Today, the Tax Foundation releases the 2024 edition of the International Tax Competitiveness Index, an annual ranking of how pro-growth the tax systems of 38 OECD economies are. It’s not great reading for the UK, which comes 30th. This is behind other G7 economies such as the US (18th) and Japan (25th), but still ahead of France (36th) and Italy (37th). And new modelling carried out with the help of the Centre for Policy Studies shows that next week’s Budget could push the UK even further down the tax rankings.
Importantly, the Index is not measuring the size of the tax burden – instead, it examines how effectively a tax system raises revenue, and the economic damage it inflicts as it does so. The countries at the top – Estonia, Latvia and New Zealand – have relatively simple tax systems with low marginal rates, few loopholes and limited reliance on the most damaging taxes.
The UK has improved one place since last year, thanks to the decision in the 2023 Autumn Statement to make full expensing permanent. The UK also has strengths in cross-border taxation, where it has the largest network of tax treaties in the OECD.
However, that’s where the strengths end. Notwithstanding the full expensing change, the UK’s corporate tax regime has worsened in recent years, largely due to the decision to raise the corporate tax rate to 25% from 19%. But there are other longstanding issues.
While a broad-based consumption tax is one of the least damaging ways to raise large amounts of revenue, the UK’s VAT regime is riddled with exemptions. Just 48% of potential sales are covered by VAT, compared with the OECD average of 58%. Furthermore, the registration threshold (the annual revenue a business needs to surpass before applying for VAT) for businesses is very high – £90,000 compared to £35,000 in the rest of the OECD. These two features mean the UK relies on more damaging taxes to raise revenue.
The UK also has many distortive taxes on property, such as inheritance tax and financial transactions tax. The UK’s property taxes impose the highest burden, measured as a percentage of the capital stock, in the OECD. The UK also taxes not only the land, but also the structures built upon it. Most notably, business rates rules mean that a business can face increased property taxes if it upgrades its premises, disincentivising investment.
With the Budget coming up, the UK’s tax competitiveness could get even worse. The most likely decision Rachel Reeves will make, a tax rise on capital gains, would push the UK further down the rankings. For example, raising the capital gains tax rate to 33% would mean the UK would fall from 30th to 32nd overall. Raising it to 39% would see the UK have the third highest rate in the OECD (it currently has the 16th-lowest rate) and fall to 33rd overall. A more extreme option – equalising it with the top rate of income tax at 45% – would see the UK fall to 34th. It’s also unlikely to raise much revenue – in fact the Treasury has estimated that raising the capital gains tax rate by 10 percentage points would lose the government £2 billion.
Future pressures on spending, and ideological pressures from the wider Labour party, mean that no bad ideas are off the table. A wealth tax, while unlikely this Budget, would see the UK fall to 34th, while raising very little revenue. Raising the rate of dividend taxation to equalise it with the top rate of income tax would see the UK fall to 32nd. If all the above changes were combined (with capital gains tax being raised to 33%), the UK would be 35th. This would only be ahead of France, Italy and Colombia – hardly models of free-market efficiency.
There are innumerable other ways that Labour could make the tax system worse, such as extending the scope of inheritance tax or driving up the rate of national insurance. But if Labour want economic growth, they need to get serious about tax reform. This is less about lowering rates, and more about raising more money from less damaging taxes, like VAT, and using those funds to abolish or reform harmful ones, like stamp duty and capital gains. Rachel Reeves needs to show courage and vision for the tax system in the UK. If she doesn’t use this Budget to begin these reforms, she will have wasted a golden opportunity.
Click here to read the Centre for Policy Studies’ new briefing note on the UK’s tax competitiveness.
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