By: Rory Meakin, research fellow at the TaxPayers' Alliance
The more time spent analysing potential tweaks and improvements to the existing tax system, the more it becomes apparent that the UK desperately needs something more substantial than fiddling at the margins.
Tax itself is, per se, economically damaging. It inserts a wedge between the payment a buyer makes (either as a consumer buying goods from a retailer or as an employer buying labour from a worker) and the money a supplier receives. That wedge makes many transactions not worth engaging in. Those involved find other things to do with their resources, and inevitably less productive things at best and nothing at all at worst.
Some householders might repair a fault themselves rather than engage a professional. A business might not take on more custom and hire more staff or invest in plant and machinery. An employee might not take a training course or higher level of professional qualification. Tax won’t affect many such decisions like these but for some of them it will.
Few would argue that efficiently-run, good public services can provide value for money when costs are kept under control. But ‘tax wedge’ still disrupts economically valuable transactions, even when some level of public services spending is worth the tax necessary to pay for it. Beyond the inescapable damage of tax wedge, though, the tax system suffers from a suite of inter-related deficiencies.
It is phenomenally complicated, having expanded to tens of thousands of pages in length over the last few decades. This diverts valuable highly-skilled human capital away from productive use into zero-sum tax compliance jobs. It is highly distortionary, levying different rates of tax on the same products or income. Is a chocolate bar marketed for consumption or for cooking? Are earnings paid through standard employment, through self-employment or through a company dividend? And it is especially hostile to savings and investment. An improvement to business premises, for example, will not only attract higher taxes on the profits if it is successful but will be liable to higher business rates, regardless.
All of these problems, however, are as bad as they are because the system attempts to extract so much cash out of the economy. It is no coincidence that the tax burden is at 70-year high at the same time. When VAT is at 20 per cent, the divide between vatable and exempt products is that bit more distortionary than when the rate is 17.5 per cent, or 15 per cent. Relatedly, it was in the aftermath of the great financial crisis of 2007-2008 that a new top rate of income tax was introduced, raising the rate from 40 to 50 per cent. Since reduced to 45 per cent, its extent has also crept down the income scale. Initially only the top 236,000 earners paid it but this year an estimated 860,000 will, expanding to the top 1.1 million in 2027-28. A government with a tighter control of its purse strings would not need to create new complexities and distortions, or even maintain existing ones, in an attempt to manage its deficits.
That is the ‘elephant in the room’ that the new report by the Resolution Foundation, Tax planning, barely mentions. Instead, it assumes that “taxes are not only higher than they were; they are likely to stay that way” and proposes “pragmatic” adjustments to some rates and rules to make the system less distortionary and more neutral in a way that the authors believe to be politically realistic. For example, it describes stamp duty land tax as “a bad tax” but rather than recommending abolition it suggests halving the rates. Similarly, it identifies the problem of road congestion and the opportunity for road pricing to solve it but instead of taking advantage of that to offer motorists a substantially simpler system, sweeping away fuel duty, vehicle excise duty, workplace parking levies and congestion charges, it proposes a parallel system only for electric vehicles on top of the existing charges.
Revenue raising is behind many of the compromises which weaken the proposals. Another paper in the series advocates ‘pay per mile’ charging for electric vehicles so that taxation for driving them is put “on a clear parity with fuel duty” because “an annual shortfall of £10 billion is expected by the early 2030s”. Coupled, they say, “with locally-determined Congestion Charges which have the benefit of not needing expensive infrastructure” while extending “this approach to fossil fuelled vehicles that are technologically ready for per-mile charges, as they still cause congestion” is “likely to be more acceptable than a national congestion charging system”. It is not clear why the authors think that shifting the burden of motoring taxation from rural Britain and towns to London and congested cities will be more unpopular.
If anything, the opposite is likely to be true: an approach to road pricing which is founded on revenue-raising rather than congestion-fixing will leave drivers feeling that they’re being used as cash cows and does not offer them the benefits of freer-flowing traffic, except perhaps later at additional expense in a series of further charges. Many drivers would accept being charged more for driving in places and times where it’s busy in exchange for less waiting in traffic jams. But it should also be cheaper than it is now outside those times and places. As we argued in Long term challenges for the tax system, “credible guarantees that most drivers would pay either the same or less than they do now in tax are an important foundation of that support”.
Likewise, they identify the debt bias and the bias against investment in corporation tax. They propose fixes for these in the form of permanent ‘full expensing’ with broader definitions of allowable expenses and reducing the limit on debt financing, partly as means to “offset” the “cost”. They probably comprise a beneficial pair of reforms, on balance, but they lack the transformational simplicity of the root-and-branch Single Income Tax proposals of the TaxPayers’ Alliance 2020 Tax Commission. Not only would a Single Income Tax address the debt-equity bias, it would do so entirely and also eliminate the incumbency bias and distortions relating to the timing or allocation of income within households.
Other proposals largely followed this pattern: trimming the employer national insurance rates while lowering the VAT registration threshold, or cutting inheritance tax but by introducing new bands and rates (rather than just raising the existing threshold or cutting the existing rate) with a tightening of reliefs, for example. Mostly good, but only just about and on balance. Ultimately, however, in setting their remit as being resigned to permanent spending profligacy and burdensome tax levels, perhaps it is no wonder nor even their fault.