The final two runners in the race to be the next prime minister are in an arms race over tax cuts in an effort to convince Conservative party members they are the right candidate for the job.
The Institute for Fiscal Studies looked at plans set out so far by Rishi Sunak and Liz Truss as the battle to become the UK’s next prime minister heats up.
Permanent changes to personal taxes — reversing the NICs rise
Sunak has not announced any specific intention to deviate from the current plans of freezing income tax and national insurance contributions (NICs) thresholds for a further three years — in what the IFS calls a tax rise. Current plans also aim to reduce the basic rate of income tax by one penny in the pound in 2024-25.
Truss, however, has stated that she would reverse the increase in NICs rates, at a cost of £13bn per year. The IFS said this would boost incomes across the board, but would benefit higher-income households who have the most income from employment the most.
Sunak’s apparent plan to stay on course was labelled “progressive” by the IFS, though they amount to a takeaway across the board as the high-inflation environment means that the freezing of income tax and NICs thresholds is a much bigger tax rise than originally intended.
Truss has also indicated an interest in further tax cuts, promising to “review taxation of families to ensure people aren't penalised for taking time out to care for children/elderly relatives”.
The IFS said that “perhaps” that might happen by making the income tax personal allowance — rather than just 10% of it, as it currently stands —transferable between members of couples.
Sunak said he would also cut taxes, but only once inflation has been brought under control — a matter of “when, not if”, he claimed, dismissing tax cutting pledges by opponents as nothing more than “fairy tales”.
Additional temporary support — a moratorium on green energy levies
To provide further immediate support, Truss has said she would have a "temporary moratorium on the green energy levy".
According to Ofgem, a combination of various levies increased energy bills for a household with typical energy consumption by £153 per year — though that figure will change over time as well as varying with household energy consumption.
Truss has not specified when the temporary moratorium would begin and end or which levies on energy bills would be suspended
The chart above assumes that the moratorium reduces average annual bills by £153, ignoring any other effects, and shows the average gain for households in different income groups.
Business taxation — cancelling the corporation tax rise
The March 2021 Budget announced an increase in the main rate of corporation tax, from 19% to 25%, from April 2023, for companies making annual profits in excess of £250,000.
Sunak wants to go ahead with that increase while Truss proposes to cancel it.
The UK currently has one of the lowest headline rates of corporation tax in the developed world. IFS analysis shows that increasing it to 25% would leave the UK’s rate slightly above the OECD average, though still the lowest in the G7.
Cancelling the increase would cost £17bn a year, according to government estimates.
However, this estimate doesn’t allow for corporation tax to affect investment. As Truss points out, a lower tax rate would strengthen incentives to invest in the UK and thereby promote economic growth, helping to recoup some of the initial cost of the tax cut.
“We would therefore expect the long-run cost to be considerably lower than £17bn a year,” the IFS said in its analysis.
Sunak argues that cuts in the headline rate of corporation tax have had only a limited effect on investment, and that it would be more effective to target incentives for investment more directly.
As chancellor he invited views on a range of possible ways to increase investment allowances and suggested that he intended to announce some such increase in the autumn Budget, to take effect next April.
The candidates have been more muted about their intentions for public spending.
Whoever is in office in the autumn will have to make a choice between topping up spending plans to shore up public services, or requiring any additional costs to be met from within existing budgets.
The former would eat into the fiscal headroom available for tax cuts; the latter would mean a deterioration in the quality of public service provision.
“Truss has promised to hold a new spending review, but it is possible that such an exercise could lead to lower, rather than higher, departmental budgets. She is, after all, promising more than £30bn per year of tax cuts,” the IFS said.
The Office for Budget Responsibility estimated that the government was on track to meet both of these self-imposed fiscal targets with around £30bn to spare.
This does not mean that a new prime minister and chancellor would automatically have £30bn of "headroom" within those rules for tax cuts.
“It is a projection around which there is a huge amount of uncertainty,” the IFS warned.
The think tank said Truss’ package of tax cuts would cost more than £30bn — possibly considerably more, depending on how exactly she proposes to cut green levies and on the costs of other policies that she proposes to examine or that have not been spelt out fully.
Without counteracting measures this would likely result in the current fiscal rules being broken, with day-to-day spending still exceeding tax revenues at the end of this parliament and with national debt still rising as a proportion of national income.
This suggests that Truss would be likely either to make cuts to overall spending plans or to change the fiscal rules.
"When it comes to tax and spend, Rishi Sunak is proposing nothing beyond current government policy in the short term — unsurprisingly, given that he set these policies as chancellor. We therefore know a lot about what we would get under his premiership, at least initially, without his having to say much,” Robert Joyce, deputy director of the IFS, said.
“We would have tax heading towards its highest sustained level in 70 years as a share of national income, though with an intention to bring taxes down once he has ‘gripped inflation’,” he added.
“Liz Truss is proposing something quite different from Sunak, with tax cuts worth more than £30bn per year — and possibly considerably more — relative to current plans.
“This certainly represents a genuine choice for those who will elect the next prime minister. But those pledges will have implications beyond the tax system, and these remain unclear,” he warned.
On 5 September one of the two will be announced as the next Conservative party leader and therefore prime minister.
“As the two-horse race ensues the contest would benefit from having a clearer idea of how their broad approaches to spending and management of the public finances, as well as tax, compare,” Joyce said.