Chancellor Rachel Reeves says she needs to raise £20bn. How might she do it?

With just weeks to go before the government’s crucial first Budget on October 30, Chancellor Rachel Reeves is clearly aiming to raise funds.

She said there was a black hole in the public finances – and since arriving at 11 Downing Street in July it had become apparent she had uncovered £22bn of unbudgeted overspending this tax year.

Now, whether this is actually a newly discovered black hole is still debated. Regardless, given that Ms. Reeves has ruled out borrowing to fund day-to-day expenses, she may still need to raise taxes to pay for them.

So, if you were in her shoes, how would you improve it? Let’s not pretend this is too precise a game – for simplicity’s sake let’s call this figure £20 billion.

This number is somewhat arbitrary. In fact, this year’s overspending has nothing to do with how much additional tax revenue will be needed next year or five years from now. The Budget is expected to mainly find tax increases having an impact in 2025-26 and beyond.

Regardless, when the budget comes we will have an updated economic forecast, new forecasts for government revenue and spending, and possibly new fiscal targets. So, come October 30, a lot will change.

Nonetheless, if you were a chancellor tasked with raising £20bn, you might want to have the option of raising the rate on one of the four main taxes: income tax, VAT, national insurance and corporation tax. Together they account for two-thirds of the total cash received by the government.

However, for better or worse, the chancellor ruled out such a tax increase during the election campaign and she has made clear she will not back down from her pledge. For our purposes, therefore, such tax increases are clearly prohibited.

This is a big limitation. Remember, in its final year, the Conservative government cut taxes by £20 billion through cuts to National Insurance rates. One way to raise money is to reverse this cut and get us back to where we were before November.

So by ruling out a Tory reversal of national insurance cuts, the Chancellor has made our search for £20bn a game even more… taxable.

But once you put all those tax increases aside, there are still more potential ways to raise additional revenue that we can look at.

One is through capital gains tax, which is levied on profits from the sale of assets that appreciate in value, such as a second home or shares held in a non-Individual Savings Account (ISA).

But when it comes to a capital gains tax, “I don’t think it’s going to raise a lot of money immediately,” said Judith Friedman, emeritus professor of tax law and policy at the University of Oxford. “It might bring in a few billion dollars, but it’s not going to give you £20 billion.”

Another route is through inheritance tax. But Dan Neidel, founder of the Tax Policy Institute, a think tank, said this situation “only happens if you’re reasonably wealthy.”

Capital gains tax and inheritance tax currently raise less than £25 billion a year, so an additional £5 billion would still require a significant increase in these taxes.

However, you can also raise cash by raising national insurance or income tax without actually changing their overall tax rate.

When it comes to national insurance and income tax, there will be a much larger sum on the table if the chancellor is interested in looking into the rules on the tax treatment of pension contributions.

Currently, for most people, if you put any earnings into a pension, you won’t have to pay income tax on those earnings. If your employer makes pension contributions on your behalf, they won’t pay your employer’s National Insurance on it, as if they were paying it to you as salary.

Combined, these benefits cost the UK exchequer around £50 billion a year. Most of these benefits go to high earners, who not only put more money into pensions but often deduct income taxes at a higher rate than average workers.

This is an area ripe for reform. In fact, the center-right think tank Center for Policy Studies proposed an overhaul of the system 12 years ago. The centre-left chancellor will be keen on the potential revenue here.

Now it must be said that when it comes to squeezing more tax from the people, there are two broad approaches the Chancellor can take. We might call them expediency and economy.

The stopgap solution is to look for places where you can raise money with the least amount of screaming. Under this approach, there doesn’t have to be much logic in any tax increase—just find the money in hidden corners.

The economic approach is slightly different. It started with the idea that there are more or less logical ways to tax people, and that tax systems should avoid cherry-picking certain types of activities in an arbitrary way.

This is a world where you generally want to avoid taxing certain incomes or savings higher than others because that can be unfair and distort people’s decisions.

Therefore, you need to have a vision of how the various parts of the tax system interact. The phrase “fiscal neutrality” is sometimes used to describe a system that aims to tax taxes as fairly as possible.

While our tax system is clearly full of anomalies and illogicalities, when it comes to pensions specifically, economists tend to hold a broad view of what a fiscally neutral tax system should strive to achieve.

The basic principle is that people should pay tax on their pension once, not twice.

So you either have a tax break upfront on the money people put into pension savings, and then tax the pension income that people enjoy when they get older. Alternatively, you don’t provide any prepayment relief at all and tax the income that goes into the pension fund, but not tax it when the pension is paid out.

Judged against these principles of neutrality, our current system is a bit of a mess.

Many people enjoy a 40% income tax relief on pension income and a 20% income tax relief on pension expenses. This is not logical.

Additionally, employer National Insurance has no charges at either end; when you receive your pension you get a tax-free lump sum, even if you enjoy tax relief on the money you contribute to your pension.

You don’t need to know all these details to see that a chancellor who wants extra tax revenue can look at pension contributions and see an orchard full of ripe fruit waiting to be picked.

What makes it so striking is that whether you view the orchard through the glasses of expediency or through the lens of economic logic, it looks rich.

Sir Edward Troup, a tax lawyer who formerly worked at the Treasury, expects the chancellor to take action in this area in the budget.

“The question is how far and how fast can she go?” he said.

“Whether she’s really trying to get some money in the next few years – which is going to be painful – or whether she’s going to introduce some slow-burn reforms and increase the amount of money that’s going to come from people who are retiring in the next five, 10, 20 years Tax revenue, 30 years?

I also wonder if the Budget will try to correct the irrationalities in the system or just raise as much money as possible?

Of course, there may be other important tax changes in addition to those I’ve talked about. More than one of the Prime Minister’s audience has written to suggest a new tax on land values ​​(an idea popular with the Greens and sometimes the Lib Dems). That may be a step too far for this Budget, even if it appeals to many economists.

The important thing to note is that a £20 billion tax increase is significant for UK finances, but it is by no means a huge amount from a historical perspective. This equates to around £6 per week for every man, woman and child in the country, or around £25 per week for a family of four.

Another way of looking at it is that this would allow NHS England to run around 40 days a year. Or to put it another way, £20 billion is less than 1% of our annual national income. Accounting for approximately 1.7% of total government expenditure. It’s not revolutionary, but it’s not nothing either.

We’ll have to wait until October 30 to see exactly which approach Rachel Reeves takes.

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