Conor Nakkan, IF researcher, investigates the announcements and issues with the current tax system.
Unearned vs earned income
The UK tax system has historically favoured unearned income over earned income. In practice, this means that individuals who generate income from work often face higher effective tax rates than those who derive income from unearned sources such as: dividends, rent, and capital gains. For example, under the current system, an older person with £60,000 in income from capital gains or dividends pays less tax than someone (under 65 years) earning £35,000 through employment. This disparity undermines equity and encourages high earners to reclassify income in order to take advantage of lower rates on unearned income.
The old own assets
This preferential treatment is compounded by asset ownership patterns. In the UK, assets generating unearned income are predominantly owned by older generations. According to the Office for National Statistics (ONS), the median wealth of individuals in their early 60s is nearly nine times that of those in their early 30s. This gap is largely due to decades of property ownership, savings, and pension growth. In contrast, younger generations face rising living costs, stagnant real wages, and housing affordability issues. As previous IF research has demonstrated, these factors are making it harder for younger people to save or enter the property market, limiting their ability to benefit from the tax advantages associated with asset ownership
Ageing population
Additionally, demographic changes will place increasing pressure on the UK’s public finances. With an ageing population, the fiscal demands on pensions, healthcare, and social care will rise significantly over the coming decades. The Office for Budget Responsibility (OBR) projects that healthcare spending alone could grow from 7.9 per cent of GDP in 2023–24 to 14.5 per cent by 2073–74, largely due to age-related expenditures. Without reforms, younger and future workers may face a growing tax burden as government debt continues to expand. The current UK tax system is ill-prepared for these demographic and fiscal challenges.
A closer look at the Budget
In light of these issues, it is worth asking: do the tax measures in the Government’s Autumn Budget address these issues and improve intergenerational fairness, or do they preserve the unsustainable status quo? The answer, in short, is mixed.
Capital Gains Tax
On the positive side, the increases to Capital Gains Tax (CGT) represent a modest move towards balancing the scales. From 30 October 2024, the lower rate of CGT will rise from 10 per cent to 18 per cent, and the higher rate from 20 per cent to 24 per cent. While these CGT rates remain lower than those on earned income, the increase represents a welcome step in aligning the tax treatment of earned and unearned income. Coupled with the increased rates on business asset disposal relief (BADR) and investors’ relief (IR), the OBR estimates these CGT changes will generate £2.5 billion by 2029–30.
Inheritance Tax
Tweaks to inheritance tax (IHT) also generate additional revenue and address some of the more problematic aspects of the current IHT regime. In addition to extending the freeze on the current IHT threshold for a further two years to April 2030, the Government will now apply IHT to all pension wealth that is transferrable at death. This is a much-needed policy change. Pensions were designed to support ageing costs and a dignified retirement, not act as a tax-favoured vehicle for wealth accumulation and transfer. Along with a £1 million cap on assets claimed under agricultural property relief (APR) and business property relief (BPR), these IHT changes are expected to raise £2.3 billion by 2029–30.
Employers’ National Insurance Contributions
By far the largest tax measure in the Budget is the change to employers’ National Insurance Contributions (NICs). From April 2025, the government will:
- Increase the employer NICs rate from 13.8 per cent to 15 per cent.
- Lower the secondary threshold (at which NICs are applied) from £9,100 to £5,000.
- Double the employment allowance from £5,000 to £10,500.
- Remove the employment allowance threshold, allowing all eligible employers to claim it, not just those with liabilities below £100,000.
The OBR estimates these changes will raise £25.7 billion by 2029–30 before accounting for behavioural impacts. But once indirect and behavioural effects (such as changes in labour supply and nominal and real wages) are accounted for, this reduces to £16.1 billion in 2029-30. The difference between these two figures highlights some of our main concerns with this policy. Namely, that firms will likely pass on most of their higher tax costs to employees and consumers via lower wages and higher prices. Moreover, in response to lower wages and higher employer costs, labour supply and demand is also expected to decrease. Taken together, these indirect effects may disproportionately impact lower-paid and younger workers. Therefore, while the changes to employer NICs raise vital additional revenue, when viewed through the lens of intergenerational fairness, they might not be in the best interests of young people.
Consider the fiscal big picture
It is also worth stepping back to consider the bigger fiscal picture and the Government’s broader rationale for increasing taxes in the ways it did.
The Budget’s tax measures are expected to raise an additional £36 billion per year, pushing the tax-to-GDP ratio to a historic high of 38 per cent by 2029–30. However, these tax increases only cover around half of the £70 billion increase in spending, with the remainder to be covered by borrowing. According to the OBR, the net effect of the Budget’s policies will increase Government borrowing by £19.6 billion this year and by an average of £32.3 billion over the next five years. While some of this borrowing may be necessary to invest in struggling public services and infrastructure, the debt burden will ultimately fall on younger and future generations if this investment fails to stimulate the desired economic growth.
In justifying these tax measures, Rachel Reeves implicitly focused on two main tax policy principles: revenue adequacy; and equity. Throughout her speech, Ms Reeves repeatedly emphasised that the Government’s tax measures were necessary to “raise the revenues required to fund our public services” and to “restore economic stability.” At the same time, Ms Reeves went to great lengths to reassure the public that the Government would not be increasing taxes on “working people”. However, other important tax policy principles, such as efficiency, simplicity, and neutrality were much less prominent.
This framing might, on the one hand, tell us something about how the Government is likely to think about tax policy over the next five years. Arguments for further tax reforms may be more influential if they are framed in terms of generating additional revenue for public services without burdening low- and middle-income taxpayers. On the other hand, this does not mean that we should lose sight of the importance of advocating for tax reforms that enhance efficiency, reduce complexity, and improve neutrality.
Looking ahead
While the recent Budget takes some modest steps towards addressing some of the issues with the UK tax system, more extensive reforms are needed to achieve intergenerational fairness and fiscal sustainability. To tackle these challenges effectively, the UK requires more comprehensive tax reform that moves beyond incremental adjustments. The Intergenerational Foundation (IF) has long advocated for an overhaul to create a more progressive and efficient tax system that meets the demands of the future.
A key component of such reform would involve equalising the taxation of all income types under a unified Income Tax schedule, ensuring earned and unearned income are treated consistently. This approach would simplify the system, reduce opportunities for tax avoidance, and mitigate the current preference for unearned income. It could also generate substantial additional revenue, reducing the debt burden for future generations. Moreover, to further address regressivity and reduce complexity, National Insurance Contributions (NICs) should be abolished, with their rates also consolidated into a unified Income Tax schedule.
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Image: Thanks to HM Treasury