26 October 2020

We can boost growth without denting tax revenue – here’s how

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Today sees the launch of a new joint report from the Centre for Policy Studies and the US-based Tax Foundation – A Framework for the Future: Reforming the UK Tax System.

The goal of the report is twofold: first, to assess the competitiveness of Britain’s tax system versus those of other OECD countries; and second, to develop a series of reform proposals that would make the UK tax system significantly more pro-growth without putting a dent in government revenues.

On the first point, our findings are not encouraging. Despite the UK tax system having some appealing features – like a low corporation tax rate and a wide network of international tax treaties – we finish 22nd out of 36 OECD countries on the latest edition of the Tax Foundation’s International Tax Competitiveness Index, which I wrote about here last week.

Particular weaknesses in the UK tax system include a strong bias against capital investment, which is apparent in the structure of both corporation tax and business rates; relatively high top rates of tax on earnings and dividends; and a property tax system that is both burdensome and highly distortive.

Our reform proposals follow naturally from this comparative analysis and are designed to address the flaws in Britain’s tax system head-on. 

On personal income taxes, we call for a flatter tax structure that fully reflects taxes already paid at the corporate level. That means abolishing the additional (45p) rate of income tax, maintaining a competitive capital gains tax system, and significantly cutting dividend tax rates – we suggest a higher rate of 26%, and a basic rate of zero.

On property taxes, we call for a truly radical reform. Stamp Duty Land Tax would be abolished altogether, generating a significant boost in property transactions that would offset some of the revenue cost. Stamp taxes on shares would also be axed.

Business rates would also be completely overhauled. The value of buildings, infrastructure, plant, and machinery would be stripped out of the tax base, so that rates only applied to the value of the underlying site. Businesses would no longer be punished for investing in their premises.

Boosting investment is also the goal of our corporation tax proposals. The ideal is a system of ‘full expensing’, in which companies can fully and immediately deduct investment costs against taxes. That would have strong growth effects but might also be very expensive in revenue terms.

In the short term, then, we suggest simply making the £1 million Annual Investment Allowance permanent. Investments deducted under various capital allowances and the Structures and Buildings Allowance should also be up-rated annually, so that they hold their value over time – an approach known as ‘neutral cost recovery’.

This agenda is by no means a fix for every problem in the British tax system – and throughout the report we point to other issues that a fully comprehensive programme of tax reform should address. But we have focused on competitiveness and tried to target our reforms where we think they will have the biggest impact on Britain’s future growth potential.

We have also tried to make our proposals as affordable as possible, both by looking at some of the revenue-boosting dynamic effects reform could have, and by coming up with ways to achieve pro-growth ends at a lower up-front cost. Inevitably, though, competitiveness-boosting reform will involve some tax cuts that reduce government revenue, at least in the short and medium term. 

How, then, to balance the books without undermining the pro-growth nature of our tax reform package as a whole?

Our main revenue-raising suggestion is a modest broadening of the VAT base (to the OECD average level). This would simplify VAT and remove some of the distortions inherent in the current panoply of exemptions, zero-rates and reduced rates. It would also yield more than £35 billion a year – enough to fund our pro-growth reforms and a £400 per person VAT ‘prebate’, designed to offset the impact of a broader consumption tax base on less well-off households.

We are, of course, under no illusions about the political popularity of this idea. Previous attempts at VAT base broadening have been embarrassing failures (remember the ‘omnishambles’ Budget?) and policymakers will undoubtedly be wary about going down that path again.  

Yet any worthwhile policy agenda must involve trade-offs – and at some point we’re going to have to confront the fact that broad-based consumption taxes are the only way to raise significant additional revenue without seriously compromising our growth prospects.

Ultimately, if there’s one message that policymakers should take from this report, it’s that the UK cannot afford to take its tax competitiveness for granted.

After all, the UK looks to be on the verge of a second coronavirus-induced lockdown. Britain’s future trading relationship with the European Union remains uncertain. And all this comes hot on the heels of a decade characterised by lacklustre investment, stagnant wages, and pitiful productivity improvements.

Britain needs real economic growth, and it needs it badly. But short-term stimulus is not the answer—we need growth that is broad-based, sustainable, and based on better long-term economic fundamentals. Tax reform is no silver bullet, but it is an essential part of turning that need into reality.

The proposals outlined in A Framework for the Future would – if enacted – leave the UK with one of the most competitive and pro-growth tax systems in the developed world, catapulting us up the International Tax Competitiveness Index from 22nd place to 9th. That may not be the answer to all of Britain’s economic problems. But it would be a decent start.

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Tom Clougherty is Head of Tax at the Centre for Policy Studies.

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