15 July 2019

The tax system is in need of reform and barriers in the way of change can be overcome, says Dr Gemma Tetlow.

Few marches will be held to protest the narrowness of the VAT base. Few headlines will be written about the risk posed to the public finances by the growing fuel efficiency of vehicles. It is, undeniably, difficult to construct a burning platform for tax change.

And with the UK Government not short of difficult issues to deal with, tax reform may well seem like one minefield that ministers do not need to walk into. Those who lose from tax changes are often quick to notice and vocal in their opposition. Those who might gain – or who are disadvantaged by the status quo – often notice less. But, as a new Institute for Government report highlights, the next and future governments need to make the case for changes to the tax system.

Ageing population is creating spending pressures as revenues fall

The UK’s ageing population is putting pressure on public spending on health, adult social care and pensions. To maintain the scope and quality of services that are currently offered, public spending on these areas are likely to need to rise by around £38 billion a year in today’s terms by the end of the next decade. Paying for that extra spending without raising taxes or borrowing would mean other areas of spending – police, education, defence etc. – would need to be cut by half as a share of gross domestic product (GDP).

But as the spending pressures rise, economic and behavioural changes are pushing tax revenues in the opposite direction. The declining prevalence of smoking and the growing fuel efficiency of cars are undermining revenues from tobacco and fuel duties – with growing fuel efficiency set to ultimately eradicate £28 billion of annual tax revenue from fuel duty alone. And the increasing number of self-employed people and people working for their own companies is reducing revenues from taxing work because they are taxed more lightly than employees.

Squaring this circle requires difficult choices. The Office for Budget Responsibility’s analysis shows that governments cannot simply borrow more: meeting the additional spending needs of the ageing population without changing the tax system would leave the UK’s public finances on an unsustainable path. Some other changes – scaling back the scope or quality of public services and benefits or increasing tax revenues – will also be needed.

Poor tax design is costly

This is partly a political question which depends on any future government’s preferences for redistribution and the size and scope of the state. But there are also elements of the solution on which all political parties ought to agree.

The UK’s current tax system is far from ideal. It creates unnecessary distortions, disincentives and costs. Though some of these problems have been around for a long time, growing fiscal pressures mean the cost of failing to address these problems will increase – and simply raising the rates of existing taxes could well exacerbate the issues. Addressing these failings, on the other hand, could offer an unusual free lunch by both boosting economic growth and tax revenues.

Barriers to change hinder the Government’s ability to choose the best course of action

Tax changes in general – and some specific changes in particular – are hard to make. The past 10 years have shown that governments found it easier to raise National Insurance Contributions (which are charged only on the earnings of non-pensioners) than income tax (which hits all forms of income); were able to raise tax on car (and other) insurance premiums but not on petrol or diesel; and could raise VAT but not charge it on pasties or static caravans. But without tackling the barriers that stand in the way of tax reform, there is a risk of following the path of least resistance and simply making piecemeal changes. That would likely exacerbate existing inefficiencies and distortions, as well as heap additional tax burdens on some groups without a clear electoral mandate for doing so.

Brexit currently casts a long shadow over Whitehall, depleting the Government’s political capital and distracting attention from other long-term policy questions – including tax reform. But developing an effective tax system is an important objective for any modern government, and there is scope to start making the changes and preparing the necessary groundwork for a time when the Government comes to focus on these issues.

Our research so far suggests a number of ways to help break down the barriers to tax reform – from building the case for change well in advance and packaging reforms together, to strengthening scrutiny and evaluation of tax policy and giving careful thought to implementation. The objective of our ongoing work is to highlight the priorities for action. Building a burning platform for tax reform won't be easy, but appreciating the need for change – despite the obvious hazards – is an important first step.

Comments

Tax Policy should also be fair. Whilst I am not in the bracket, the highest effective incremental rate of Income Tax is 60% for those earning £ 100k to £ 125k. Above that it drops back to 40% and then to 45%. I do not know why there is not more coverage of this anomaly, as it seems both unfair and naturally wrong. This comes as a result of the rate of withdrawal of the personal allowance. I know that this has led to unforeseen consequences.

If the withdrawal were at £ 1 in every £ 4 of income, then the effective rate of tax would be 45%, which would roll into the 45% top tax rate, and thus be fair. Or make it even easier, and leave the Personal allowance alone and just bring the 45% rate in at £ 100k.

I think that the truth is that no-one has made a fuss, and it has probably been a very lucrative tax raising measure, however, it is not fair, and makes what is otherwise sensible, a regressive tax.

Yours truly

Hugh Turner