The best medicine for the Covid economy? Tax reform
In last week’s Spending Review, the scale of the economic challenge facing Britain was made unequivocally clear: the worst drop in GDP for centuries, unprecedented peacetime borrowing, and lasting scarring effects on productivity and the labour market.
The chancellor is keen to stress that these problems will require a concerted response in the years ahead. Fiscal consolidation, including some tax rises, will undoubtedly be needed at some point.
That time is not now. While the economy is still recovering from the hammer blow of the pandemic, it is far too early to be implementing tax rises.
But when that time does come, we will need a tax system that can cope with the scale of the challenge effectively, supporting fiscal consolidation and structural reform in the wake of coronavirus. And that’s something the government should be thinking about right now.
Edward Troup, the previous Treasury director general, recently wrote in the Tax Journal that tax reform “will be delivered only if there is agreement on what change should happen; a plan on how to deliver it; affordable reform, with strong political support and widespread public acceptance of the need for change.”
It is fair to say that we are currently nowhere near achieving any of these five tests, save perhaps acceptance of the need for taxes to rise, eventually.
With around £40bn of extra tax revenue needed, according to the Resolution Foundation, the tough questions that so many chancellors have ducked over the years will become difficult, if not impossible, to put off any further. Calls to target the super-rich or multinational corporates may play well politically, but they will be insufficient: to raise revenue on this scale there will have to be broad-based tax rises that affect many, if not most, in society.
This Conservative government has just broken its manifesto commitment to spend 0.7 per cent of national income on international aid. Some have wondered whether this U-turn might set the stage to break the commitment not to raise the “big three” taxes — income tax, national insurance and VAT — which between them provide around 60 per cent of tax revenue.
But to focus on revenue alone would be a missed opportunity. What our tax system most desperately needs is reform.
For while the government will need to raise revenue, it should also use that process as an opportunity to fix many of the structural problems of our outdated, byzantine tax system. Everywhere in the tax system there are needless distortions affecting decisions on how and when to take income, or where to invest.
There is a clear economic case for narrowing the tax treatment of different forms of income, for example. Removing the discrepancies in the NICs that employees and the self-employed pay would iron out perverse incentives for companies to move workers off payroll and, as the Institute for Fiscal Studies has argued, better reflect the small differences in state benefit entitlements enjoyed by the two groups.
Meanwhile, reform of capital gains tax has the potential to reduce tax arbitrage and burdensome administration on the part of HMRC. Given how lightly capital gains are taxed relative to income from labour, there is a clear incentive to repackage income from labour as capital gains.
Indeed, the line between labour and capital income is often very blurry, as carried interest and employee share schemes illustrate. It is not just “tax the rich” campaigners who are raising this issue — the Office for Tax Simplification and indeed the former Conservative chancellor Nigel Lawson have both argued for more closely aligned rates.
Sunak will be painfully aware that many of these crucial fixes are risky: one need only look at the fate of Philip Hammond’s NIC reforms, the turbulent history of capital gains tax rates, or episodes such as George Osborne’s “pasty tax” debacle to appreciate that many substantial reforms of the tax system face even more substantial political barriers.
Yet it would be foolish to imagine that the politics of tax reform will get any easier as time goes by and the need for major reform increases. Given the scale of the fiscal consolidation that will eventually have to happen, efforts must start now to outline a clear vision for where tax policy is going and to make the case for controversial, yet economically sensible, reforms.
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