Burnham’s first job: fix Britain’s broken tax system

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Barring some form of constitutional crisis, Andy Burnham will become Prime Minister. We do not even know who his new Chancellor will be, let alone what their policies and priorities are. However, whoever gets the top job at 1 Horse Guards Road, they should make tax reform their top priority if they want to bring about economic growth.

This week, a report I co-authored with Roger Bootle and Ben Sweetman for Policy Exchange has been published. In ‘How to Make Taxation Less Taxing’ we highlight the many issues plaguing the UK’s tax system and provide a blueprint on how to reform it so that it reduces the burden on households and firms, incentivises work and investment and stimulates economic growth. Below are three examples of how this could be achieved relatively quickly.

First, the ridiculously high marginal rates of tax faced by many households on relatively modest incomes must be addressed. The gradual loss of the personal income tax allowance as incomes rise and the interaction between income tax and the benefits system creates some absurdly high marginal tax rates, sometimes in excess of 100% at particular points as incomes increase. Across a wide range of incomes, the marginal tax rate goes up, down, up again etc, creating what has been dubbed a Manhattan Skyline. 

This creates severe disincentives to work hard and take risks. For example, workers – including GPs – work fewer hours, don’t take overtime, and turn down promotion opportunities in order to reduce the amount of tax they pay. This not only means that workers are missing out on opportunities to improve life for themselves and their families but economic growth is lower than it otherwise would be while public services face additional strain.

Eliminating various cliff edges and these ludicrously high marginal tax rates must be a priority for the new Chancellor so that hard work is rewarded rather than punished.

Second, the VAT system needs to be reformed. The UK is unusual in that it has a relatively narrow VAT base and contains different rates and exemptions. The rationale behind this is well meaning as it is an attempt to lower the cost of living by ensuring that people pay less for essentials such as food. Unfortunately, it makes the system much more complicated and means that the government misses out on revenue.

Rather than attempting to provide welfare through the VAT system, the government should instead eliminate the different rates and exemptions of VAT and levy a single rate on the majority of goods and services. This would raise a significant amount of revenue which could be used to cut more economically damaging taxes while providing targeted support to low-income households.

Third, Stamp Duty Land Tax (SDLT) should be abolished. As should stamp duty on shares. SDLT is arguably the most damaging tax on the books. It traps people in homes which are either too large or too small for them, gums up the housing market, and restricts labour mobility. This has a dampening impact on productivity and so lowers economic growth.

Relatedly, the UK is a relative outlier in that it levies stamp duty on the transaction on shares while many other highly developed nations do not. Stamp duty on shares reduces the efficiency of the stock market for British firms and makes raising capital more expensive while diminishing London’s position as a global financial centre.

Abolishing stamp duties would be costly for the Exchequer given the amount of revenue they raise. However, given the immense damage which they do, their abolition will stimulate economic growth which is not only a good thing in itself, but will also provide the government with additional revenue from other sources.

As discussed above, these measures can be achieved relatively quickly as they will not require major decisions regarding public spending. While a good start, these measures alone will not be enough to lower the burden on households and firms and boost economic growth. We therefore recommend being even more ambitious by reducing and eliminating other taxes.

However, this must be done in a fiscally responsible way and should only occur once public spending has been cut. In a previous report, we set out a credible plan to reduce public spending such as by reforming the welfare system and public sector pensions while freezing the state pension, increasing the age at which it can be claimed, and abolishing the triple lock. Once this has been achieved – which will be no easy task in itself – the new Chancellor should be even bolder.

The top rate of income tax should be abolished. This was introduced by Gordon Brown for purely political reasons and as a trap for a future Conservative government. It acts as a disincentive to households to work hard and be productive. Moreover, it damages the UK’s international competitiveness as it encourages highly productive British people to leave the country and deters entrepreneurs in other countries from moving here. The end result is that the country misses out on the talents and tax revenue of these people meaning that economic growth remains low and those on middle-incomes have more of their hard earned money taxed.

As for inheritance tax, the rate is relatively high in the UK compared to many other countries. Moreover, many countries – including those considered highly progressive such as Sweden – levy no inheritance tax at all. Inheritance tax in the UK can have significant negative economic impacts, primarily through its distortions to investment and asset management. Many heirs and business owners make financial decisions aimed at minimising their inheritance tax liabilities, rather than focusing on the most productive use of their resources. This has a negative impact on economic growth and so inheritance tax should be abolished.

Britain should make the most of its Brexit freedoms by looking at tariffs. When it left the EU, it replaced the EU Common External Tariff (CET) with the UK Global Tariff (UKGT). I actually worked on the design and implementation of the UKGT and while it was an improvement on the CET as it abolished nuisance tariffs and levied duties in whole numbers, it largely replicated the CET. Pretty much every mainstream economist accepts that tariffs are economically damaging as they are a barrier to trade. They reduce choice and raise prices for consumers while protecting inefficient firms and industries. The government should be bold and eliminate tariffs on the majority of goods and services imported by the UK.

Finally, the next Chancellor needs to look at National Insurance Contributions. National Insurance is a tax on work and on workers. Whether it is levied on employers or employees, the incidence falls on workers. This tends to be either in the form of lower wages or fewer job opportunities. As such, people work less and so miss out on the opportunity to earn more money and improve life for themselves and their families. Or, they are deprived of the opportunity to work at all and it is often the young and the low skilled who are disproportionately impacted. It will be costly and should be done in stages, but National Insurance should be phased out completely.

These policies would be radical – it would amount to the biggest shake up of the tax system in over a century. It would therefore take a brave and skillful set of politicians to make it happen. However, the country has suffered almost two decades of low productivity and stagnant economic growth and our lengthy and complicated tax system is one of the main culprits. We can’t go on like this. The next government must take tax reform seriously, reduce the burden on households and firms and reward rather than punish hard work and investment.

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