Most Budget-day tweaks make the tax system worse. These wouldn’t

6th April, 2023

The tired metaphor is that the chancellor will try to pull a rabbit out of the hat on Budget day. The sleight of hand is usually less delightful: he’ll stuff some frozen prawns behind the radiator and a turd underneath the sofa, and hope to make a getaway before anyone notices the stink.

The game is so predictable and such useful theatre for the ­government (and the press) that it is easy to lose sight of the absurdity. Each Budget day, the chancellor shuffles taxes, tweaks rules, makes surreptitious changes to allowances and promises to come back and do the same thing in 12 months — or sooner, if we are unlucky. This is no way to run a tax system.

The endless fiddling has a political logic, but it is both a symptom and cause of a shambolic patchwork of taxes. That patchwork is unfair, distorts the economy and promotes the crime of tax evasion as well as levels of paperwork that should also be deemed criminal.

“It’s hard to think of a tax that doesn’t need serious reform,” says Helen Miller, deputy director and head of tax at the Institute for Fiscal Studies.

One common problem is that fundamentally similar things end up being taxed differently. The eye-catching examples — are Jaffa Cakes biscuits or cakes? — are less important than distortions to how we all earn money. A person can do much the same work in the same conditions whether employed, ­self-employed or incorporated as a small business, but the tax implications are very different. There is no justification for this (muttering about entrepreneurship included) and considerable effort is squandered by accountants trying to figure out how to help clients squeeze through this income tax loophole — and by HMRC trying to work out how to stop them.

With some sensible allowances for capital investment, it is possible to tax all income on the same basis. But we don’t. And this is just one of ­hundreds of examples of clumsy taxation.

A government with brains and stomach would scrape away the decades of bodging and rebuild the tax system on firmer foundations, but it’s been a while since such a government was seen around here.

For an achingly nerdy vision of what a better tax system could be, skim “Tax by Design”, the conclusions of a review conducted by the Institute for Fiscal Studies under the leadership of Nobel ­laureate James Mirrlees in 2010. (Mirrlees died in 2018, having seen his review almost completely ignored by the government.)

“Tax by Design” argues that a good tax system should strive to be as simple as possible and neutral between similar activities, such as buying cakes or biscuits, or earning income from different sources. It should also be progressive, in the sense that the rich should pay a larger share of their incomes.

But — and this is something almost everyone gets wrong — having a progressive tax system overall does not require progressivity in each detail. For example, in a gesture towards promoting social goals, the UK system has a long list of VAT exemptions and discounts on everything from food to children’s shoes to tampons to chartering helicopters. Helicopters notwithstanding, many of these seem appealing. Who wants to tax a poor family’s efforts to buy potatoes?

Yet if we honestly ask about the best way an entire tax system could help the poorest in society, the answer would not be cheaper food and children’s clothes for all but more generous benefits and better-quality public services.

Going down a list of products and tax-exempting the ones that seem like Good Things — from “magnetic tape adapted for recording speech for blind people together with the apparatus for making and playing the adapted tape and certain low-vision aids” to, um, helicopters — is not the foundation of a fair and progressive society. You may feel it’s impossible to have a progressive tax system with a broad, high rate of VAT, yet Denmark seems to manage it.

Not that Denmark, or anywhere, is perfect. US income taxes appear to be designed to maximise the pain of compliance, something which suits tax preparation companies and small-government propagandists but is simply absurd. Miller told me the UK’s messy system is not exceptional.

There are some radical ideas around for tax reform. A land value tax is a perennial idea, for good reasons. Or what about a universal marginal income tax rate of 50 per cent, pivoting at an income of £10,000 a year? If you earned nothing, you’d be £10,000 below the pivot point and would thus receive 50 per cent of that, or £5,000, as a ­negative income tax. If you earned exactly £10,000 you’d pay no income tax. If you earned £110,000 you’d pay £50,000. The same marginal tax rate for everyone, but a progressive system overall. Cute.

But one needn’t be cute to make the system fairer, simpler, more transparent and less distorting. And while the list of possible reforms is long, the list of sensible principles is bracingly short:

  • Levy VAT on as many products as possible
  • Merge National Insurance with income tax, and tax all income on the same basis regardless of source
  • Reform council tax to make it less regressive and based on ­property valuations from the ­current century
  • Automatically update thresholds and allowances with inflation
  • Spend the proceeds of all these reforms to help those in need.

Will it happen? Simplifying reforms are sometimes introduced, from the introduction of universal credit to the introduction of VAT. But not often. Rather than discussing the ­broad principles of fair and effective taxation on Budget day, we’ll be trying to sniff out those prawns before they start to rot.

Written for and first published in the Financial Times on 10 March 2023.

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