The latest international tax competitiveness rankings, published annually by the US-based Tax Foundation, came out this week. As usual, they did not make for pretty reading in Britain.
In 2023, the UK has slipped three places to 30th on the overall ranking – out of 38 OECD countries. That puts us comfortably behind our G7 peers Canada, Germany, the United States, and Japan – and behind a total of nineteen other European countries. You might not have expected Brexit to produce Singapore-on-Thames, but surely competitive policy divergence should look better than this?
The overall ranking is flattered by our good cross-border tax rules – which account for one-fifth of the Tax Foundation’s competitiveness score. On this category we finish second – just behind Switzerland – thanks to our extensive network of tax treaties. But we are doing pretty badly on personal taxes (26th) and corporate taxes (28th), and very badly on consumption taxes and property taxes (35th in each case).
One of the useful things about the Tax Foundation’s index is that you can use it to ‘audit’ different tax systems around the world, assessing their comparative strengths and weaknesses from a pro-growth perspective. That is something my co-authors and I did in detail in 2020, in ‘A Framework for the Future: Reforming the UK Tax System’. But it is worth going through the main problems with the UK tax system again here.
On personal income taxes, we suffer from high marginal taxes rates. We are marked down for an effective top rate on earnings of 62% – which kicks in as the personal allowance is withdrawn from £100,000. We also tax dividends much more heavily than most other OECD countries.
Of course, things are actually worse here than the International Tax Competitiveness Index can capture – the withdrawal of child benefit and childcare subsidies, for example, can result in even more punitive rates of tax. The current cocktail of high inflation and frozen tax thresholds also means that more and more people are being dragged into higher tax bands – by the time the freeze ends, the IFS thinks 16% of adults will be paying the higher or additional rate of tax, compared with just 4 percent in 1990.
On corporate taxes, we no longer have a particularly low headline rate – a factor that has sent us plummeting 17 places down the rankings in this category. The introduction of full expensing for (most) investment in plant and machinery is a welcome sweetener – and in the long run will likely offset the (negative) growth effect of the higher headline rate. But it is a temporary and incomplete policy; it does not apply to the full range of business investments and is set to expire in 2026. Meanwhile, the broader corporate tax code is cluttered with various targeted taxes and incentives which undermine the neutrality of the tax system and distort behaviour.
Our property tax regime is a disaster. As a percentage of our total capital stock, we raise more from recurrent property taxes (like business rates and council tax) than any other OECD country. That wouldn’t necessarily be a problem if the taxes were well structured – property taxes can be quite efficient – but sadly that isn’t the case at all in Britain. Business rates can significantly discourage investment in premises and infrastructure, and council tax is still based on property values from 1991. We also rely heavily on stamp duties (on land and shares) which are highly distortionary, and just about the worst possible way for a government to raise revenue.
The consumption taxes picture is a bit more complicated – not least because many on the political right actually like the big flaws in our VAT system and in some cases campaign to make them worse. But here’s the thing: VAT should be the most efficient part of the tax system, raising loads of money with a (relatively) limited impact on growth. Yet we mess it up by having a very narrow tax base by international standards. Widespread exemptions and reduced rates create enormous complexity, and our very high registration threshold massively distorts behaviour. Other more economically damaging taxes have to be higher as a result.
So what can be done? Short term, the most pressing thing is to make full expensing permanent – failing to do that will mean a further drop down the competitiveness rankings (to 33rd place out of 38) and, more importantly, giving up the long run GDP growth that the policy should otherwise produce. (Our modelling suggests output will be about 1% higher with full expensing than without it.)
Ideally, the government should go further and extend full expensing to a wider range of assets – including structures and building, for example, would massively amplify the impact of the policy. It is true that the transition to full expensing looks costly in the short term from a fiscal perspective, but in the long run costs are much lower. As the IFS has put it: ‘Short-run scorecard impacts should not govern long-term policy choices.’
But there’s also the potential for a much larger pro-growth tax reform agenda here. In a UK-focused note I produced to accompany the Tax Foundation’s latest International Tax Competitiveness Index, I outlined a revenue neutral package of reforms that would catapult the UK to 3rd place in the rankings, behind only Estonia and Latvia. This consists of the following:
- Abolishing stamp duties and inheritance tax altogether, and getting rid of council tax, business rates, and corporation tax in their current form.
- Residential property would instead be subject to a new ‘proportional property tax‘ – a low, flat-rate tax on up-to-date property values.
- Business property would be subject to a new ‘commercial landowner levy‘, paid by property owners on the unimproved (land) value of sites.
- Corporation tax would be replaced with a ‘distributed profits tax‘. The 25% tax would only apply to money paid out to shareholders – effectively creating full expensing for all business investment.
- Income tax would be restructured, with the personal allowance (and the National Insurance threshold) rising to £15,000 per year. Withdrawal of the personal allowance for higher earners would be eliminated, but the threshold for the additional (45p) rate would fall to £100,000.
- Capital gains tax would be reformed and dividend tax rates would be cut (with the highest rate falling to 29%).
- VAT would be radically simplified, with zero and reduced rates eliminated, and a much broader range of consumption taxed at the standard rate. The registration threshold would be halved.
Clearly, that is not going to happen right now. VAT reform would have tricky distributional consequences that would need to be addressed. And it would cause a one-off rise in the price level – which is not exactly welcome at the moment. The suggested property tax reforms, meanwhile, would benefit families and businesses in the North and Midlands, but also create a lot of losers in London and the South-East, where property values are highest. No sensible politician is going to overhaul property taxes just before a general election.
The point, however, is that it is possible for us to have one of the most competitive tax systems in the world without having to give up revenue. We just need to look at the best tax systems around the world and learn the right lessons from them. And once we have an idea of the sort of tax system we should be aiming for, we can work out how to inch our way towards it.
Over the longer term, an enlightened, pro-growth approach to tax reform might focus on incrementally replacing the current system of property taxes with a more rational one, as properties change hands, and gradually rebalancing the tax burden away from income and investment and towards consumption. It might also incorporate efforts to establish a consistent carbon price across the economy, as a market-based alternative to the dirigiste net zero agenda.
One of the great difficulties of British tax policy is that it is made piecemeal to fit a cycle of set-piece budgets and seasonal statements. These are acts of political theatre as much as economic strategy. But if we can somehow find a way to make tax policy for the long term, the benefits could be enormous.
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