Next week the Chancellor will present the annual UK budget in which he must strike a balance between providing support to the economy in these unprecedented times whilst suggesting that measures will need to be put in place to plug the fiscal gap. Unlike in times past when the purdah period ahead of the budget meant there was complete radio silence on the expected measures, this year the plans have been splashed all over the weekend newspapers. They highlight that the government is planning a “restart” grant scheme to provide funds to allow businesses to reopen after the Covid lockdown and an extension of the furlough scheme through June. In addition, the government is expected to announce measures to support house buying, including a time-limited extension to the stamp duty holiday and help for people hoping to get on the property ladder.
Any message that the government is trying to convey via the media should be taken with a huge pinch of salt. Whilst it is giving the impression that it remains committed to providing support, a £5bn restart fund is chickenfeed in fiscal terms (0.2% of GDP) – as one below-the-line contributor to the FT story sardonically commented, “why not just send a card?” I have noted on previous occasions that the media representation of fiscal aggregates is akin to a form of money illusion if measures are simply reported in absolute terms without giving any form of context. A £5bn fund sounds big to the average punter but it will only deliver a payout of up to £18,000 for the biggest firms. Small businesses will obviously get less and the payout may not even cover the fixed costs of running a business during the lockdown. This is not to say that support is unwelcome but it highlights that the state’s generosity is more limited than ministers would have us believe. Nor is it clear that measures to further inflate the housing market will do much to tackle the UK’s economic woes. Inflating the price of non-productive assets may make voters feel good but it is of questionable economic benefit.
Naturally politicians want to deliver only good news whilst hiding the bad and there has been less discussion of any fiscal tightening measures. However, Chancellor Sunak has promised to “level with people” over the “enormous strains” in Britain’s public finances and warns that the bill will fall due at some point. Matters have been made more complicated by the foolish commitment in the 2019 election manifesto to rule out increases in income tax, national insurance and VAT rates though whether that is adhered to in the long run remains to be seen. One of the measures likely next week is a freeze in income tax thresholds which will push people into higher tax bands as their income rises, although the fiscal effect of this will be limited, yielding less than £1bn in FY 2022-23. There has been some chatter about whether corporate taxes will rise. Whilst this may be postponed to the future as there are genuine questions as to whether this is the right time to be talking about fiscal tightening, it is a measure likely to come onto the agenda sooner or later.
… And beyond
Much of the discussion around fiscal tightening centres around tinkering with existing taxes. But looking ahead, now would be as good a time as any to open up a discussion about the future shape of the tax system. After all the current system largely grew out of a twentieth century economy but given the impact of the pandemic on the structure of the economy and the need to reshape fiscal policy in its wake, it would now seem to be a good time to announce a long-term public consultation on the scope of tax reform. This would build on the excellent body of work conducted by the Mirrlees Review in 2010 and 2011 which was motivated by the fact that the tax system has grown in an ad hoc way and “remains the product of often incoherent piecemeal changes rather than strategic design.”
Although the British system is fairly efficient in an international context, offering relatively few loopholes and opportunities for avoidance, and is on the whole non-intrusive, it is far from perfect. We can broadly categorise measures into easy fixes and ones which require a much deeper level of consideration. In terms of the former category, I repeat my call for a reduction in the benefits taper rate (the rate at which in-work benefits are withdrawn as people take on paid employment) which would eliminate the burden on some of the least well-off in society whilst also increasing their work incentives.
Other relatively easy fixes include increasing capital gains tax to align it with income taxes, as recommended by the Office of Tax Simplification, to ensure equal tax treatment of labour income and wealth income. Another fix would be to limit the rate of pension tax relief to 20%, thus reducing the regressive treatment of pension contributions which currently favour higher rate taxpayers, whilst abolishing the double taxation of interest income would be a welcome vote winner. Finally in terms of easy fixes, there is a case for abolishing the distinction between national insurance contributions (NICs) and income taxes as a way of simplifying the tax system. In fairness this was considered in the 1980s but the then-Chancellor concluded that “the benefits of a combined charge would be unlikely to justify the ensuing upheaval.”
There are a number of more complex questions to be asked of the tax system which require a lot more thought. To the extent that income tax, VAT and national insurance contributions together account for around 60% of revenues there is a case for thinking about ways to widen the tax base. One option would be to consider the possibility of a wealth tax. I did look at this issue three years ago and concluded that there are many practical objections which means it may be more trouble than it is worth. But there are some attractive features, especially in the wake of the pandemic in which young asset-poor people have been forced to make sacrifices to shield older asset-rich people.
Another area ripe for reform is corporate taxation. The
standard belief is that there is a case for raising the tax rate which is relatively
low in an international context. There is some merit to this but there is a lot
more to the issue than simply tax rates. For example, a
recent OECD symposium looked at ways to levy tax based on the location of
customers rather than legal domicile and there is a big debate around the
taxation of digital services which is very much in its infancy. A related issue
in the corporate taxation debate is the extent to which debt finance receives
more favourable treatment than equity finance. By allowing the tax
deductibility of debt interest payments against profits, the base against which
corporate taxes are levied is artificially reduced.There is scope to look more closely at this anomaly.
Last word
There are numerous other areas ripe for reform (local authority financing being one of them and I will come back to that another time). As Stuart Adam and Helen Miller noted in a recent IFS report “The parts of the UK tax system that dictate how different forms of income are taxed are of central importance and are not fit for purpose … The tax treatment of returns to investment is a mess … And this is just the start; the list of problems is long.” These are very strong arguments in favour of rethinking the tax system to make it more applicable to the economy of the 21st century. Just as we need a debate about what we want the state to provide following the pandemic, we need a debate about how to pay for it.
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