The UK Conservatives' Woeful Record on Tax Reform

A version of this op-ed was first published by The Times newspaper on November 2, 2023. This has been slightly updated to reflect the changes seen in that Autumn Statement, ahead of the country’s forthcoming budget.

The period before a budget or autumn statement provides a predictable ritual. Conservative backbench MPs call for tax cuts. Speculation arises about whether the Office for Budget Responsibility’s forecast will grant the “wiggle room” to deliver tax cuts while hitting the government’s debt target. The Treasury, aware of the fickle nature of these projections, plays down the prospect. Commentators pile in, suggesting that high debt, an ageing population, above-target inflation and past austerity make tax cuts imprudent.

This performative debate, starting again before the March 6 Budget, obscures two simpler truths. First, the tax burden ultimately will rise to its highest level since the Second World War because the Conservative government wants a state that spends about 45 per cent of GDP. That requires a high tax burden. Second, this historically high tax burden is unnecessarily painful, because Tory governments over 13 years have failed to reform taxes to raise revenues in a more growth-friendly manner.

Most economists agree on the principles for an efficient tax code. Keep tax bases broad and marginal rates low. Ensure that the tax system is neutral between different decisions or investments. Avoid penalising saving or taxing transactions, such as home or share sales. Impose higher levies on factors of production that don’t move (like land) or activities that produce externalities (like pollution). Administratively, a good system also avoids duplication, limits the number of rates and thresholds and keeps taxes predictable.

Yet the UK tax code fails to live up to these ideals. Yes, it’s complex, leading to high compliance costs and enriching an army of accountants. But it is also distortionary to household and business decisions, with the Tories having shown no consistent strategy to rectify it.

They came to office with the intellectual ammunition for reform, so there’s really no excuse. Lord Forsyth of Drumlean had delivered a tax commission for the party in 2006. The Institute for Fiscal Studies’ brilliant Mirrlees Review, a comprehensive economic analysis of the tax code, was published in 2011. The Taxpayers’ Alliance brought together the country’s leading free-market thinkers to publish their own 2020 Tax Commission in 2012.

Each report had different remits and nuances, but there was consensus in many areas. The Conservatives even raised expectations that they might deliver them by creating an Office for Tax Simplification to advise “the chancellor about how to make the UK tax system simpler, not least for individuals and smaller businesses”. Its early reports led to 36 reliefs being abolished in the 2011 budget. A good start.

That office was abolished last year, with no obvious legacy. Its fate is a microcosm for how a reforming zeal on tax quickly gave way to fatalism and short-term thinking.

Yes, the Tories have reformed stamp duty, abolishing the hated “slab” structure that created perverse cliff edges in the housing market. They’ve made business rates more accurate by reassessing buildings’ rateable value every three years, rather than five, and more recently rationalised alcohol duties to get them closer to applying taxes per unit of alcohol. Yet even in these areas they didn’t completely deliver on the economic logic.

Elsewhere, policy has been volatile. They simplified air passenger duty to only two destination rate bands, before re-expanding it to four. They aggressively raised the personal allowance in the 2010s, lifting people out of income tax, only to freeze it during this era of high inflation, dragging them back in.

All the big revenue-raisers, meanwhile, have become a structural mess. Our VAT system has numerous exemptions and zero-rated items, with its tax base resembling a Swiss cheese, given its many holes. We effectively have two different personal taxes in income tax and national insurance running simultaneously, too.

Extremely high marginal tax rates apply to certain segments of income. Those earning between £100,000 and £125,140 pay a 62 per cent marginal income tax rate on additional earnings because their personal allowance is tapered. Child benefits start to be withdrawn at £50,000, resulting in similarly high marginal rates for parents with children where the highest earner earns up to £60,000 per year.

Business taxation has been on a rollercoaster, creating huge uncertainty. The Tories first made investment allowances in the corporation tax code stingier as a quid pro quo for cutting the headline rate to 19 per cent. Then they raised that rate back to 25 per cent while making certain investment allowances more generous, but only temporarily. In November, they made such “full expensing” permanent, but only for certain forms of investment. The system still favours debt over equity financing, and advantages some investments over others.

On property, council tax bands in England are still based on 1991 property valuations, while the tax itself isn’t proportional to house values, meaning that expensive properties are under-taxed. The horrible stamp duty transactions tax deters people from moving house, while part of the business rates burden falls on improvements that companies make to their buildings, rather than land, disincentivising investment.

All these inefficiencies collectively cause significant damage. Two thirds of economists in a recent Centre for Macroeconomics-CEPR economists’ survey said that a well-designed tax reform could increase or substantially increase economic growth, while everyone else was uncertain. Asked what tax reforms should be prioritised, personal income taxes came top, but respondents invariably said that an across-the-board system overhaul was desirable.

Why has this not happened? Politicians would say that tax reform creates winners and losers, the latter of whom squeal loudly. Don’t you remember the flack George Osborne got for broadening VAT with the “pasty tax”? Reforming taxes is certainly easier when you’re cutting the burden too, because that way you can limit or “pay off” those who suffer. But this circles us back to our initial truths. If the Tories won’t curtail spending to cut taxes, they at least should avoid compounding their damage by ensuring that revenues are raised in ways that are conducive to work, investment and growth.