The UK tax system is a hot mess

Jeremy Hunt
Jeremy Hunt
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Amid all the predictions and speculation about Wednesday’s Autumn Statement, here’s one forecast you can take to the bank: it will contain lots of fiddly changes that will make things more complicated and do nothing to fix the fundamental flaws that are holding back economic growth.

“A tax system is a political philosophy expressed in numbers,” wrote the academic Stefan Collini in a recent edition of the London Review of Books. In theory, perhaps.

But imagine taking the 21,000 pages and 10 million words that constitute the UK tax code and trying to reverse-engineer the guiding ideology that shaped it.

You’d surely be stumped; it is not so much the manifestation of any grand vision as it is a complete hot mess.

The UK government’s revenue-raising mechanisms are the product of compulsive tinkering and inveterate dithering. It is also, frankly, the upshot of what a variety of chancellors have felt they could get away with.

The result is a patchwork of rules and varying thresholds that can be wildly unfair, encourage evasion and distort the economy.

Given that there’s barely a cigarette paper of difference between the Conservatives and Labour on fiscal matters it seems unlikely this dire situation will be remedied any time soon.

Jeremy Hunt says he can’t afford to cut taxes much if at all; the shadow chancellor Rachel Reeve doesn’t want to scare the horses with promises to raise them.

The two main parties therefore look likely to dance around the key topic of tax in the lead up to the next election. This can already be seen in the main mechanisms Hunt and Reeves are using to boost revenues.

The current Chancellor is raising money by stealth, letting inflation push people into higher income tax brackets. This alone will bring in about £40bn annually by the end of the decade.

The would-be Chancellor, on the other hand, has ruled out any tax rise beyond populist measures like introducing VAT on private school fees and believes she can raise an “election war chest” by closing loopholes in the existing system.

Such measures could generate around £3.5bn a year, according to a report by the Resolution Foundation, which, considering the UK’s myriad and byzantine tax reliefs “cost” the Treasury £195bn in 2021, is pretty small beer.

On Monday, Rishi Sunak said that, now inflation has halved, his government can turn its attention to cutting taxes and attempting to boost growth.

Unfortunately, most of the kites that have been flown in recent days at best address the symptoms of our economic malaise, rather than the underlying pathologies.

Take, for example, reports over the weekend that Hunt is looking to cut income tax (or possibly national insurance) by a penny in the pound and to raise the VAT threshold for businesses from £85,000 to £90,000.

Cutting the basic rate of income by this amount would cost about £6bn according to HMRC estimates. In other words, not a great deal. Spread across all those affected, the impact would be barely negligible. It’s a gesture at best.

For that money, Hunt could abolish stamp duty on primary residences – which Paul Johnson, the head of the Institute for Fiscal Studies (IFS) describes as “arguably among the worst, most damaging taxes we have”.

Why is stamp duty so bad?

Because, as the IFS has pointed out, it throws “an almighty spanner into the gears of the housing market”, discouraging a host of useful transactions such as downsizing in retirement (which could free up unused housing) and moving to find a better job.

Or the Chancellor could address the extraordinary situation whereby someone earning £50,000, with three children under 18, faces a marginal tax rate of 71pc.

This is the result of rules in place since 2013, which limit the amount of child benefit if a parent or their partner earns more than £50,000 a year.  If they are also still paying off a student loan (which is a graduate tax by any other name), their marginal rate increases to 80pc.

As a variety of campaigners have pointed out, this is a massive disincentive to work, which is exacerbating the shortage of key workers and retarding economic growth.

The recently retired tax tribunal judge Richard Thomas has described the high income child benefit charge as “the worst tax policy decision of this century”.

The best designed taxes raise money without stunting productive capacity. In other words, they don’t diminish or disincentive effort or investment in a particular area or activity.

That being the case, the £85,000 threshold above which businesses start paying VAT is also a contender for the title of worst fiscal policy in the UK.

The damage this does is clearly shown by the line on a simple graph plotting the number of businesses at various different levels of turnover, which drops off a cliff just before you get to the £85,000 threshold. As Dan Neidle, the tax lawyer and campaigner, points out, this illustrates a completely rational response to an extremely flawed system.

“If you’re a coffee shop making £84k then £1k more income means registering for VAT and putting your prices up by around 15pc. Making you uncompetitive compared to the others who aren’t registered,” he tweeted. (It’s 15pc rather than 20pc, by the way, because most businesses can recover some VAT on their rent and other costs. More complexity! Hooray!)

Businesses therefore deliberately hold back growth in order not to meet the threshold. All in all, Neidle estimates there are around 26,000 businesses that have slammed on the brakes at a time when we need everyone to be putting their shoulders to the wheel.

Raising the threshold is a classic sticking plaster; it will help – a bit. But the real issue is that there’s a threshold at all. The Chancellor may be able to generate some ephemeral headlines on Wednesday but not much growth.

Meanwhile, the wait for a politician possessing the necessary combination of gumption, political wiggle-room and backbone to address the UK tax system’s most glaring flaws continues.

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