The Treasury changed hands four times in the five years from 1958 to 1963.
It started when, in January 1958, Chancellor Peter Thorneycroft objected to any spending increase and resigned, with Enoch Powell and Nigel Birch resigning alongside him. The new Chancellor, D. Heathcoat Amory, raised expenditure by £155 million in his budget. Then in 1960, the interest rate was lowered to 4%, only to be pushed back up to 6% two years later. Slow growth, rising prices and rapidly shifting policies meant no one knew what was coming next: from the credit squeeze of 1959 to Selwyn Lloyd’s ‘pay pause’ budget of 1961. Then came the reshuffle, in which Lloyd was its biggest loser – but it didn’t solve the problems. Unemployment, which stood at 500,000 in October 1962, rose to 810,000 by January 1963. Economic policy looked like what T. S. Eliot wrote in The Waste Land: ‘A heap of broken images, where the sun beats.’
But why? The historian David Thomson explains it excellently:
That the Treasury changed hands four times in five years was an indication of the importance of financial direction and economic planning, but also of the lack of any one agreed set of principles for shaping such policies. The differences between the Chancellors, as between the political parties, were mainly variations of emphasis and choice of devices, rather than any avowed clash of purposes.
Sounds familiar. The rumoured income tax rise – which would have breached the Labour Party manifesto – was at the top of the news for days, and suddenly we get reports that Rachel Reeves is ditching the tax rise after an improved fiscal forecast. The problem isn’t higher tax or lower tax, different taxes, specific taxes or big bases – it is that there is no plan.
What Mervyn King wrote in his timely book ‘The British Tax System’ is still relevant: ‘what is required is a strategy for tax’. It is not single policy changes that have created uncertainty for businesses and individuals. The issue is that the policies are not part of a bigger picture – a grand strategy. The discussion about single policies may be interesting, but it is futile without knowing the destination. When you don’t know where you want to go, direction doesn’t matter. This seems to be what the Labour Government has been stuck in: taxation plans based on making the numbers add up for this year, rather than a coherent long-term framework.
But the important question is: what would a good tax plan look like? Which taxes should be abolished, which reduced and which increased? Let’s go back to first principles. Starting with the basics, a good tax system is one which does minimum damage and generates maximum revenue. A bad tax system generates minimum revenue with maximum damage. Revenue is simple to understand. But what do we mean by ‘damage’? Damage is defined by distortion. If your tax system is rapidly influencing behaviour away from what people would have done without taxes, you have a distortion problem. This is the merit of a flat-base model: the distortion from the natural economy is almost zero. Even if economists like Nobel laureate James Buchanan argued that flat-base taxes are an implication of the rule of law, it is hard to imagine them applied right now.
What can be done to minimise distortion is more flexibility. Rapid increases in tax rates are one of the main issues in our system: individuals intentionally earning below £100,000 because they would end up with less after the taper up to £125,000. Now the tragedy of this behaviour has been extended to £50,000 earners too. The same pattern exists for businesses. Small firms cannot expand because once they pass £100,000, VAT hits rapidly, so many intentionally stay small. A less abrupt change in rates would be a priority for flexibility. You don’t need to be an economist to see that a system in which people and businesses intentionally limit their income to stay under thresholds is not a healthy one.
Where should a healthy tax system generate most of its revenue? We know a good tax regime is a pro-growth regime, and no tax is more pro-growth than a consumption tax. Buchanan wrote in ‘The Power to Tax’:
Restriction of the tax base to consumption outlays will reduce the revenue potential of Leviathan… A by-product advantage of the consumption base lies in the additional saving, and additional economic growth, that is generated.
Why consumption tax? Because, in simple language, it punishes those who take resources out of the economy (consumption) and rewards those who add to it (saving, investment, business). A flat-base consumption tax is immune to two things: lobbying and the punishment of growth. Buchanan’s defence of uniform taxation was based on the logic of political economy: a system with differentiated rates incentivises interest groups to lobby for lower rates on their own products, whereas this is impossible in a uniform system. And when you tax income, you tax both consumption and saving; when you tax consumption alone, saving is protected – creating an incentive to build rather than weaken economic activity.
The main criticism is that a consumption tax is regressive. It is common knowledge that the rich consume more in absolute terms, but the gap between consumption and income varies across wages, making income tax more progressive. The solution would be exemptions for low-wage earners who spend almost all of their income on consumption.
Is a flat-base consumption tax easy or even possible to achieve? Definitely not. But it is good to keep it in mind as a north star. And, as Friedrich Hayek said, what task is more important than ‘the task of making politically possible what now seems politically impossible’?
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