Maximise tax revenues or face more austerity

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Britain’s taxing question is whether to maximise revenues or face more austerity. Given the scale of state spending that’s the stark choice facing chancellor George Osborne if he wants to balance the books in this parliament, says James Sproule

We are once again considering the tax options facing the chancellor as he prepares his July budget. As a matter of general principle we still like Nigel Lawson’s too frequently ignored rule: taxes should be simple, low and compulsory. So what might we hope for today?

Tax revenues fall into four broad categories: tolling taxes, sales taxes, capital taxes and charges. Two-thirds of the £631bn raised in 2014 came from just three taxes: income tax, national insurance and VAT – and the revenue contribution of these key taxes has been growing. The vast panoply of additional taxes, charges and duties raise just £209bn.

Turning first to income taxes and national insurance, revenues here naturally vary with earnings and, ultimately, the state of the economy. In 2014 they raised £157bn.

Naturally if rates go too high, people do less of whatever activity is pushing them into the higher tax bracket, and if the tax goes on long enough or becomes high enough, the more ambitious start to pack up and leave – a point we are arguably approaching.

VAT raises some £105bn, up from £57bn in 1999-2000. Experience from the US suggests that where a sales tax differential is more than two to three per cent, you start to get significant amounts of cross- state border shopping. The EU, in a bid to stop “harmful” tax competition, has implemented tight VAT bands and the more the EU seeks to ease cross-border shopping, the more revenues here could be in danger.

Next up: capital taxes. These are levied when an asset is sold, so all you have to do to avoid the tax is not sell the asset. This is, of course, exactly what happened in 2010; as the rate of capital gains tax shot up from 18 per cent to 28 per cent, the amount of revenues collected fell from £4.3bn to £3.9bn.

Finally, there are charges, the biggest of these being council tax. Remember, Margaret Thatcher called it the community charge, emphasising it was a fee to pay for local services. This is why there was not much difference in the level of charges between the duke and the dustman – they were both receiving services for which they were paying a fee. She clearly lost the political argument, but the fact that council taxes are still not highly progressive does suggest there is more merit in the idea of this being a charge for services than is generally acknowledged.

Already we know that the failure to balance the books in the last parliament was due to a failure of tax revenues to match the Treasury’s expectations. We have to ask ourselves why.

Looking at the figures there is not a single culprit, but some are more guilty than others – in particular, income taxes are not raising as much as might have been envisaged. We know the exchequer is reliant on a very few paying a lot of tax. At least in part what we are seeing is a change in willingness to earn to the point where very high tax rates are triggered.

As a society the UK faces a choice: we can tax to show what we approve of, or more likely disapprove of, or we can maximise revenues. Given the scale of state spending and the willingness of the populace to pay taxes, any approach which does not seek to maximise revenues means that there is going to be a need to continue with austerity that much longer.

James Sproule is the IoD’s chief economist and director of policy. Read more from James Sproule

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About author

James Sproule

James Sproule

James Sproule has been Chief Economist and Director of Policy for the Institute of Directors since January 2014. Prior to joining the IoD James led Accenture’s UK Research and Global Capital Markets Research. He started his financial career as a merchant bank economist working with both Bankers Trust, Deutsche Bank and Dresdner Kleinwort, and eventually helped to found the boutique bank Augusta and Company.

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