The Time for Tax Rises Isn’t Now – So Let’s Talk About Principles

UK Policy Public finances Income and Inequality

The Time for Tax Rises Isn’t Now – So Let’s Talk About Principles

Commentary
Posted on: 3rd February 2021
James Browne
Head of Work, Income and Inequality Analysis

Let’s get the bad news out of the way first: Tax rises will be coming post-Covid. Demand for more spending on health and social care, likely permanent damage to the economy from the pandemic and the costs of an ageing society that are not going away all mean that higher taxes are inevitable at some point. If the tax system is to bring in more revenue fairly and without hindering growth, we need to redesign it from the bottom up.

Unlike after the 2008 global financial crisis, there’s now a remarkable consensus right across the political spectrum that the government should wait until the economic recovery is well established to start the repair job on the public finances. This means that the chancellor has an opportunity think strategically about tax reform. Instead of announcing new tax rises in next month’s budget, he should outline the principles that will govern his approach to tax reform in the years ahead. These choices will set the path for the next decade, just as those made in the wake of the global financial crisis did for the 2010s.

But after 2008, short-run, tactical reforms moved us further away from a well-designed tax and benefit system. Austerity cuts hit the poorest hardest and weakened the link between benefit entitlement and family needs. And many of the measures to raise additional revenues from the richest have been poorly designed, causing unnecessary economic damage and greater complication to the system. Inequities in the taxation of earned and unearned income have increased. The taxation of land and property has become ever-more in need of reform, and the taxation of carbon emissions ever-more incoherent. Overall, the tax-benefit system increasingly divides people into put-upon contributors and recipients who are taking advantage and whose benefit entitlements need to be tightly controlled.

This is not a tax system that is in good shape to raise additional revenue. We need to take a strategic approach to tax reform over the next decade could avoid these pitfalls and ensure that revenue is raised and redistribution achieved in the most efficient way. In a report out today, I outline four principles to govern future reforms. First, reforms should make the tax system fairer, both by ensuring that the better off bear the largest burden and that similar types of activity are taxed similarly. Secondly, revenue should be raised and redistribution achieved in the most efficient way, minimising disincentives to work or invest and using the tax system to discourage undesirable activities like carbon emissions. Likewise, reforms should aim to make the tax system simpler rather than introducing different allowances and tapers as has happened all too often over the last ten years. Finally, reforms should promote the idea that we are ‘all in this together’ as citizens, each making a contribution as we are able and receiving support in harder times.

Three priority key areas of reform follow from this. First, the balance of taxation should be shifted away from earned income towards unearned income and land and property. These are both less highly taxed than income from work, a benefit that largely accrues to the wealthy. The wedge between the treatment of earned and unearned income in the tax system has built up over many years largely by accident as policy makers have cut income tax rates and increased National Insurance contributions, believing that income tax is more salient to voters. Taxes on land and property are in dire need of reform, with council tax still based on property values that are 30 years out of date and more expensive properties being taxed less heavily. Making changes in these areas would therefore be highly progressive.

Next, with the challenge of net zero ahead, a comprehensive tax on carbon emissions will be an important tool. We need to reach a comprehensive and coherent system of carbon taxation, applied appropriately across all types of emissions: at present, some areas, most notably domestic gas, are even taxed less heavily than other goods that do not emit carbon.

Finally, the tax system should seek to address the inequitable impacts of falling global interest rates over recent decades. As interest rates have fallen, assets that generate a constant stream of benefits over time such as shares, bonds and property have risen in value. This has benefited older asset holders, but made it more difficult for younger generations to save a large enough deposit to own their own home and put enough away for a comfortable retirement. The tax system has not responded to this challenge: the capital gains in ISAs and primary residences that older generations have received have not been taxed at all, and those made in pensions will be treated very generously. And although there have been some attempts to help younger generations accumulate assets – through Lifetime and Help to Buy ISAs, for example – the scale of these efforts has been small. Re-examining the favourable tax treatment given to pensions, ISAs and primary residences, and assisting younger generations to accumulate assets should therefore be the third priority of tax reform over the decade ahead.

If we follow this approach, we will not only raise revenue, but reset the tax system for the 2020s to be more pro-growth, fairer, simpler and more inclusive.  

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