The chancellor should start by abolishing national insurance, writes Tim Harford
In his opening words, George Osborne dismissed the idea of “easy answers to problems built up over many years”. A shame. There may be no way through our economic swamp, but there are plenty of things Mr Osborne can do to sort out the national joke our Budget process has become. Here are five.
The chancellor was keen to encourage hard work, but offered instead a national insurance exemption for small businesses that looks vulnerable to abuse.
Here’s an alternative: scrap national insurance entirely, and raise the lost revenue through income tax instead. If NI ever made any sense it was as part of a system of social insurance, designed for an age of the male full-time breadwinner, in which workers chipped into a central pot and withdrew contributions when needed. We no longer have that system.
This means that NI is just another income tax. It is an income tax levied on a narrower tax base, penalising workers and favouring those who live off capital. It is an income tax levied on a different basis and calculated in different ways, breeding cost and confusion. Mr Osborne has raised income tax allowances but NI has not kept pace. When the chancellor boasted of 2m low-paid people being taken out of tax altogether, it was untrue: almost all of them will still pay national insurance.
If NI was replaced with an equivalent but broader-based income tax, the effective tax rate on employment would fall, creating jobs and encouraging aspiring people to work harder – exactly what Mr Osborne says he wants. It would create some very vocal losers and would reveal that income tax rates are not quite as modest as they appear. That must be why neither he nor any of his predecessors has had the courage to scrap national insurance.
Mr Osborne’s second reform should be to impose value added tax on almost everything, including a VAT-like tax on financial services. VAT is an excellent tax: it is broadly based and it does not much distort decisions. VAT targets consumption rather than income, which makes it a good way to tax people’s long-term income prospects rather than their transitory income. This also encourages people to save. But VAT has so many exemptions that these benefits are frittered away. Many of these exemptions are arbitrary: children’s clothes are zero-rated but educational toys are not; Jaffa Cakes are spared VAT but chocolate biscuits attract it. The reduced rate for burning fossil fuels to heat our homes is just perverse.
The obvious objection to a broad VAT base is that it would be regressive. It would indeed be if Mr Osborne did not offset it, using income tax and benefits to cushion the blow. The Institute for Fiscal Studies believes such a reform could be introduced in such a way as to compensate pretty much everyone, while still generating £3bn of extra revenue.
Item three: Mr Osborne should scrap business rates, which are a distortion to the process of doing business, and introduce a land tax, which is not.
And for item four, the chancellor should replace council tax with a straightforward proportional tax on the value of property, a simpler and more progressive approach. He should scrap stamp duty on property: even if you gave a roomful of special advisers all year to try, they would be hard-pressed to invent a clumsier and more foolish tax.
All these ideas suggest themselves quite naturally to anyone willing to step back and survey the tax system as a whole. Most of them are explored in tremendous detail in the Mirrlees Review, published by the Institute for Fiscal Studies in 2011. The review has been quietly absorbed by Treasury officials but has made no discernible impression on the chancellor himself.
The one genuinely praiseworthy measure in Mr Osborne’s Budget – an attempt to encourage parents into work by providing tax breaks for childcare – could have emerged from a reading of the Mirrlees Review. I am willing to bet that it is a happy accident instead.
None of this is Mr Osborne’s fault alone. Successive chancellors have seized the occasion of the Budget to juggle, to conjure, to deceive and to wait for the applause. Mr Osborne’s announcement of cheaper beer, a penny off the price of a pint, was a parody of these tricks. The chancellor almost laughed as he announced the wheeze, and he knew that the newspapers would play along with the joke.
And so, a fifth and final suggestion for Mr Osborne. He should abolish the twice-yearly circus of Budget and Autumn Statement, and start thinking as seriously about his long-term strategy for tax as he thinks about his long-term strategy for re-election. It is time for William Gladstone’s famous old red box to seek its rightful place in a museum.
Originally published in the Financial Times