Tax after Coronavirus Inquiry: Economists favour reforms to employment and property taxes

4 Sep 2020

The Treasury Committee held the first oral evidence session of its Tax after Coronavirus inquiry this week (1 Sept). The witnesses were Paul Johnson, Director at the Institute for Fiscal Studies, Dr Gemma Tetlow, Chief Economist at the Institute for Government, Mike Brewer, Deputy Chief Executive and Chief Economist at the Resolution Foundation, and Professor Philip Booth, Senior Academic Fellow at the Institute of Economic Affairs. They spoke for greater neutrality in employment taxes and better taxation of property.

When asked by committee chair Mel Stride (Conservative) about major taxes the Government will need to look at, Johnson said that taxes will have to rise because the economy will be smaller than expected and the pressure on public services will be greater. In the medium term he expects a rise in national insurance, income tax and VAT because that is where two thirds of tax revenue come from. He said increasing the income tax basic rate of 20 per cent by two per cent or three per cent would not do any ‘significant economic damage’. Tax rises to make the tax system more efficient would be welcome (e.g. council tax, capital gains tax and moving tax rates on the self-employed up towards tax rates on employees) but would not bring in much money. We could broaden the base of VAT, such as on some of the things that we currently zero rate, although it would be ‘politically unpopular’ he acknowledged. Limiting pension tax relief to the basic rate would be ‘distributionally progressive’. He added that there is a case for at least a modest increase in tax on occupational pensions in payment, given that they will have not have had national insurance paid at any point in the past and have been extremely well tax relieved.

Tetlow supported Johnson’s call to broaden the base of some taxes and warned that simply increasing the rates of existing taxes runs the risk that you increase distortions. Brewer found it quite difficult to think of tax rises that are pro-growth. Booth suggested broadening the VAT base and potentially some kind of tax on users of services and cost of housing would be another ‘non-anti-growth’ way of raising taxes significantly.

Angela Eagle (Labour and pictured thanks to Parliament UK) probed about Digital Services Tax and wealth taxes. Brewer remarked that with increasing digitalisation, globalisation, mobility of income and difficulty of pinning down income, something like a wealth tax, particularly on immovable forms of wealth, might be sustainable throughout the next few decades. Land is a perfect thing to tax; we just need to find a way of valuing it all, he said.

Booth said his big concern is the next 30 or 40 years when, because of demographic pressures, the relationship between the tax base and government spending changes dramatically.

Brewer told Conservative Steve Baker that we either need substantial tax rises or we need to provide less good health and social care and pensions, or the population must pay more themselves. Tetlow said the challenge is how you avoid having a generation that effectively pay twice – paying taxes today for health and social care for current older people and then pre-funding their own care later on. Perhaps you try and take additional tax from those who in the past have not paid as much?

Julie Marson (Conservative) asked about the taxable capacity of the UK. Johnson said it is possible to run a pretty effective and efficient economy with a higher tax burden than the UK currently has, such as in northern and western Europe, and we have the capacity overall to raise somewhat more tax than we do at the moment. Brewer said there are plenty of areas where he would suggest that you could raise taxes without reducing growth rates substantially, by focusing on those areas right now where there are tax distortions between different kinds of activity, which are unhelpful. Booth said we should be reducing the size of the state rather than increasing it.

Separately, Tetlow said there is no clear evidence that there is a growth-maximising level of tax; it matters how you tax, not just the total level you are taxing at. She added that the overall impact on growth depends on what the Government spend that money on. Brewer said we should not just think that cutting tax rates will boost the economy; we should also think about what the Government could do with spending to improve the long-run growth rate of the economy, e.g. by improving productivity.

If we do need to raise taxes, when should we raise them, without creating a risk to the economy, asked Anthony Browne (Conservative). Johnson replied that he does not think we should be looking at tax rises this year and he would be surprised if we saw significant tax rises next year. He said: “If we do need higher taxes then, we are probably looking at bringing them in from two to three years hence, rather than six months to 18 months hence, when we hope the economy will be firing on all cylinders, or close to it.” When depends on the level of growth and the new equilibrium level of economic output and demand for even more public spending. Booth said you do not necessarily have to implement tax rises immediately, but the thinking and the planning should be done very quickly.

