Rishi Sunak’s budget should start laying the groundwork for tax reform

Could tax rises form part of Rishi Sunak’s budget on 3 March? While the middle of a major recession is not the right time, the longer-term economic damage wrought by the coronavirus, alongside demographic trends, mean higher taxes may well be required soon.

Governments have historically found major tax reforms difficult to achieve, but the chancellor is more likely to succeed if he makes the case early to get the public onside and build political support. His budget is the right place to start.  

Tax rises are not needed now but likely will be at some point

Almost all economists agree: now is not the time for fiscal retrenchment through tax rises or spending cuts. Economic activity is currently constrained by public health restrictions. It is impossible to predict the effect of lifting these restrictions, and it would be very risky to increase taxes before the recovery is secured. This is especially true because low interest rates mean the government can borrow so cheaply right now.

When the economic recovery has been secured, however, tax rises are likely to be on the agenda. The Office for Budget Responsibility expects the economy to be smaller as a result of the coronavirus crisis than it would otherwise have been. A smaller economy means lower tax revenues and, keeping spending plans unchanged, higher deficits. There is also likely to be pressure for more spending. This was true before coronavirus, as an ageing population places growing demands on health and social care. Coronavirus may mean increased spending on these public services too as services deal with covid-related backlogs and the public demands more resilient public services in future.

High deficits will not be sustainable forever. With spending cuts unlikely, tax rises seem sure to be needed eventually.

‘Good’ tax rises are difficult to implement

All taxes lead to some type of economic distortion, for example by discouraging some economic activity. However, some tax systems are better designed than others, meaning they can raise the same amount of money and achieve the same amount of redistribution with a lower economic cost. An IfG report, Taxing Times set out the many ways in which the UK tax system is currently poorly designed – for example, by taxing income earned through self-employment much less than income earned by employees.

There are ways to raise taxes in a way that reduces distortions – for example by reducing the gap between self-employed and employee taxes. Improving the structure of the tax system can mitigate or avoid the economic damage (and greater discouragement of economic activity) that would otherwise arise when raising the tax burden. Despite this, structural tax reforms have proved difficult to implement in the UK. In the wake of the financial crisis, taxes were raised mainly by increasing the rates of VAT and National Insurance Contributions. And when then-chancellor Philip Hammond attempted a modest increase in tax on the self-employed (though still leaving it at a level below employee tax rates), he met a fierce backlash from the press, the public and backbenchers and was forced to U-turn a week later.

The chancellor should ‘roll the pitch’ for necessary reforms 

While tax reform is difficult, it need not be impossible. In another IfG report, Overcoming the Barriers to Tax Reform, we identified several ways in which ministers, officials and others can contribute to successful tax reform. One recommendation was to ‘roll the pitch’ for reforms and build public support by explaining the need for tax changes and the weaknesses of the existing tax system. Some previous attempts at reform – including Hammond’s 2017 self-employed tax rise – suffered from being announced abruptly without having first won the public argument on the case for reform.

Crises can also create opportunities to build support for tax reforms that would otherwise be off the table. Leaving it too long after the crisis has passed to talk about tax rises may risk missing a rare moment when support for comprehensive reforms might be easier to come by.

While it is too soon for the chancellor to start fiscal retrenchment in this budget, it is not too soon for him to lay the groundwork for future tax changes. This means levelling with the public about the likely need for tax rises at some point, especially if he is announcing more generous spending at the same time. In the past, some former chancellors have missed the opportunity to use their budgets to make this case for reform, instead setting out spending increases while sidestepping the chance to package that with tax increases

This is not the right time to raise taxes. But Rishi Sunak has the time to identify areas of the tax system that are ripe for reform, to consult widely and to allow public debate. This should secure a more receptive audience for the chancellor when he sets out the changes he will, almost definitely, be forced to make.