The UK is in dire need of tax reform

Ben Ramanauskas

November 19, 2019

The political parties are in campaign mode. Regardless of how you feel about a general election so close to Christmas, whoever wins could give the economy an early Christmas present in the form of tax reform. These are the main ones that the next government should prioritise.

First up, it’s stamp duty land tax. This has the dubious distinction of being one of the most damaging taxes on the books. One of the main issues with it is that it’s a tax on transactions. This type of tax interferes with the proper functioning of markets by reducing liquidity, thereby making it more difficult for individuals and businesses to buy and sell assets.

Stamp duty land tax is no different. In fact, a paper from 2017 by the Adam Smith Institute highlighted just how economically damaging it is. It found that it is four times more harmful to economic efficiency than income tax, eight times more harmful than VAT. What’s more, it’s costing the UK economy approximately £10bn every year.

It is also exacerbating the housing crisis. The fact that housing is so unaffordable in the UK and why you’re paying a significant proportion of your income on accommodation, with little chance of being able to own your own home anytime soon is mainly down to our restrictive planning system. However, stamp duty land tax plays its part.

Levying stamp duty on the purchase of homes keeps people trapped in homes that are either too large or too small for them. This is particularly the case when it comes to older people who would like to downsize after their children have flown the nest.

It means that elderly people are less likely to move to a smaller home and that its abolition would incentivise older people to move, thereby freeing up the housing market. In fact, a 2017 paper showed that the rate of home moving would be 27 per cent higher if stamp duty was abolished.

So, instead of tinkering with thresholds, let’s abolish stamp duty land tax altogether. While we’re at it, we should scrap duty on shares as well.

Then there is corporation tax. This is also a deeply damaging tax as it discourages business investment. Given the fact that investment leads to higher productivity, which in turn leads to economic growth and better living standards, anything which discourages investment should be seen as a bad thing.

There is also evidence that the burden of corporation tax is borne by workers in the form of lower wages. It’s not just wages which take a hit thanks to corporation tax. There is a great deal of evidence which shows that it also reduces employment opportunities for people.

Although the headline rate for corporation tax has decreased over the past decade, this does not tell the full story. The government also made changes to how it treated capital expenditures. The government reduced the value of depreciation deductions for investments in machines and industrial buildings, effectively increasing the effective marginal tax rate on new investment.

So, although it was disappointing to hear that the headline rate of corporation tax will not be cut anytime soon, it’s not a complete disaster. What is more important is how we treat business investment.

The best thing any government could do is to make the annual investment allowance unlimited. This will lead to an increase in investment and so improve our sluggish productivity growth and ultimately lead to higher economic growth and a better standard of living for us all.

Then there are taxes on income. Due to inflation, each year many people end up paying income tax for the first time or paying a higher rate. However, they are not any better off than they were beforehand, it’s just that the government sets the basic rate of income tax at £12,501, the higher rate at £50,001, and the additional rate at over £150,000.

This is known as fiscal drag, and it allows the government to get its hands on more of your money. This discourages people from working and lowers productivity. It’s also a tax raise through stealth.

Fiscal drag should be reduced by linking tax bands to inflation. This will ensure that only those who can afford to pay the higher rate, or any income tax, will be those who can afford it.

Indexing can be done pretty much immediately, but in the longer term, we need a massive overhaul of how we tax income. Take national insurance contributions for example. This is a misnomer: they are a tax, pure and simple. It is obvious to see this with employee’s national insurance contributions, it’s money taken from your pay packet.

However, the same is true for employers’ national insurance contributions. There is a great deal of evidence which shows that this is also a tax on workers. A study looking at the US equivalent of employers’ national insurance contributions found results “consistent with the hypothesis that 100 per cent of the tax is borne by labour”.

In Chile, the equivalent of employers’ national insurance contributions was cut significantly and quickly. One study looking at the impact concluded that “the incidence of payroll taxation is fully on wages”.

While it’s promising that the Conservatives have promised to increase the threshold at which workers start paying national insurance, the next government should be much more ambitious in the long run. National insurance contributions should be abolished and combined into a single income tax of 30 per cent.

What’s more, the different tax bands should ultimately be abolished and a flat rate introduced. This will simplify things for businesses who would no longer have to administer what is effectively two tax systems. It would also increase productivity and labour market participation as people would not worry about moving into a higher tax bracket.

Our tax system is a mess. It’s too long and it’s too complicated. In an ideal world, we would be able to simply abolish all taxes and start from scratch. Sadly, this is not feasible. However, if the next government implemented the measures listed here then the economy would grow and we’d all be better off.


Written by Ben Ramanauskas

Ben Ramanauskas is a research economist at Oxford University and a former adviser to the International Trade Secretary.


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