Tetlow opined that trying to announce specific measures quickly runs the risk of ending up being backed into a corner of introducing the most politically feasible tax changes, which are often not the most sensible economically in terms of tax changes. Brewer made the case for some tax rises now to account for the great variation in how people have been affected by COVID-19.

Siobhain McDonagh (Labour) asked about principles that could lie behind future tax policies. Tetlow said the notion of fairness is quite a ‘difficult, nebulous one’, and there will always be trade-offs between the principles that you start out with. Government should be clearer about its own objectives for the tax system, she said. Booth warned that the simpler a tax system is, sometimes the less transparent it becomes. Johnson said the fundament of both transparency and simplicity is to try to treat similar activities similarly. He complained that we look far too often at either one tax or indeed one little bit of one tax. He finds it hard to discern a set of principles underlying tax policy over the past decade.

The UK’s tax system is incredibly complicated despite having an Office of Tax Simplification (OTS) for ten years, complained Alison Thewliss (SNP). Booth said that if you have distorting taxes, they lead people to pursue one type of economic activity rather than another type of economic activity. There are also costs in terms of compliance and those compliance costs bear particularly heavily on small businesses because there are very significant economies of scale in complying with tax rules. He also complained about the increasing ‘professionalisation of tax’ – that is, increasing complexity leading to a need for people to get professionals to advise them. On the OTS’ record, Brewer said OTS looked at income tax and national insurance from employers and whether those could be aligned or made simpler. Obviously, the way to achieve massive simplification there would be to merge the two together entirely, he said. You could get rid of many thousands of lines of legislation, but that would be a major policy decision with major distributional and social implications and so may be off limits for the OTS. He remarked that for the average employee, we have a very simple tax system and complexity is an issue for the self-employed, for small businesses and for very large multinational corporations.

Asked about tax reform, Johnson said the current structure of stamp duty for housing is extraordinarily damaging to the housing market and the economy.

Felicity Buchan (Conservative) asked how we can be ‘nimble’ on tax and be forward looking. Booth suggested tax policy should be set out in a Green Paper or White Paper and have wide discussion. Johnson said if you are trying to encourage people to use lower emitting cars, the case for an up-front tax, which is higher for higher emitting cars, is certainly there. He said if people prefer online shopping, if that is the more efficient way of doing it, then is the correct response to try and preserve the high street in ‘aspic’ at potentially high cost, both to the public finances and people’s welfare?

When asked by Buchan about DST, Brewer said that the need for such a tax is not just to protect the high street, it is also because the way the tax system is structured allows some large technology companies to pay very little tax in the UK.

Labour MP Rushanara Ali asked about equality in the distribution of the tax burden. Booth would like to increase the real incomes of the less well-off by means other than through the tax system, because of the damage that tax can do to economic growth. An easy win would be liberalising the land use planning system to reduce house prices, and hence rents. Few wealth taxes have stood the test of time, he added. Brewer said there is a very strong role for the tax system in affecting inequality at the very top, where we know the amount of income certain people are receiving and declaring depends quite considerably on the tax system.

Ali asked if we could do more to deal with tax evasion and tax avoidance. Booth said a more rational and logical tax on property would almost certainly lead to those in larger, more valuable properties, including overseas owners of property, paying more tax. He would prefer the Treasury to redouble efforts to ensure that income which was hidden as capital gains was really taxed as income rather than seeing an increase in capital gains tax to income tax rates.

Conservative Harriett Baldwin said tax is money taken off the individual by the state in order to spend it on public goods, under threat of imprisonment, and therefore, it should be tilted towards taxing ‘bad things’ rather than profitable or economically productive things. Johnson replied that tax is only ever going to be a supporting role in tackling ’bad things’ such as obesity or dirty air and it will not ever raise very substantial amounts of money.

Panellists were asked what they would change because of the COVID-19 crisis. Johnson would like to get rid of or substantially reduce stamp duty on housing and make council tax proportional to the value of the property, freeze the personal tax allowance and potentially put a couple of pence on the basic rate of income tax. Booth would like to replace all existing property taxes with a tax on user services on owner-occupied and other property and rents, or a tax on ‘imputed income’ as it is sometimes known.

Separately, Johnson is not convinced that the COVID-19 crisis will have a big impact on measured tax gaps. Tetlow said that there is always a danger with a ‘one-off windfall tax’ that taxpayers think that you might come back and hit them again with that and that has longer-term impacts on behaviour.

The session can be read in full on this link.

By Hamant Verma