Tax policy rabbits are no substitute for real reform

The Conservative Party leadership contest has generated a flurry of tax-cutting pledges. After a decade of dedication to reducing public borrowing – which has constrained explicit promises on tax cuts – a number of the candidates to succeed Theresa May are keen to suggest that there is now scope for tax cuts. This makes for good headlines but needs to be seen in the long-term context. All candidates should be clear about what objectives they hope their tax proposals will achieve – and also use the opportunity to address deeper structural problems with the tax system.

Tax cuts should be based on evidence of what works

Sajid Javid has suggested he would cut the top rate of income tax “if it brings in more revenue”. Dominic Raab has proposed cutting the basic rate of income tax to as low as 15% as a way of “defending the enterprise economy and lower- and middle-income aspirational working Britain”. Jeremy Hunt has said he would cut corporation tax to the lowest level in Europe “to send a signal to the world that we are going to be the best place to do business”.

Tax policy making is central to what government does. Without raising revenue through taxation, governments cannot deliver public services or make welfare payments. But taxes also reduce the welfare of those who pay them and can affect behaviour – for example, by encouraging employers to use self-employed contractors rather than permanent employees. It is therefore important that tax policy is well-designed.

In practice, as Institute for Government work has highlighted, tax policy is too often made in a rush, without adequate evidence or consultation, and with eye-catching ‘rabbits’ being pulled out at Budgets and party conferences – and in leadership races – to garner favourable headlines.

Whoever is ultimately elected Conservative leader should be clear about what objectives they hope their tax proposals will achieve, examine the evidence on whether this is likely to happen, and make an effort to evaluate it after implementation.

Leadership candidates should not be fooled by ‘fiscal illusions’

The leadership candidates appear to have been buoyed in their support for tax cuts by the apparently strong position of the public finances. Having peaked at nearly 10% of national income in 2009/10, annual public borrowing is now down to just over 1%, which is low by UK historical standards. Public sector net debt (PSND) has also started to fall relative to national income, for the first time in 16 years, and was projected in March to fall by 10% of GDP within five years.

But much of this projected fall in public debt reflects what the independent Office for Budget Responsibility describes as a ‘fiscal illusion’, while the fiscal watchdog’s longer-term projections point to a more challenging outlook for the public finances.

The ageing population will place growing demands on public spending while trends – such as the electrification of vehicles and the growing prevalence of digital services and self-employment – are likely to undermine the tax base. This underlines the need to place the UK’s tax system on a more efficient and sustainable footing and shows why leadership candidates should be wary of being taken in by any fiscal illusions. Longer-term fiscal pressures should give them cause for pause before making tax cuts – particularly as history suggests tax cuts are harder to reverse than they are to implement.

Any tax giveaways should be coupled with reform

The candidates’ proposals have focused on cutting headline rates of some of the major taxes, but they do not touch on the many areas of the current tax system that are widely acknowledged to be inefficient and ripe for reform – such as the varying tax treatment of different forms of work and taxes on property transactions.

Governments often shy away from making structural reforms to the tax system: losers from such reforms tend to be concentrated and vocal, while gainers tend not to notice. And recent experiences – such as when Philip Hammond had to row back on plans to increase class 4 National Insurance contributions for the self-employed and the outcry which followed the 2012 “omnishambles” Budget’s proposals for higher tax on pasties and static caravans – suggest politicians are rightly nervous of reforming tax, even when expert opinion backs the reforms.

There is also a lack of public understanding about tax policy. This makes it difficult for politicians to make the case for complex changes to the tax system, and so the offer of giveaways to the losers is often used as a way to soften any blows which follow. The next Prime Minister could follow this approach. They may be focusing on short-term political gain, but they have an opportunity to think beyond the immediate challenge of the leadership contest and couple any tax goodies with fundamental, long-term reform.