare and free childcare for working parents can easily lose you six figures over the toddlerhood of your children for earnings on the wrong side of £100,000. Add in the loss of the personal allowance from £100,000, and it becomes an invidious tax trap.

These are fortunate people who earn well. A progressive tax system would see them pay a higher rate of tax in both percentage and absolute terms. But it is also patently poor tax policy. We are taking the most productive workers (in purely economic terms) and putting in place strong disincentives for them to earn more.

It also creates an inflexible distribution of work within families. One person earning £200,000 gross will take home around £118,000 after tax. But a couple who each earn £100,000 gross will take home around £137,000. If you have children, the choice of whether both members of a couple continue working and whether you therefore pay for childcare in your offspring’s early years is fraught. It doesn’t help that the tax system pushes everyone in one direction. Both of you working may or may not be the best solution for any particular couple.

These issues are not often discussed openly because they are all, to some extent, diseases of affluence. It is easy to consign everyone earning over the average to punitive measures. But tax policy, done well, should be about balancing fairness, property rights, social outcomes and fiscal outcomes.

Compounding all this are the self-imposed rules of the chancellor. Like many of her predecessors, Rachel Reeves has committed to fiscal rules. They increasingly constrain her. Because interest costs are high and OBR projections matter, the deficit can swing a lot between budgets. While it encourages fiscal rectitude, it also has the negative consequence of forcing real-world policy changes to taxes and spending because of a projected number which is, in some cases, little more than a guess.

It's also worth noting that the Bank of England is still selling the gilts it holds from the Great Financial Crisis in 2008. By releasing lots of bonds into the market, they tend to make the bonds the government is selling today worth less. That ultimately forces the government to pay a higher rate to borrow; more money on interest costs and less to pay for the NHS.  

All of these factors have created acute pressure to reduce the deficit. Yet on the spending side of the equation, the government has been unable to push through modest reductions.  This does not bode well for the quality of the policy that will result. But we have, in Torsten Bell, the current Pensions Minister, a seemingly substantial figure with a deep and long-standing interest in tax policy as an engine to create social outcomes. Next month, we will look at him and what he could mean for pensions and personal finances.