Guest Blog - Rachel Reeves should embrace tax reform this Autumn

One year on from a tough first Budget, the Chancellor, Rachel Reeves arguably finds herself in an even more difficult position second time around. A combination of higher government borrowing costs, u-turns on disability benefit reform and the winter fuel payment, and a likely downgrade in the Office for Budget Responsibility growth forecast, means Reeves will need to take substantial policy action to keep within her fiscal rules. Even if those rules did not apply, nervousness in the bond market means now is not a good time to increase borrowing.

Welfare reform is not on the table, at least for now, and the spending review set departmental budgets for most of the parliament. So this almost certainly means further tax rises, a year after Reeves suggested she would not need to repeat the scale of tax increases in October 2024. A new Institute for Government report looks at Reeves’ options and argues she should take a new tax reforming approach for the remainder of the parliament.

Reeves will be tempted to follow what we describe as the ‘path of least resistance’, a route chancellors have generally favoured when needing to raise revenue in the past few decades. This approach involves identifying an assortment of tax-raising measures that are easiest politically to deliver, for example, because they are not salient to the public. A classic of the genre is Insurance Premium Tax, which was increased on three separate occasions between 2010 and 2016 and now raises 80% more than it would have done without those changes. Chancellors can raise billions through several of these smaller measures.   

However, this approach is problematic for at least two reasons. The first is economic. The cumulative effect of Chancellors taking this approach of convenience over decades is our mess of a tax system. Our property taxes disincentivise moving, different income sources are taxed differently, as are different consumer goods and services, while the VAT threshold disincentivises business growth. In addition, the lack of a strategy means any policy is potentially on the table, creating uncertainty. The second problem is political. Picking convenient tax rises might be easier in the short-term, but it leaves the Chancellor with no discernible narrative for how her tax policy should support her overarching objectives. Without a positive story to tell, the potential negative effects of tax rises dominate.   

Improving the structure of the system through a programme of tax reform is the only way to credibly have a tax policy that both raises substantial revenue and supports Reeves’ growth mission. Tax increases that improve incentives, especially when accompanied by strategic smaller tax cuts, can simultaneously fund public services and improve the economy. If Reeves sets out clear plans for reform and objectives for the tax system, she can also provide additional certainty and avoid the damaging rumour mill each year.

What, then, should Reeves do this autumn? It would be difficult and unwise, to attempt to deliver comprehensive tax reform in a single Budget without first laying the groundwork. Reforms need to be carefully developed internally to ensure they achieve their intended effect, and communicated clearly externally so the public understands what the chancellor is trying to do. There are some improvements to the system Reeves could announce quickly, for example changes to the VAT threshold or increasing taxes on undertaxed sources of income. But if she finds herself in need of serious revenue in November, she should look to broad-based tax rises that will do the least economic harm. This may mean having to revisit the rash manifesto pledges not to increase the main rates of National Insurance, Income Tax and VAT.

As important as the policies she announces this time is the message she sends. She should unveil a comprehensive tax strategy for the whole system, setting out what it should achieve and where it currently falls short. This will provide a blueprint that she can use to guide her subsequent budgets. She need not commit to specific measures, so she would retain flexibility going forward. But this would still provide additional certainty because businesses and the public would understand what any policy changes would be looking to achieve, providing a direction of travel for subsequent reforms. No Chancellor has ever published a comprehensive tax strategy for the whole system. No Chancellor since Lawson has articulated a coherent tax reform agenda. Now is the time for Reeves to break with that precedent to turn around her fiscal and political fortunes. 

The CIOT publishes guest blogs to stimulate debate on tax policy and related matters. The views expressed in guest blogs are those of the writers and are not necessarily shared by CIOT.