Sam Hall is a senior research fellow at Bright Blue.
A bold tax reform bill has reinvigorated the Republican party in the United States. This was the first major legislative achievement of the Trump White House and Republican Congress, and has triggered a string of positive jobs and pay announcements from business. Despite initially unfavourable polling, the tax cuts have proved popular with middle America. But critics of the Bill are right to highlight the huge increase in the budget deficit and the concentration of the gains among the wealthy.
In the UK, the Conservative Government’s appetite for tax reform is low. Constrained by a challenging fiscal position, George Osborne’s ambitious rhetoric in the early days of the Coalition translated in to only a handful of successful reforms.
The most notable has been the rise in the income tax personal allowance from £6,475 to £11,850, giving a majority of people a tax cut and exempting the lowest earners from income tax altogether. The cut in the rate of Corporation Tax from 28 per cent to 19 per cent has given the UK the lowest headline rate in the G20. The carbon price support, a levy on power generators’ carbon emissions, is the main reason that coal’s share of electricity generation in Britain has fallen from 40 per cent to seven per cent in the past five years.
There is a big opportunity for the UK Government to make its own bold reforms to the tax code. These reforms, however, should follow different principles from Trump’s and have different objectives.
Above all, tax reform should be fiscally responsible. Of course some expansionary tax cuts can increase government revenue by stimulating higher economic growth. But unfunded tax cuts on a grand scale will inevitably increase the budget deficit and pass the cost of today’s spending on to the next generation. At a time of myriad and growing fiscal pressures, the Government cannot afford to forgo huge amounts of revenue. Similarly, as new technology and business models erode the tax base, the tax system needs to respond and adapt to ensure sufficient funding is raised for public services.
Two other principles should apply. The first is that reform should clearly and primarily benefit lower earners. It is bad politics and bad policy for the Government to give tax cuts to the wealthiest at a time when low-income workers are, on average, struggling with shrinking real wages. Second, taxes should act more as price signals to deter behaviour that creates costs for society, such as climate change or obesity.
So what would this look like in practice? The Government should tax income less on average, particularly low incomes. In recent years, this has been delivered by raising the income tax personal allowance. But to ensure the lowest earners benefit, the focus now should be on raising the salary threshold for paying employees’ National Insurance. At its current level of £8,164 per annum, this creates a high marginal tax rate for those on the lowest incomes.
Additional revenue could be raised by addressing the growing unfairness in how different categories of employment are treated within the tax system. The Government should be brave and revisit its proposals to increase the National Insurance contributions of self-employed people, a growing form of employment in the modern labour market. It should also make owner-managers of for-profit companies pay income tax on any dividends they take out, rather than the current (lower) rate of tax. It’s also time to reduce higher rate pension tax relief, an increasingly expensive policy for the Treasury that, by definition, solely benefits the better-off.
The Government should proceed with its planned cuts to Corporation Tax to 17 per cent. As companies consider where to invest or where to place their headquarters after Brexit, the UK should make itself as attractive as possible with a low headline rate. It is also an important policy in the context of the industrial strategy which is encouraging more business investment. But in some areas where business has not delivered sufficient investment, such as skills training, the Government should consider a targeted levy. Bright Blue has argued for a ‘graduate levy’ on large graduate employers to subsidise a new lifetime loan account to enable all adults to pay for several higher education courses throughout their lives.
Property taxes should be shifted away from transactions towards higher value property ownership. At the last Budget, the Chancellor scrapped Stamp Duty for nearly all first-time buyers, a policy that Bright Blue had been campaigning for. This important reform reduced the amount of money that aspiring homeowners need to pay upfront to get on the first rung of the property ladder. Longer-term, however, Stamp Duty should be reduced further, or abolished entirely. By taxing transactions, it acts as a barrier to a more efficient distribution of the housing stock, for instance by disincentivising older people from downsizing.
Given the huge increase in house prices since 1991 when council tax valuations were last carried out, councils should be permitted to add a couple of extra council tax bands, so that the most expensive properties contribute more. Another progressive step would be scrap the forthcoming cuts in Inheritance Tax that will eventually allow couples to hand on property worth up to £1 million tax-free.
Consumption should be taxed more according to the external costs it imposes on society. It’s time to unfreeze the carbon price support, fuel duty, and Air Passenger Duty, which in effect tax carbon emissions from electricity, road transport, and aviation respectively. The Government should develop new taxes for plastics, which are a growing concern to the public and harm marine wildlife. Similarly, the new sugar tax should be extended beyond sugary drinks to all food products to help combat rising rates of obesity.
Some consumption taxes need long-term reform as a result of technological advances. A major source of government revenue currently is fuel duty, generating around £28 billion a year for the Exchequer. As internal combustion engines are replaced by electric vehicles, this figure will gradually disappear, leaving a major hole in the public finances. The Government should therefore start developing and phasing in a new road pricing mechanism that would charge motorists for their road use, as well as the air pollution, congestion, and carbon emissions they produce.
Tax reform in the UK should not mean deficit-ballooning tax cuts for the wealthy. The Government should instead pursue a balanced set of changes that ensures public services are well-funded, hard work – particularly by the low paid – is rewarded, and activities that cost the taxpayer are discouraged.