9 October 2019

It’s high time for a truly pro-growth tax reform

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Lost in the fog of our recent political drama, a major report makes clear just how out of shape our tax system has become.

Last week the Tax Foundation, a US thinktank, released its annual International Tax Competitiveness Index. The UK came 25th out of 36 major industrialised nations. For a country that aims to have one of the world’s most dynamic economies, that simply will not do.

Our tax system is an alluvial plain, littered with the deposits of Budgets past in which Chancellors have used fiscal policy to sweeten up certain industries or consumer groups. The result is a tax code that is excessively long, hugely complicated, full of distortions and, in some areas, downright unfair. The fact that since 2010 we have had an Office for Tax Simplification (OTS) speaks volumes.

If the Conservatives win a majority at the next election, rather than simply offering to cut certain rates or fix the odd anomaly, they should produce a comprehensive plan for a simpler, unashamedly pro-growth tax system. And it should be steeped in a political narrative about freedom, fairness and, for voters worried about public services, higher overall revenues.

That does not simply mean cutting rates and hoping the Laffer Curve works its magic. Rates are important, but so is overall structure and efficiency. Just look at Sweden, which has very high taxation yet comes 8th in this year’s International Competitiveness Index because its taxes are structured in a more logical, economically efficient way than our own.

The case for reform is made more urgent by two interconnected trends: the UK’s anaemic economic growth since the 2008 crash and the state of the public finances. For all the talk of austerity over the last decade, national debt in March of this year stood at 85.2% of GDP, up from 69.6% in March 2010. Worse still, unless there is some serious action to boost growth that fiscal situation will get a lot worse in the years to come and we simply will not be able to afford the kind of public services voters expect.

What should it look like?

So what should a Great British Tax Reform look like? This is not the place to go into a detailed discussion of all 17,000-odd pages of the British tax code. But there are some clear areas where an incoming government could get started.

One of the reasons the UK fares badly compared to other industrialised countries is the way the tax system treats investment. To resolve that, a more generous set of allowances for investment, coupled with a reform of business rates would be a great place to start. We know the UK has a productivity problem, so it seems perverse that we actively discourages investment. If there is to be a No Deal Brexit, our parent organisation the Centre for Policy Studies (CPS) recommends an unlimited Annual Investment Allowance as one of the headline measures to boost British business.

As Sam Bowman, a fellow at the Adam Smith Institute, has pointed out, there is clear evidence that offering more generous allowances – letting businesses write off the cost of new buildings and machinery –  hugely encourages investment, which in turn enhances productivity and wages.

Likewise, the way business rates are calculated actively penalises companies for investing in machinery. Just look at Tata Steel, whose tax bill rose £400,000 when they installed a new blast furnace at their Port Talbot steelworks. Increased allowances and changing business rates so they reflect land value instead of ‘rateable value’ are the kind of widely supported changes that could help create the political space to do some trickier reform.

As for simplicity, a report from our parent organisation, the Centre for Policy Studies, shows that it’s possible to drastically reduce the number of taxes paid by small businesses without having any effect on revenue. Accountants PwC estimate it takes 105 hours for the average UK business to file their taxes, time could be more productively employed elsewhere if the filing system were made simpler.

The same is true of personal taxation, where national insurance has remained a separate levy despite effectively being the same as income tax. Merging the two would be a long-term project, not an ‘easy win’, but it would make the system a lot clearer. In the meantime, the Government could do a lot worse than following another CPS recommendation, to raise the NI threshold so the first £12,000 of earnings were completely tax-free.

Another area the UK falls down is property taxes, of which Stamp Duty Land Tax is the most egregious example. It’s hard to find anyone who thinks charging a tax on people moving house is a good idea, especially in a country where property prices have ballooned in recent decades. Clearly, SDLT is not the cause of the housing crisis, but it’s certainly making it worse. As the Mirrlees Review noted back in 2011: “It creates a disincentive for people to move house, thereby leading to potential inflexibilities in the labour market and encouraging people to live […] in properties of a size and in a location that they may well not otherwise have chosen.”

Now, few are under any illusions that business tax reform is going to a huge vote-winner on the doorstep, which is why Chancellor Sajid Javid should make for ideal ‘year 1’ reforms, whose benefits would start to be realised further along the electoral cycle – a happy coincidence, of course, rather than the actual reason for doing the reform in the first place.

Of course, this all rests on a Conservative majority at the next general election. As I’ve written before, Labour’s John McDonnell appears to view taxation as an instrument of class warfare as much as economic policy, and his party’s agenda would only add to the already crippling complexity of our tax code.

At the moment the Tory offer centres on getting Brexit done and boosting spending on various services. That may be smart politics in the short term, but in the longer term there’s no substitute for good, old-fashioned economic growth – creating the world’s most competitive tax system would be a fine way to help deliver it.

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John Ashmore is Acting Editor of CapX