The UK tax system is in need of reform - that requires a different approach from government
When Chancellor Rishi Sunak announced a generous package of support to help the self-employed weather the storm of coronavirus, he hinted there would eventually be a quid pro quo: higher taxes. This reform has long been needed – the self-employed have always paid lower taxes than employed people generating the same income but this tax advantage is no longer matched by lower entitlement to state benefits, as once it was. Philip Hammond tried and failed to implement a similar reform three years ago.
Guest blog by Gemma Tetlow, chief economist at the Institute for Government.
It is welcome that Sunak took this opportunity to flag the need for reform. While it might seem an odd time – when the government has so many other demands on its attention – to worry about longer-term tax reform, it is important that governments do not pass up these moments. As Sir Edward Troup, former permanent secretary to HM Revenue and Customs, put it to us: “it's only when there is a far greater threat than paying more tax, whether it's Napoleon, the French at the end of the 17th century, the French again in the 19th century, the First World War and the Second World War, that you can overcome the massive amount of resistance you get to anything which you would badge as being tax reform.”
Linking the need for future tax rises to the support the self-employed are now receiving (and might hope to receive again in future), will help to build the case with the public. But, as we set out in a new report , it is unlikely to be enough in itself to overcome the obstacles that have prevented successive governments from achieving much-needed tax reform in the UK.
Our earlier report entitled Better Budgets in 2017 – produced in partnership with the Chartered Institute of Taxation and the Institute for Fiscal Studies – recommended ways that weaknesses in the UK’s processes for making new tax policy could be addressed, to improve the quality of new policies being added to the statute book. Government has adopted some of these recommendations, but many of them were directed at avoiding ill-thought out measures that make the tax system worse. Our new work looks at what is needed to reform the existing system – to deal with long-standing problems – which can be even more challenging. The aftermath of the coronavirus crisis presents an opportunity as well as a necessity for change, but the government needs to be thinking now about how it will use it.
Why does the tax system need to be reformed?
The unequal tax treatment of the employed and self-employed is just one of many distortions and inefficiencies in the UK tax system that have long been identified but which successive governments have struggled to deal with. Others include the UK’s unusually narrow VAT base and ineffective and expensive tax reliefs. The structure of the UK tax system has also failed to keep pace with economic and behavioural trends – such as the increasing prevalence of digital services, which are harder to tax, and the declining prevalence of smoking and alcohol consumption, which have traditionally been valuable sources of revenue.
At the same time, there is increasing pressure for more public spending – particularly on health and social care services – from the UK’s ageing population. Even before Covid-19 struck, there was little evidence of any public appetite for scaling back the scope or quality of other services or benefits to make way for extra spending on health and social care. But the UK’s tax system in its current state is not up to the task of funding these demands in the longer-term. The coronavirus crisis is a long way from being over, but it will undoubtedly leave the UK with a higher level of public debt and, so far, the indications are that it will create a desire for a more – not less – expansive state. All this adds to the pressure for tax reform.
Overcoming barriers to tax reform
One major barrier to reforming the tax system is poor public understanding of it and thus limited appreciation of the problems and the merits of change. The tax system is inherently complex and it would be too much to expect wide swathes of the public to have a deep – or even passing – understanding of much of it. But UK governments have deliberately sought not to include the public in discussion of these issues – favouring, for example, pulling proverbial rabbits out of hats on Budget day to command the headlines, rather than paving the way for change in advance. Most chancellors have believed that this is a politically beneficial tactic but there is mounting evidence – including Hammond’s 2017 U-turn on National Insurance contributions for the self-employed in 2017 and George Osborne’s 2012 ‘omnishambles’ Budget – that this can backfire, forcing policy reversals and often further restricting scope for future reform.
As former Treasury minister and shadow chancellor, Ed Balls, told us: to reform the tax system “you have to win the argument for why”. Explaining “why” requires setting out for the public an explanation and evidence of the problems you are seeking to address. Treasury civil servants produce copious analysis of this sort that is presented to ministers, but this evidence is never shared with the public. Doing so would require a cultural shift within government – but other countries show that it can be done and is helpful. In Ireland, for example, analysis of tax issues and options for reform produced by civil servants used to be kept secret. But, since 2016, has been published each summer ahead of the Budget and widely debated in the media before the government then sets out its chosen policies.
If that would be too big a leap in the UK, there are other ways that the public could be made more aware of the evidence and brought on board with the need for reform. In particular, the government could set up a tax commission to serve this role. Such commissions have been used successfully to look at tax reform in other countries and have been used in the UK to look at similarly contentious issues – such as the Pensions Commission in the early 2000s, which paved the way for (once unthinkable) increases in the state pension age. A commission of this sort should draw on range of expertise, including tax professionals, either serving as commissioners or feeding in through open consultation processes.
Tax reform could also be facilitated by Parliament playing a more active role. MPs’ interest in tax is limited – and, when they do show interest, it is typically in narrow, high profile tax issues, rather than the overall structure of the tax system. They could instead play a more constructive role by holding the government to account for tackling problems in the tax system that threaten long-term fiscal sustainability. For example, the Treasury Select Committee could hold regular inquiries into the detailed reports produced by the Office for Budget Responsibility on fiscal risks and fiscal sustainability. As Lord Macpherson, former Treasury permanent secretary, put it: “since the House of Commons came into existence because of the King wanting to tax his subjects, I’m surprised it doesn’t take more interest”.
But it is not just MPs who too often fail to focus on the bigger picture that is so important for understanding the need for and approaches to tax reform. Often tax professionals and other tax experts focus on detailed problems arising in the areas of the tax system in which they are most well-versed. This is understandable given the needs of clients and the complexity of the system. However, it limits the amount of time that is spent understanding, highlighting and discussing with government the wider structural problems. There is a role for many people to play in this – not just those within government. The CIOT’s series of debates with IFS on these sorts of topics are a welcome addition. We also highlight in our report other ways in which government could garner useful input from the private sector – including by making administrative tax data more easily accessible to researchers addressing policy-relevant questions and by ensuring policy consultations happen at an earlier stage more often.
Hammond – chancellor at the time – took up some of the recommendations we made our earlier work on creating Better Budgets, including moving to have only one fiscal event each year – a practice that Sunak should continue with, if circumstances allow. The current government should also move to accept other recommendations in that report – such as establishing clear principles and priorities for the tax system – alongside further recommendations in our latest report for helping to overcome the barriers to reform of the existing system. Doing so would help ensure that the UK tax system raises revenue efficiently and sustainably. Without such reform – possibly entailing tax rises – the government will struggle to raise the revenues needed to fund the services and benefits that the public expect. Those expectations are likely to be higher after Covid-19 – a crisis that has highlighted the value of publicly funded health services, the fragility of social care services, the value of social safety nets and the unique capacity of the state to step in at times of crisis.
Every journey must start with a single step and Sunak took that when he hinted in March at tax increases for the self-employed in return for coronavirus support. There will need to be more steps to come if he is to be remembered as a tax-reforming chancellor.
Dr Gemma Tetlow is chief economist at the Institute for Government. She joined the organisation in April 2018. Between 2016 and 2018, Gemma was economics correspondent at the Financial Times. Prior to that, Gemma spent 11 years at the Institute for Fiscal Studies, leading the organisation’s work on public finances and pensions. Gemma has a PhD in economics from University College London and an MSc and BSc in Economics from the University of Warwick.