Written evidence submitted by Taxpayers' Alliance
What are the major long-term pressures on the tax system in the UK, including those arising from changes in working practices, demographics, the environment and other factors? How are these affecting the efficiency of the tax base and the overall level of demand for public services?
Technology and spending profligacy are the major long-term challenges which are piling pressure on the tax system.
Technology is making taxpayers, particularly corporate taxpayers, more mobile, which in turns reduces the power tax authorities have at their disposal. It is too early to tell how much of the shift to working from home will be permanent, but the extent to which it becomes so could open up British labour market to global competition. In turn, HM Treasury may become less able to raise labour taxes without employment consequences. As factors of production become more mobile between tax jurisdictions, a tax at a given rate becomes more economically harmful than it was before. Consequently, optimal tax rates (both the growth-maximising rate and the revenue-maximising rate) fall.
Technology is also enabling taxpayers to avoid traditional duties through electric cars, bikes and scooters for fuel duty and vaping for tobacco duty. Use of virtual private networks and crypto-currencies may enable gambling duties to be evaded while a replacement substance for alcohol may transpire.
As a consequence, the tax base is likely to deteriorate further still. The current level of economic damage wrought by the quantity of tax extracted from taxpayers is exacerbated by the distortionary and economically unwise choice of how the tax burden is distributed. By reducing economic growth and damaging prosperity, unnecessarily high and distortionary taxes shrink the tax base over time, which in turn prompts politicians to choose between cutting spending or worsening the tax burden further still in an attempt to raise revenues.
The choice of ‘pay as you go’ funding models for areas such as healthcare and pensions are good examples of this fiscal ratchet.
What more can the UK do to protect its tax base from erosion as a result of globalisation and technological change, and what further impacts will the coronavirus pandemic have on our tax base?
The most important priority for the UK to protect its tax base is to maximise economic growth and the tax system’s competitiveness. Pro-growth non-fiscal measures such as reforming planning restrictions to allow more homes to be built in high-demand areas should be advanced. It might be too soon to assess long-term transport needs in case demand patterns have permanently changed (which is why HS2 should be at least paused until after the pandemic). Nonetheless, the tax system can be made more efficient.
An important factor in maximising economic growth is the level of the tax burden and how efficiently it is distributed. Unfortunately, the UK’s tax burden is at its highest level since the aftermath of the second world war, with the exception of a one-year spike in 1969-70. It is also inefficiently distributed throughout the economy. Transaction taxes on shares and property are particularly damaging. Recent governments have also set the level of the top rate of income tax and capital gains tax at what they estimated to be the revenue-maximising rates. In other words, the level where the rate is causing so much economic damage that were it to be raised any higher then it would actually reduce revenues.
The best way to counter the growing damage to the UK tax base would be to substantially reform the tax system with a view to simpler, fairer, lower taxes. In 2012 the TaxPayers’ Alliance published The Single Income Tax, a comprehensive review of the tax system which proposed replacing taxes on all forms of income, including national insurance, capital gains, inheritance, corporation and income taxes, with a single income tax at a single rate of 30 per cent. The proposal would eliminate much distortion between different economic activities and with it the requirement for much tax legislation (a great deal of which is designed to work around the problems caused by the distortions inherent to the current system).
It is too early to tell what the impact of the pandemic on the tax base will be. It will depend on how quickly immunity is reached, how great the long-term health effects of the virus turn out to be, how great the extent of unemployment and scarring are, and how permanent shifts to online shopping and working are.
Do these pressures need to be met with tax reform, and if so, is this the right time for reform?
The long-term pressures of technology and over-spending have long been in need of substantial tax reform but the pandemic makes some aspects of the necessary reform more urgent than ever. Most pressingly, the sharp rise in unemployment benefit claimants which the pandemic has already caused and the high risk of that translating into mass unemployment mean that the immediate fiscal consequences of labour income tax reform are much less problematic than they are in normal times.
