Sam Robinson is a Senior Researcher at Bright Blue. Bright Blue’s new report, Rightfully rewarded? Reforming taxes on work and wealth, is available here.
This has been a turbulent time for the Government. Months of negative headlines, which have reached a furious crescendo this week, have drained authority and distracted from the task of governing.
The Government will no doubt be hoping for a reset that can turn around its fortunes. But, even when the ‘partygate’ allegations finally abate, there are significant headwinds ahead.
In the short term, the Omicron variant will have no doubt dampened the nascent economic recovery, even while rampant inflation is fuelling a cost-of-living crisis. In the longer term, action is needed to repair the public finances after unprecedented public spending during the pandemic, and to deliver on the Government’s central mission of ‘levelling up’.
Tax policy has a central role to play in addressing all of this. Indeed, the Government has begun the task of restoring the public finances by introducing several big revenue-raisers such as the Health and Social Care (HSC) Levy from April this year. The HSC Levy, however, has continued a trend of shunting the tax burden onto young workers and increasing the already stark differences in the way the tax system treats different sources of income.
While the need to raise revenue cannot be ignored, there is a better way forward on tax reform. A centre-right Government that is committed not only to stabilising the economy but also to ‘levelling up’ the UK in the long term should rebalance the tax system from income associated with work and effort and onto income associated with privilege and luck.
First, lowering taxes on work. The HSC Levy will not be abolished, as some Conservative MPs have been pushing for, but it can be improved. The priority should be significantly lowering the rate of the employer element of the HSC Levy, accompanied by broadening the scope of the levy to apply to pensions and rental income.
Not only would this spread the impact of the levy more fairly, but it would have beneficial economic effects. Indeed, if the state of the public finances allow, Government could go further and also cut Employers’ National Insurance more generally.
In the short term, all this would support businesses by lowering the cost of their payroll at a time when there is significant upward pressure on wages. In the longer term, lowering taxes on employers is likely to feed through into either: higher real wages – especially crucial now that wages have dipped back below 2008 levels; more employment; more profitable businesses; or, a combination of these effects.
This could further aid the economic recovery after the pandemic subsides. But it will also help to pave the way for the high-wage, high-productivity economy that this Government originally set out to create.
To partly offset the net reduction in taxes from work, the Government should look to reform taxes on wealth – chiefly, Capital Gains Tax (CGT) and Inheritance Tax (IHT).
Wealth in the UK is relatively undertaxed: as household wealth has risen from 300 per cent of GDP to around 700 per cent today, the main wealth taxes – including CGT and IHT – have failed to keep pace.
But reforming the way we tax wealth is about more than just a missed revenue opportunity. It is also about fairness. Raising the basic rates of CGT to 18 per cent and 28 per cent, while removing Business Asset Disposal Relief, would reduce the large discrepancy in effective tax rates between income from work and income from assets.
Though we ought to tax capital gains more heavily, it is also vital that it is taxed more fairly. It is time we stopped taxing ‘paper gains’ arising only due to inflation, especially in the current economic climate, by reintroducing inflation indexation. And if we are taxing the upside of investment more then we should cushion against capital losses better, by allowing capital losses to be offset against income for wider range of assets and over a wider period.
Reforms to Inheritance Tax are also a powerful way of supporting the becalmed ‘levelling up’ agenda in the long term. The IFS recently found that the role of inheritance in social mobility is increasing, with real impacts on the life outcomes on today’s young people: among those born in the 1980s, inheritances are predicted to increase lifetime incomes by five per cent on average for the bottom fifth of the wealth distribution, and by 29 per cent for those whose parents are in the top fifth.
Compounding this problem, IHT in its current incarnation is horribly designed. The arbitrary ‘seven-year rule’ means that those who pass on assets well before death face no tax. Reliefs intended to help family businesses are woefully targeted: Business Property Relief applies not just to shares in a family business but can also apply to the value of shares in companies with no family connection. Little wonder that the very wealthiest estates end up facing a lower effective tax rate than other more modest estates.
Moving to a Lifetime Receipts Tax (LRT) with a starting allowance of £125,700, with headline rates mirroring the Income Tax schedule and thresholds set at ten times Income Tax thresholds, would end the arbitrary distinction currently made between the timing of gifts. And it would reduce the ability of the wealthiest estates to minimise effective tax liabilities, ensuring inheritances are taxed more progressively.
To do what we propose around work and wealth taxation, there will be difficult and potentially unpopular decisions along the way. But the reward would be a tax system that can, in the short term, help to boost post-Covid economic growth; and, in the long term, lay the foundations for a more equitable tax system and a more meritocratic society.