Look forward to painful tax increases

Which taxes are set to go up? Cliff D'Arcy investigates.

Is it possible to spend more than you earn, constantly, without getting into financial trouble? I certainly had a good go at trying this during the Nineties. By living well beyond my means, I ended up £50,000 in debt, and even considered bankruptcy.

Today, I'm a staunch saver and investor, not a borrower, but it took years of painful adjustment to turn around my finances. Sadly, it seems that our government is in a similar boat. That's because the government is spending £4 for every £3 it collects in taxes. That's not unlike someone taking home £15,000 a year while spending £20,000. Quite simply, it's a recipe for long-term ruin.

Going for broke

Thus, unless the government tightens its belt, it is doomed to borrow hundreds of billions more in order to cover its spending gap. In fact, in the first five months of this financial year (from March to August), the government spent £65 billion (2008/09: £26 billion) more than it collected in taxes. For 2009/10 as a whole, the government expects this shortfall to rise to £175 billion (2008/09: £90 billion), although economists reckon £200 billion to be the eventual outcome.

To put this colossal figure into context, £200 billion works out at £8,000 for each of the UK's 25 million households, or £4,167 for each of the UK's 48 million adults. However, this is just one year's shortfall; we also have our national debt to worry about. This exploded to £805 billion at the end of August, from £633 billion a year earlier. This burden adds a further £32,200 per household to our financial headache - plus interest, of course.

Taxes up; spending down

Facing its worst fiscal problems since the Second World War, Britain is in deep trouble. Yet, while Cabinet members and opposition leaders trade punches by urging ever-deeper spending cuts, MPs are terrified to talk tough on taxes. After all, Labour and the Conservatives are fighting to win an election to be called by June 2010, so they don't want to frighten us with a dose of harsh reality.

Nevertheless, the simple truth is that public-spending cuts must be accompanied by tax rises if the national finances are to be returned to an even keel. Indeed, if HM Treasury doesn't come up with realistic plans to balance our budget within a few years, the UK could suffer an embarrassing downgrade in our credit rating from its current rock-solid AAA-rating.

Now let's take a look at where the government gets its tax revenues:

The 12 top taxes

In 2008/09, the Institute for Fiscal Studies (IFS) estimates government taxes totalled £516.6 billion, or £10,300 per adult. The following 12 taxes account for almost all tax revenues:

Source: Institute for Fiscal Studies

As you can see, the top four taxes -- income tax, National Insurance contributions (NICs), value added tax (VAT) and corporation tax - contribute £381.9 billion, or almost three-quarters (73.9%) of the total. The next four biggest earners - fuel duties, council tax, business rates and alcohol duties - contribute £81.7 billion; a further 15.8%. The last four taxes add £27.2 billion, or 5.3% more.

The bitter truth

Even if we were to lift 'sin taxes' - fuel duty, alcohol and tobacco duties - by half (50%), this would raise only an extra £21 billion, which hardly covers a tenth of the gap in our national spending. From the table above, it's absolutely clear where tax rises have to come: from the 'Big Four' of income tax, NICs, VAT and corporation tax. Anything else simply adds more red tape and fiddles around the fringes of the problem.

So, if your Member of Parliament and his party promise not to raise headline taxes, don't believe a word. Without action to tackle our deficit spending and national debt, the UK's national overdraft could soon exceed £1 trillion, or seven-tenths (70%) of our national output of around £1.4 trillion a year.

Finally, one paradox could thwart our efforts to increase tax revenues. Raising personal, corporate and consumption taxes from their current levels could have the opposite effect of what is intended. Indeed, higher taxes could lead to more business failures, higher unemployment and lower consumer spending. Combined, these knock-on effects could depress - instead of raise - tax revenues. Clearly, balancing the UK's budget is on par with squaring the circle!

More: Ten tips for smarter saving | The 21 worst Cash ISAs