In the last public finances release before the general election, the chancellor and incumbent government have been greeted with what, at face value, seems like reasonably good news. Public sector net borrowing for the 2014/15 fiscal year stood at £87bn. 

The result undershot the target of £90.2bn set by the independent Office for Budget Responsibility (OBR) during the 2014 Budget. It means that GDP has fallen by more than £60bn from £153.5bn in 2009/10.

With public borrowing still close to £90bn per annum, whoever governs after the next election will have to make significant spending cuts if the public sector is to balance the books. This, in part, reflects the fact that little progress has been made on cutting spending in the current parliament.

Cebr has suggested that the details of how the two largest political parties would “achieve unpalatable cuts” remain elusive. A messy outcome to the general election, such as a three party coalition or an informal pact, Cebr claimed, could make achieving consensus on cuts very difficult.

Researchers explained that challenges on the tax side of the public finances will “compound difficulties on the spending side” and that “George Osborne has presided over a huge erosion of the income tax base”, with rising personal allowances reducing the number of income tax payers by over 2.5m compared with 2007.

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This “erosion of the tax base and reliance on high earners” was termed by Cebr as problematic. Income taxation deters wealthy individuals and entrepreneurs from moving to the UK, and also encourages UK-based individuals to relocate to more favourable tax regimes. This would lead to a loss in government revenue. 

The government is reaching revenue-raising limits in many areas, with consumers changing their behaviour to minimise their tax burden. Motoring is a very clear example.

About two-thirds of new cars sold are in “fuel efficient categories” which are completely exempt from vehicle excise duty in their first year on the road, Cebr said. These cars generate less road fuel duty revenue for the government too. 

Cebr also believed that the Office for Budget Responsibility remains too optimistic on the outlook for economic growth beyond 2015. Tax revenues are likely to come in lower than official projections.

The increase in VAT to 20 per cent has been a significant source of revenue growth, with receipts standing 35 per cent higher in 2014/15 than in 2007/08. In contrast, taxes on household income are just four per cent higher, while taxes on corporate incomes are 12 per cent lower. 

If the new government fails to reach a consensus on the need for spending cuts, Cebr suggested, then we “shouldn’t rule out another VAT rise to address what is still a colossal hole” in the public finances.

Scott Corfe, associate director at Cebr said: “Nearly six years on from the end of the ‘great recession’, the UK’s public finances are still in a mess. Lack of consensus on the need to make spending cuts after the next election could leave the UK walking towards future tax rises.

He suggested that as “income tax increases for low-to-middle earners seem a political non-starter”, this would most likely come in the form of indirect taxation – such as VAT.

By Shané Schutte