Income tax 'needs to climb'

The UK may have to increase the basic rate of income tax by 6p in the pound, a leading think-tank has warned.

A new report from the National Institute of Economic and Social Research (NIESR) has cast a cold light on the challenges facing the UK economy.

It advises that the next government must introduce radical changes to taxation and spending if the UK economy is to deal with its budget deficit.

Failure to do so would leave the country vulnerable to the next big financial crisis, the NIESR said.

Along with the equivalent to a graduated 6 per cent hike in income tax, the NIESR argued the case for a full rate of VAT on everything except food and children's clothes, and an additional £15 billion of spending cuts.

The NIESR report predicted that the UK would do no more than "crawl" towards recovery, with growth limited to just 1 per cent this year and 2 per cent next. Only by 2013 will the economy expand by a trend rate of 3 per cent.

No reliance could be placed on consumer spending to help matters either. While wages remain under pressure, the NIESR forecast that consumer activity would be equally subdued in the short-term future.

Borrowing will still be at £82.3 billion over the year by 2012/13, the report claimed, or 4.7 per cent of GDP.

Public sector net debt will not return to pre-crisis levels before 2030, according to the research, and it is this that the NIESR highlighted as a key long-term risk.

Public finances need to develop much stronger "shock absorbers" than currently planned, the NIESR said, if the economy is to have the integral strength to withstand future financial crises.

Accordingly, the report recommended an extra cut in government borrowing by as much as 2 per cent of GDP.

It also suggested that tax rises would be a more efficient way of raising extra funds, endorsing a National Audit Office conclusion that efficiency savings are "largely a myth" and an essentially useless way of attempting to reduce the burden on the public purse.

Ray Barrell, director of macroeconomic research at the NIESR, said: "There is no longer any strong evidence that spending cuts are better than tax rises at bringing the deficit down."

For that reason, the NIESR urged a gradual 6p in the pound rise in income tax, along with a fiscal drag whereby tax free allowances are frozen whatever the increases in both wages and inflation, and supported the planned increase in national insurance contributions.

Raising employers' NICs would not be a tax on jobs, the study argued, and would have much the same effect as a rise in employees' NICs or in income tax.

Mr Barrell added: "The crisis has made us 4 per cent poorer. It means we have to assume there is a problem with our spending plans. Increasing debt means we are borrowing from our children and our grandchildren. We need more spending cuts and higher taxes to bring the deficit down."

However, the NIESR advised against a hike in VAT for the threat it would pose to inflation.

Although trenchant spending cuts are needed, the NIESR put the case for delaying their introduction for year so that they would not harm the economy and blunt national income growth yet further.

Martin Weale, the NIESR's director, said: "At least 30,000 jobs would go and possibly 60,000 and that would cut consumer spending further and GDP would decline by 0.1 per cent."

That doesn't mean, though, that the public sector is not to experience a severe contraction. The report calculated a total reduction in the public-sector workforce - from next year - of around 30,000 a quarter for five years, totalling some 600,000 staff.

The NIESR was more optimistic on the chances that the UK economy would avoid being engulfed in the same sort of crisis that is currently overtaking Greece.

Mr Weale said that while some EU countries could suffer further downgrades in their credit rating, fears of contagion across the eurozone were misplaced. The UK's debt position was markedly better than that of Greece, especially when the structure of the debt and the size of the UK economy were taken into account.

Britain has issued debt with an average life of 12 years compared with two years for Greek debt. UK debt was also expected to peak at 81 per cent of national income, compared with Greece's 112 per cent.