To encourage job creation, the chancellor should immediately abolish national insurance entirely for both employers and employees. It should then be replaced with a temporary payroll tax of 10 per cent on wages and salaries (above £4,500 per employee) from October. This would cut a typical payroll tax bill by 38 per cent this year, meaning that fewer companies will have to lose staff and more will be able to hire.
This would recoup some lost revenue but with a view to phasing it out over this parliament. He should also introduce an earned income surcharge on PAYE income tax, but using income tax definitions and rules. Gaps between the measures would result in a fiscal shortfall, but would serve as a powerful stimulus for employment.
What overall level of taxation can the economy bear without undesirable or counterproductive harm to economic growth?
The UK economy could withstand a higher tax burden than it currently bears. Other economies have higher tax burdens than the UK. Importantly, however, the tax burden that the economy could bear without undesirable harm to economic growth is already much lower than the current tax burden.
Recent governments have set the level of the top rate of income tax and capital gains tax at what they estimated to be the revenue-maximising rates. In other words, the level where the rate is causing so much economic damage that were it to be raised any higher then it would actually reduce revenues. Most other taxes are causing substantial harm to economic growth, even if the level of harm is not so great that even revenues would be reduced by raising their rates further still.
If the UK wants Singaporean economic growth rates, for example, we will need a Singaporean tax burden. The tax burden is not the only factor which affects growth, of course, but it is an important one. Burdens over 20 to 25 per cent of GDP start to reduce economic growth, with undesirable consequences for prosperity and well-being. How much of those undesirable consequences we might wish to bear is a judgement, but the TaxPayers’ Alliance recommends a tax burden of a third of GDP, which lies somewhere between the current level and the growth-maximising level.
Which areas of the tax system are most in need of reform, and which are best left alone?
Taxes on income and transactions present the most pressing case for reform. The multitude of different taxes on different types of income generate a raft of distortions and incentives to structure affairs artificially to avoid them. Corporation tax, national insurance, capital gains tax and income tax are all ultimately taxes on income which should be simplified into a single income tax. Tax liability for economic activity varies depending on other income, whether it is capitalized, whether it is paid in salary or dividend and whether it is employment or self-employment, among other factors. Ultimately, these decisions ought to have no tax consequence and should only be taken to reflect genuine commercial imperatives. Our Single Income Tax proposal is designed specifically with this in mind.
Meanwhile, while they are smaller in scope and less complex, taxes on transactions in the form of stamp duties on shares and property are highly destructive and are recognised by economists as a prime candidate for abolition.
Beside reform of property taxes, consumption taxes offer the least scope for fruitful tax reform, particularly if the political implications are considered.
What reforms should be considered in response to the pressures on the tax system?
The best way to counter the growing damage to the UK tax base would be to substantially reform the tax system with a view to simpler, fairer, lower taxes. In 2012 the TaxPayers’ Alliance published The Single Income Tax, a comprehensive review of the tax system which proposed replacing taxes on all forms of income, including capital gains, inheritance, national insurance, corporation tax and income tax, with a single income tax at a single rate of 30 per cent. The proposal would eliminate much distortion between different economic activity and with it the requirement for much tax leglislation, a great deal of which is designed to work around the problems caused by the distortions inherent to the current system.
Raising the thresholds of inheritance tax and stamp duty land tax to £1 million would effectively simplify both for the large majority of taxpayers. For example, rules on lifetime gifts for inheritance tax become redundant if there is little prospect of being caught in the tax due to a high threshold.
What is the role of tax reliefs in rebuilding the economy and promoting economic growth and efficiency? Does the current regime of tax reliefs perform this role well?
Tax reliefs usually provide a means for chancellors to exempt specific groups from the damaging effects of the relevant tax. For example, principal private residence relief from capital gains tax spares families from the consequences of capital gains tax on selling a family home. Capital gains tax distorts ownership patterns and should be abolished but chancellors tend to be unmoved by the obscure economic damage the tax wreaks in most circumstances. However, these consequences would be politically explosive were they to be suffered by a majority of voters on family homes, which explains the relief.
