20 February 2013

With one month to go until the Budget, IFS and the Institute for Government are holding a joint event on how tax policy might be better made. In this observation, Paul Johnson, IFS director, reflects on why we still have a long way to go in designing a more coherent tax system and why the current policymaking process may be partly to blame.

"Taxes, like death, are unavoidable. But we can design our taxes. We are not bound to have a tax system as inefficient, complex, and unfair as our current one. To improve things, we need to see the system as a whole. We need to design the system with a clear understanding of the population and economy on which it operates, and we need to apply economic insights and evidence to the design. We also need a much more informed public debate and a much better set of political processes than the ones we currently have."

So my co-authors and I said in the introduction to the Mirrlees Review published in 2011. The question is: what is it that prevents better decision-making and the creation of a better system? That is an issue discussed in the latest IFS Briefing Note.

It’s not the lack of importance. Four pounds in every ten generated in the economy is collected in tax. The way the tax system is designed inevitably has a huge effect on the operation of the economy. That is inescapable. By designing the system better, there are really substantial economic benefits to be reaped. As we showed in the Mirrlees Review, the costs of a poorly designed tax system run into many billions of pounds in reduced output and welfare. In that review, we also set out one possible strategy for unlocking some of these benefits, a strategy based on treating the tax system as just that, a system, and recognising that there are often substantial costs associated with treating similar activities differently.

And it’s not that there haven’t been some attempts to improve the process of tax policymaking. The current government has attempted to produce a more coherent structure for developing tax proposals, from policy formulation through to legislation and implementation. This new approach to tax policymaking is backed up by the Tax Professionals Forum. There is also the innovation of the Office of Tax Simplification.

Nor is it a want of consultation. The amount of consultation in the current policymaking process is almost overwhelming.

But there do seem to be three very substantial barriers to better policy.

First, tax policy is made annually (or increasingly biannually) in Budgets (and Autumn Statements). No government or opposition lays down a strategy for the tax system as a whole. There is every indication that policies are made in isolation, and with little sense of how they fit together over the long run. While there is much consultation, most of the effort is put into tinkering with the existing system to try to make the bits that don’t work well work a bit better without necessarily thinking more fundamentally about why the bits in question are not working well, or continue to give rise to ‘avoidance’ issues. There is little attention paid to any form of long-term strategic framework for the development of the tax system as a whole.

Second, there is a remarkable lack of challenge within the executive and effective scrutiny and challenge from the legislature. The Treasury challenges spending departments. Who is to challenge the Treasury when it makes tax policy? The enhanced role of HM Treasury, in the wake of the O’Donnell Review may at times have limited the challenge that comes from HM Revenue and Customs. While the Treasury Select Committee and the Public Accounts Committee have increased their oversight of tax policy, they remain poorly resourced for focusing on such a large and complex issue.

Third, the general quality of political and public debate is limited, allowing poor policy to be passed off as good all too easily, resulting in an unhelpful focus on specific parts of the tax system, and often making change politically difficult. Very specific elements of the system – notably rates of income tax – achieve totemic significance far beyond their true importance, while changes to other parts of the system are often given wholly inadequate attention.

Tax policy is inevitably a difficult and highly political area. But there are things that can be done to improve the process for making policy.

There should be a tax strategy and objectives set out by each Chancellor against which policy proposals can be measured. This would increase transparency and accountability and, if followed, would also increase stability and certainty.

More challenge and scrutiny should be introduced into the policymaking process both within the executive and by the legislature. If necessary, parliament should be given greater resources, the House of Lords should play a greater role, and consideration should be given to creating a specific select committee devoted to tax policy.

We need an explicit process for reviewing the effectiveness of tax policy post implementation.

There is a case for at least a public review of the working of the relationship between HM Treasury and HMRC.

The Autumn Statement should be more explicitly focused on consultation on fiscal policy and the presentation of the latest economic and fiscal forecasts. It should not be an additional opportunity for Chancellors to pull rabbits from hats.

There is an urgent need for an improvement in the public debate about tax policy.

And of course we need politicians willing to be honest in their communication, open and long term in their thinking, analytical in their approach and courageous in their decisions. National welfare really is reduced by billions of pounds because we have a tax system that is not well designed. Finding ways to improve the policy development process should be a matter of priority for all political parties.

We need to see taxes as part of a system rather than individually, we need a strategy against which to judge proposals, and we need more transparency and more challenge and accountability in the tax policymaking process.

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