A comprehensive review of the taxation system in the UK has just been published by Institute of Fiscal Studies.
Tax and public finances: the fundamentals by Isaac Delestre and Helen Miller
Summary at
https://ifs.org.uk/publications/tax-and-public-finances-fundamentalsThis report highlights 10 key facts about UK tax and public finance policy that will underpin the choices faced by governments in coming decades. It supports and expands the argument made in the PFMBoard above.
To quote the report: “Rather, it is a question of how those taxes are designed. The 10 key facts that we have highlighted (see the ‘Fundamental facts’ box) reflect that almost all taxes have major design flaws and significant scope for improvement. If the opportunity is taken, those improvements could go a long way to reducing the economic pain that a higher overall level of tax would entail. While there are specific choices and challenges for each tax, the problems caused by poor tax design fall into three broad types.
First, various taxes distort the choices of people and firms in ways that are unjustified (in the sense that the distortions are not necessary to achieve government aims, such as redistribution). For example: high marginal tax rates caused by ‘humps’ in income tax reduce work incentives (by more than is necessary to achieve redistribution); preferential tax rates on business incomes discourage employment (relative to self-employment); large-scale carve-outs within VAT create heavy compliance burdens; corporation tax both discourages some profitable investments and subsidises some unprofitable ones; and stamp duty prevents some people from moving house to, for example, take a better job. Such distortions can mean that less work is done, investment is lower and/or resources are not being allocated to their most efficient uses. Ultimately, inefficient tax design is an unnecessary drag on productivity.
Second, many parts of the tax system are unfair. This is not a statement about vertical redistribution, about which there is reasonable disagreement. Parts of the tax system currently treat very similar people in very different ways that are hard to justify. Two people living in houses that are worth the same amount today can face very different council tax bills if their houses happen to have been worth different amounts in 1991 (the year on which council tax valuations in England and Scotland are based). And two people earning the same income by doing the same work can face very different tax bills if one is an employee and the other is self-employed. Taxes are currently also reinforcing inequalities arising from the fact that different generations have experienced very different economic conditions. Notably, large capital gains on main homes – many of them the result of luck – have been central to a growing intergenerational divide in wealth and are completely untaxed.
Third, some parts of the tax system are not well designed to achieve policy aims. Taxes are, of course, not only used to raise revenue or (alongside the benefit system) to redistribute income. Governments have also long used tax with the explicit aim of changing behaviour. In fact, in recent decades, governments have been introducing new ways to do this. Most notably, there are now various parts of the tax system, including a large number of environmental levies, that are aimed at reducing greenhouse gas emissions. The tax system should play a key role in helping the UK transition to net zero. However, the combined effect of the various government policies is an uneven set of incentives that will make achieving net zero more costly than it needs to be.
There is nothing inevitable about the tax system we currently have or the problems it creates. It can be challenging to design taxes and, in some cases, there are trade-offs between different goals. But much is known about how to reform taxes in ways that would make the system more effective, efficient and equitable.
The main challenges are likely to be political. Many of the needed reforms would be large. There would be losers, as well as winners. The potential losers are often a more concentrated and better-organised group than those who are losing out from the current system. In addition, there is often a public misunderstanding about why the tax system is the way it is and which features are justified. For example, over 80% of the UK’s workforce are employees. They lose out from a system that gives tax breaks to the self-employed. If taxes were the same for both groups, overall spending could be higher or taxes on employment lower. Despite this, most employees do not think of themselves as losers from this system. In addition, there is widespread belief that lower tax rates on the self-employed are justified by lower government benefits for that group – this is not the case. Philip Hammond, when Chancellor, tried to implement a small increase to National Insurance contributions of the self-employed in Budget 2017; he U-turned after fierce opposition.
Despite the political difficulties of reforming taxes, governments do face a choice; not seeking to address the problems with the design of the tax system is a choice to live with those problems.
Governments should take this choice seriously. The design of the tax system matters hugely. Reforms in the areas we highlight would be worthwhile even if taxes were being cut overall. But the shape of the tax system matters even more when spending demands are placing upward pressure on the overall level of tax.
There are no silver bullets here. But better-designed taxes could bring real benefits, including by supporting higher economic growth and facilitating the move to net zero. Tax could and should be part of the solution to future challenges rather than part of the problem.”
Full report can be downloaded from
Tax and public finances: the fundamentals (ifs.org.uk)
https://ifs.org.uk/sites/default/files/2023-08/IFS-Report-R270-Tax-and-public-finances-the-fundamentals_final.pdf
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