The Adam Smith Institute on Tax in 2017
Even after nearly seven years of austerity, state spending as a proportion of GDP sits at 43.2%. If we’re going to have a state anywhere near this size we need to minimise the destruction caused by the taxes we raise to fund it.
As Sam Bowman said on Monday "not all taxes are created equal". The starting point for all tax reform is that taxes change behaviour. Simply put, if you put a tax on something you should expect to see less of it. This basic insight is why we tax 'bad stuff' like booze, fags, and pollution. It's also why we should be concerned about taxes on 'good things' like saving, work, and selling your house.
Now our tax system raises revenue in about fifteen different ways. And some ways are much worse than others. In particular transaction taxes and taxes on savings are especially harmful to growth.
Nearly all taxes harm the economy, but our vision is a tax code which does as little harm as possible. To make that a reality, we'll be putting forward radical but realistic revenue-neutral reforms that will boost growth, boost competitiveness and boost wages for ordinary workers.
To that end, here are three reforms we'll be pushing in 2017.
1. Abolish all taxes on savings and investment
As it stands, our tax system punishes long-term investment and rewards short-term consumption. It’s a truism that people save to finance future consumption. Taxes on interest income, capital gains, inheritance and corporate profits all effectively tax future consumption higher than current consumption, incentivising short-termism. And this future consumption tax goes up every year you forgo instant gratification. A few months back, I did the maths. Assuming a 5% interest rate and the European Commission’s estimate for the Marginal Effective Tax Rate on capital (47%), you’re effectively paying 97% extra in tax for waiting 30 years and a whopping 147% if you leave it another 10 years. It was this finding that led Stanford Economist Kenneth Judd to conclude that the optimal tax rate on capital is zero.
If we fixed this bug in our tax system and moved to a system that taxed consumption at the same rate regardless of when it takes place we could substantially boost growth or more. Nobel Prize winning Economist Robert Lucas estimated that this could boost long run GDP by 7%. That’s 7% extra to average incomes EVERY YEAR, just for tweaking how we collect taxes. As he points out, that’s better than eliminating the business cycle and every single product market monopoly. This would boost the income not just of wealthy savers but ordinary workers too, as capital investment boosts productivity makes labour more valuable.
Simply abolishing all capital taxes would blow up the deficit, and raising the revenue by simply raising a flat(ish, see point 3.) consumption tax like VAT would simply shift the burden to the poor. So how do we do it? To start with, we should tweak income tax to create a unlimited exemption for savings and investment. Think of it as an ISA on steroids. This would remove the savings penalty on those most able to increase their savings.
Next, we should abolish our complex corporation tax and switch to a simple Destination-based Business Cash Flow Tax. There’s three parts to this. First, it would tax all sales made in the UK just like VAT. Second, it would have an unlimited exemption for capital investment guaranteeing that future consumption wouldn’t be hit. Third, it would fully exempt all wages from tax making it progressive (counteracting Employer NICs that fall heaviest on low and middle earners). To get rid of the other smaller capital taxes like capital gains tax, we should simply raise the DBCFT.
These two simple (but radical) changes would boost growth while keeping our tax system progressive.
2. Abolish Stamp Duty
It’s not hard to find someone opposed to Stamp Duty. Few things unite Owen Jones, The Taxpayers’ Alliance and Kirstie Allsopp but Stamp Duty’s awfulness is one of them. The case against it is simple. It punishes people for moving and locks home-owners into properties they don’t want to stay in, while kicking away the housing ladder for first time buyers. To top it off, it doesn’t even raise that much (just 2% of total revenue). Let’s scrap it altogether.
3. Fixing VAT
VAT exemptions are the most inefficient form of welfare out there. It might seem compassionate to give a single dad on benefits a discounted tax rate when he buys his daughter a pair of £10 shoes from Matalan, but the VAT exemption also gives a discounted tax rate to a mum on a six-figure salary in finance buying her little boy a £200 pair of Baby Chanel shoes at Harrods. We have a welfare system that gives a single dad on benefits £2 and a high-flying banker twenty times as much. Surely there’s a better way?
There is. The IFS estimated that by scrapping VAT exemptions and zero-ratings we could raise £24bn. Since then, we’ve seen VAT rise to 20%, growth of around 14%, and inflation of around 21%, so it’d be even higher now. We could target that extra revenue at the poorest, make them better off than they are now and still raise an extra £3bn to pay down the deficit.
What we're doing in 2017
In 2017, we'll be continuing our media advocacy for these reforms, trying to reach as broad an audience as possible. Over the year, we plan to publish reports on all three proposals, summarising the state of economic research on each and setting out in detail our plans to fix the tax system. We'll also be putting on a range of lectures and panels, both in the ASI office and at Conservative Party Conference, forcing these ideas onto the agenda of policymakers.
If you were starting from scratch your tax code would look very, very different to what we have today in Britain. Our tax code has evolved over the years as a series of compromises, fudges and bad jokes. Adam Smith famously said "There's a lot of ruin in a nation" and it's certainly true when it comes to Britain's tax code. In 2017, let's do something about that.