Similarly, a relief exists for producers of ‘high-end television’ and another for video games, from corporation tax. These reliefs distort the economy to the advantage of certain groups in the creative industries. The existence of reliefs demonstrates how destructive governments really believe taxes to be, when those who bear them are politically significant.
What are the areas for simplification?
The best way to simplify a tax is to abolish it. That is what should be done in the case of national insurance, capital gains tax, corporation tax, stamp duties and inheritance tax. But there is plenty of scope for tax simplification in other areas, too. For example, replacing the schedule of rates of income tax with a single rate would eliminate the incentive to shift income across time, employment tenures and family members, and could make much anti-avoidance legislation redundant. In addition, there is scope to simplify taxes which ultimately should be abolished. Raising the thresholds of inheritance tax and stamp duty land tax to £1 million would effectively simplify both for the large majority of taxpayers. For example, rules on lifetime gifts for inheritance tax become redundant if there is little prospect of being caught in the tax due to a high threshold. In addition, needlessly complicated alcohol duties could be simplified into a simple tax on alcohol content regardless of the drinker’s choice of grape or hop, still or sparkling etc. Similarly, reducing the rate of capital gains tax to 10 per cent would make business asset disposal (formerly entrepreneurs’) relief redundant.
Is there a role for windfall taxes in the post coronavirus world?
It is a mistake to view windfall taxes as either a consequence-free or an appropriate response to a large unexpected shock. In the same way that a prudent household would attempt to smooth the cost of a major shock to its budget, so too the government should do so with the cost of the pandemic. It has been suggested that targets for a potential windfall tax might be companies such as Amazon or those with personal protective equipment stocks, which have performed well. But we should not want to discourage companies from responding to changed circumstances during pandemics. The next time the UK is in an emergency, we will want companies to not fear a windfall tax if they act accordingly. This would stifle innovation and could have severe consequences beyond just the tax system.
What is the right balance between taxation of work, savings/pensions and wealth?
Wealth taxes are highly destructive and, internationally, are usually abandoned soon after being implemented. As well as discouraging the accumulation of wealth in the first place, with the damaging consequences for incomes and prosperity that entails, wealth taxes encourage capital flight, which can be disastrous for the country which imposes it. This is a particularly high risk for the UK due to our open economy and high proportion of rich residents with strong links to other countries. The major long-term challenges discussed earlier to work patterns and labour mobility could enhance this risk further.
The net household saving rate in the UK is low relative to other OECD countries. This represents the total amount of net saving as a percentage of net household disposable income. This is likely to partly explain the productivity puzzle, because savings are where investment arises from, and investment is the engine of productivity growth. The government should encourage savings, not least in the form of pensions. Ultimately, the best way to do this would be to replace corporate and personal income taxes with a single income tax that taxes only distributed income, such as the TaxPayers’ Alliance Single Income Tax proposal. In the meantime, restrictions on pensions saving should be relaxed.
What is the best way to tackle tax reform, including what changes might be needed at HMRC to support implementation, and how should the Government consult with stakeholders and parliament?
HMRC, HM Treasury and the chancellor are regularly approached by stakeholders to lobby for particular outcomes, including reliefs. Some of these could lead to inefficiencies and prevent improvements to the tax system and meaningful tax reform.
Many structural and non-structural tax reliefs are created because of this. For instance, a relief exists for producers of ‘high-end television’ and another for video games, from corporation tax. These reliefs distort the economy to the advantage of certain groups in the creative industries. The existence of reliefs demonstrates how destructive governments really believe taxes to be, when those who bear them are politically significant.
 TaxPayers’ Alliance, Tax reforms to secure a recovery from coronavirus, 3 June 2020.
 TaxPayers’ Alliance, The Single Income Tax, 2012.
 OECD, Household savings, 2020, https://data.oecd.org/hha/household-savings.htm, (accessed 8 September 2020).