21 October 2022

Even before the mini-Budget calamity, Britain’s tax system was unstable and unsustainable


The perfect storm of the mini-budget, where surprise uncosted tax pledges and an open-ended energy price package met market instability and rising interest rates, has meant a wholesale rethink of the Government’s tax approach. Rather than going for growth with lower taxes, Jeremy Hunt is now focused on getting the most feathers from the goose with the least hissing – easier said than done, given that his medium-term fiscal plan could involve £35bn of tax rises and spending cuts.

But is reversing the scrapping of the planned rise in corporation tax and scrapping the planned cut to 45p rate in income tax, along with sundry other u-turns, enough to steady the ship? It’s hard enough to even understand where we stand with all the double negatives floating around, but I don’t think so.

The problem is not just that the turmoil of the last few weeks has driven up the cost of government borrowing, but that the UK’s tax system as a whole has been unsustainable and unstable for years. We hear a lot about the record tax burden – a 70 year high – and how it is squeezing working people. But beyond the headline rates and the overall burden, the entire tax system has been pushed to the brink by years of tweaking, tinkering and twisting.

Our tax system is a hulking mess of inconsistencies and incongruencies. It has a highly capricious series of carve-outs for particular goods, some industries are taxed to the hilt while others are heavily subsidised, and investment is treated as something to be penalised, rather than encouraged.

Our personal tax system is full of cliff-edges, where each additional pound earned has an outsized effect on an individuals’ tax burden. It also has far too many loopholes which are readily exploited by the richest in society while working people lose out. It doesn’t keep pace with changing economic conditions, meaning taxes effectively rise as inflation bites and wages stagnate.

Fundamentally, the system is too complex to fulfil what should be its main objective: raising money for public services with the least amount of economic damage. Instead of accounting for dynamic effects of taxation – the overall impact on the economy of raising or lowering particular tax rates – the Treasury only considers static costs and benefits. By just focusing on the obvious, and ignoring how taxes change our behaviour, we have created a system which is being quickly wrung dry.

Take income tax. If we were to raise the basic rate of income tax by 2p it would raise around £10bn. But, given the outsized strain this would have on the working population, would it really amount to a flat £10bn more for the Exchequer? One might suggest that given the strain the middle classes are facing that raising their taxes would just result in even more welfare transfers required down the line. So, in the case of income tax, as is the case with other taxes, raising headline figures without looking at the economic effects as a whole is a misguided approach.

A tax system should be simple, clear, and cause few distortions. It should be based on raising revenue to fund public services, not based on what is popular or what makes people feel good. It needs to be stable and sustainable, ensuring that it doesn’t kill off the goose that lays the golden egg.

One of Liz Truss’ most welcome commitments during the leadership election was a full review of the tax system as a whole. We should very much hope that this is taken up by her successor as a priority for sorting through this whole mess. The last comprehensive review – the Mirrlees Review – was undertaken by the IFS in 2010, in the wake of another financial crisis. It seems clear that, especially as many of the Mirrlees Review recommendations were not adopted, we are overdue a sequel; Tax Review 2: electric boogaloo.

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Morgan Schondelmeier is Head of External Affairs at the Adam Smith Institute.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.