Even before the mini-budget calamity, the UK tax system was unstable and unsustainable
The perfect mini-budget storm, where surprise uncosted fiscal promises and an indefinite set of energy prices met market instability and rising interest rates, led to a complete overhaul of the government’s fiscal approach. Rather than aiming for growth with lower taxes, Jeremy Hunt is now focused on getting the most goose feathers with the fewest whistles – easier said than done, given that his budget plan medium term could involve £35bn tax increases and spending cuts.
But is the reversal of the planned rise in corporation tax and the removal of the planned reduction in the 45 pence rate of income tax, along with various other reversals, enough to stabilize the vessel ? It’s hard enough to figure out where we are with all the double negatives floating around, but I don’t think so.
The problem is not just that the turmoil of recent weeks has driven up the cost of government borrowing, but that the UK tax system as a whole has been unsustainable and unstable for years. We hear a lot about the record tax burden – a 70-year high – and how it squeezes workers. But beyond headline rates and headline burden, the entire tax system has been pushed to the brink by years of tweaking, tinkering and twisting.
Our tax system is a huge mess of inconsistencies and incongruities. It has a very capricious series of exclusions for particular goods, some industries are taxed all the way while others are heavily subsidized, and investment is treated as something to be penalized rather than encouraged.
Our personal tax system is filled with precipices, where every extra pound gained has an outsized effect on the personal tax burden. It also has far too many loopholes that are easily exploited by the wealthiest in society while working people lose out. It is not keeping pace with changing economic conditions, which means taxes are effectively rising as inflation bites and wages stagnate.
Fundamentally, the system is too complex to fulfill what should be its primary purpose: raising funds for public services with the least economic damage. Instead of considering the dynamic effects of taxation – the overall impact on the economy of raising or lowering particular tax rates – the Treasury considers only static costs and benefits. By focusing only on the obvious and ignoring how taxes change our behavior, we have created a system that is quickly wrung out.
Take income tax. If we were to increase the basic rate of income tax by 2 pence, that would increase around £10 billion. But, given the disproportionate strain this would have on the working population, would it really be £10 billion more for the Exchequer? One might suggest that, given the pressure the middle classes are facing, raising their taxes would only result in even more needed social transfers down the road. Thus, in the case of income tax, as is the case with other taxes, to increase the big numbers without considering the economic effects as a whole is the wrong approach.
A tax system should be simple, clear and cause few distortions. It should be based on raising revenue to fund public services, not what is popular or what makes people feel good. It must be stable and durable, making sure not to kill the golden goose.
One of Liz Truss’ most welcome commitments during the leadership election was a comprehensive review of the tax system as a whole. Hopefully this will be taken up by his successor as a priority to sort through all this mess. The last comprehensive review – the Mirrlees review – was undertaken by the IFS in 2010, following another financial crisis. It seems clear that, especially since many recommendations of the Mirrlees review have not been adopted, we expect a follow-up; Tax review 2: electric boogaloo.
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The columns are the author’s own opinion and do not necessarily reflect the views of CapX.