Tax reform should focus on growing GDP, not extracting revenue from it

Rory Meakin, research fellow of the TaxPayers' Alliance


The Resolution Foundation published Unhealthy finances yesterday, a report which highlights the fiscal damage being wreaked by coronavirus and makes the case for an austerity package to fall largely on taxpayers in middle Britain. Significant effort has clearly been put into it, and among its 149 pages there is plenty of reasonable analysis and even a handful of policy proposals which have the potential to be beneficial if implemented wisely. But the report’s greatest achievement is that, from a left wing perspective, it starkly sets out the case that ordinary taxpayers will have to swallow painful tax rises if the public sector is to be immune from identifying and removing meaningful amounts of wasteful spending amidst the trillion pound annual total.


The £40 billion of fiscal tightening it identifies as necessary for balancing the books after the pandemic will mean a wide-ranging package of hikes to income tax, corporation tax, inheritance tax, capital gains tax and more. This austerity, of course, is unavoidable and must come in the form of either taxpayer austerity or public sector savings. Unlike Jeremy Corbyn’s election manifesto, there is no dishonest pretence that the burden can be borne by the richest 5 per cent alone.


Sensibly, the authors also warn against tax rises before 2023, the earliest point when they believe that the economy might be able to withstand them. Sadly, the often reasonable economic analysis (of both the short-term macroeconomic prognosis and microeconomic tax distortions) is frequently undercut by erratically mismatched political caution and an overriding objective of expanding the extent of redistribution across the income scale. How redistributive, or progressive, a policy is an important consideration but it is not the only one and when it becomes the overriding concern problems arise.


Most prominently, fiscal multiplier estimates from the OBR and the CBO are relied on to dismiss the evidence from economics that austerity is more likely to be harmful when implemented in the form of tax rises than spending moderation, which merits only a breezy reference to “wide ranging views among economists” with a footnote. In fact, because tax weakens economic incentives and government spending is often wasteful, tax rises are generally much more harmful economically, particularly in the long run. That explains why Alesina et al, for example, found that “government spending cuts and cuts in transfers are much less harmful than tax hikes”, while Molnár found “spending-driven adjustments vis-à-vis revenue-driven ones are more likely to stabilise debt”.


Similar analytical problems also affect analysis at a ‘lower’ level. For example, it rightly notes that business leaders “focus less on the headline rate of corporation tax than some politicians of both main parties have historically done, instead focusing on their overall tax bills”. But instead of noting the UK’s much less attractive effective corporate tax ranking due to very low relief levels (which balance our relatively low headline rate) it simply goes on to note “the UK now has a headline CT rate notably below the global, OECD or EU averages” which they say provides “headroom for a rise”.


Another example is how it presents its rise in tax historically. The proposal to extract 1.6 per cent of GDP in additional taxation would mean “the tax-to-GDP ratio would rise to over 39 per cent, its highest level since 1983-84”. Not quite. That figure is probably the current receipts-to-GDP ratio, which includes non-tax receipts such as nationalised industry profits, which were higher in the 1980s than now. TaxPayers’ Alliance research has shown that the tax-to-GDP ratio, the tax burden, was already at a 50-year high last year. In fact, adding 1.6 per cent to the tax burden would take it to its highest level since 1950, when the country was demilitarising after the end of the second world war.


Most of the policy proposals are bad but relatively normal, such as raising corporation tax, discussed above, and income tax or freezing thresholds. A handful of others have some merit and could be wise if the revenues were balanced out with other tax cuts, such as the capital gains tax ‘death uplift’ rule. But there are a couple of alarmingly ill-considered proposals, too, namely a ‘pandemic profits levy’ on companies that have helped the country deal with the pandemic and ‘home delivery congestion charge’.


Levying a special tax on companies such as supermarkets and personal protective equipment (PPE) suppliers is precisely the opposite of what a government should do if it wants firms to respond to changing conditions during a pandemic. The last thing we want is for marginal decisions to supply things like PPE (or anything else to help cope with an emergency) to be discouraged by a government’s reputation for imposing retrospective taxes after the event.


Similarly, there may be situations where, for instance, a supermarket offering home deliveries may simply be displacing trips by customers on foot or public transport, perhaps on the way home from work. In these situations, the tax might prompt some customers to return to shopping in person at the physical premises. But most workers commute to work by car and it is car trips that are most likely to be displaced by delivery vans, which plan their trips much more effectively than the cumulative effect of all the customers driving individually to the shop. It might raise a trivial sum at the cost of making shopping more expensive but how likely is it really to reduce congestion?


Congestion is also the focus of one of the report’s odd mix of reasonable economic analysis of distortions undercut by politics. It correctly explains how motoring taxes of vehicle excise duty and fuel duty do little to address noise and congestion externalities of driving and would be much better handled by road pricing. But instead of proposing a smart system of road pricing to replace those blunt instruments, it just recommends raising them again.


Given, too, that the report rightly acknowledged the substantial role economic growth has played restoring fiscal damage from previous recessions, any report on tax after the pandemic should be focussed on what reforms, including cuts, can provide in sharpening incentives and enhancing productivity growth. It’s a shame that was dismissed so lightly.

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