Sam Bowman is Executive Director of the Adam Smith Institute.
Happy Tax Freedom Day! Today is the first day of 2016 where Britons are no longer working to pay their tax bills and finally working for themselves. Break out the bubbly.
It’s not all good news, though. It’s a bit later than it was last year – four days later. Actually, it’s the latest it’s been since 2001. In fact, it’s only been this late four times in the past thirty years.
As it happens, another European country is celebrating its Tax Freedom Day today as well – that free market paradise, Italy. Maybe it’s worth putting away the champagne and sticking with the cheap prosecco.
But didn’t the Government cut Corporation Tax and raise the personal allowance? Hasn’t George Osborne, for all his faults, been a tax-cutting Chancellor?
Well, no. Although he has cut some taxes, he’s raised others like excise duties, and allowed inflation to bring people into higher Income Tax brackets. Since last year, no single tax has brought in much more money, but across the board taxes have taken a bigger bite. That can happen even when taxes stay the same if activity changes. We’re earning a bit more, spending a bit more on VAT-rated products, investing in more highly taxed assets.
The overall tax take as a portion of Net National Income has remained fairly steady since the late 1980s, even though government spending has fluctuated wildly over the past thirty years. (Fluctuated, but almost always staying above what we’re raising in tax. Funny, that.)
Whatever the outcome of the EU Referendum and the Conservative Party leadership contest, it’s unlikely that Mr Osborne will still be Chancellor by the end of this Parliament. His successor will want to make a name for themselves. Radical tax reform might be the way to do that.
This needn’t just be about cutting the overall tax burden, though that would be welcome. Simplifying and flattening some of the thirty-odd taxes that Britons pay – taxes like VAT, stamp duty, Income Tax, National Insurance, Capital Gains Tax – would boost incentives to save and invest, and cut the amount of time and money we waste in navigating the system and avoiding the worst taxes.
So what might a radical but realistic tax-cutting agenda look like? The emphasis should be on two things: one, raising the incomes of the working poor today; and two, boosting investment and growth to increase everyone’s incomes tomorrow.
The Government has done well to raise the personal allowance to reduce the burden of Income Tax from workers. But it hasn’t touched the National Insurance threshold at all, which still sits at £8,060/year. It’s not really true to say they’ve taken the poorest workers out of tax, because National Insurance is really just a special form of Income Tax. It doesn’t go into a special pot saved away for a rainy day, it goes on day to day government spending like most other taxation.
What’s more, raising the Income Tax threshold has diminishing returns, because lots of poorer workers don’t earn enough to surpass it either. That’s less true of National Insurance – which means that raising the threshold would also complement the welfare agenda by helping to make work pay.
But the real low-hanging fruit is in fixing Britain’s capital taxes. Capital taxes are – by definition – a tax on investment. Since people’s savings are used for investment in firms, when we tax company profits, we shift the scales from investment towards consumption.
According to Nobel prize-winning economist Robert Lucas, the economic gains from eliminating capital taxes could be greater than the gains from avoiding all recessions forever. The gains could be even higher for the UK.
Obviously, abolishing capital taxes like Corporation Tax and Capital Gains Tax would be politically difficult, since most people see them as taxes on the rich rather than taxes on economic growth. But shifting towards progressive consumption taxes, which tax income used for spending but not saving and can do so at a progressive rate, may allow us to get the best of both worlds.
Finally, revenue-neutral moves to simplify the tax system would make it clearer how much people are really paying. The Chancellor did make noises about merging National Insurance and Income Tax, which he quietly dropped, but the real prize would be to make it clear that employer NICs ultimately fall on workers’ wages. When you add up Income Tax with both employee and employer NICs, the marginal tax burden on ordinary workers’ wages exceeds 40 per cent. If more people realised how much tax they were paying, they might not feel like they’re getting such a good deal from the state.
Tax cuts in a time of austerity may seem like a hard sell. But targeting them on the income of the average worker, and shifting the burden elsewhere away from investment to boost growth would complement a belt-tightening agenda. And it would give whoever succeeds Mr Osborne a chance to make a clean break with the past.