Tax freedom day to be dragged back by crippling debt

Is inflation the only hope for the next Government?

Each taxpayer would have to give every penny earned to the Government until 25th June to cover the current levels of state spending, according to the Adam Smith Institute*. This begs the question: could increased inflation help the next Government reduce its debt in future years.

Ignoring the Government’s fiscal deficit, “Tax Freedom Day” (the date on which an average UK resident would stop working to pay their share of the nation’s tax bill and start to earn money for their own benefit) actually fell on 14th May this year, compared to 1st June in 2007, as the actual amount of tax collected during the recession has nosedived.  However, it is inevitable that this will fall much later in the coming years due to the escalating Government deficit, which hit a record level of £175bn this year - the budget deficit for May 2009 alone was £17.5 billion**.

The total national accumulated debt currently stands at over £774bn, so it could be argued that, in broad terms, each rise of 1 per cent in inflation would effectively reduce the real cost of this debt by about £8bn.  Bearing in mind that the cost of servicing government debt is currently £30bn in interest payments each year, there may be a seductive political argument that higher inflation offers an alternative to reducing levels of spending and/or increased taxation.

Stephen Herring, Senior Tax Partner at BDO, said:

“The poor figures for public finances last month emphasise this will be a tough conundrum for the next Government; on the one had, it is tempting to consider that rising inflation reduces the real level of the national debt. On the other hand, one must not lose sight of the need to keep inflation at reasonable levels to ensure that savings and earnings do not lose their value, especially for those on fixed pensions.

“There are many ways that the national debt can be reduced but none are pain free. Inflation is one of the more alluring but fundamentally dangerous tools. It would be wishful thinking to assume that this provides a risk free alternative to tough choices on Government spending and taxation policy. 

“As well as the current debate between the politicians about public spending, we now need a parallel debate about whether the necessary tax increases will fall upon businesses, individual taxpayers or the consumer.”

-Ends-

*The Adam Smith Institute; Calculation of “Tax Freedom Day” for 2009
**Office for National Statistics; Statistical Bulletin May 2009

For more information, please contact Matthew Longbottom at BDO on 020 7893 2717 or email matthew.longbottom@bdo.co.uk

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