15 Jul 2014 10:00am

Paul Johnson: The tax system and infrastructure

For every £10 worth of output produced or consumed in the UK, nearly £4 is taken in tax. That’s what it takes to fund the pensions and health care, education and roads, and all the other public services we expect.

A tax system on that scale inevitably has a huge effect. Its design matters for economic growth, for productivity and for equity. Every effort ought to be made to ensure that it operates as well as possible and causes as few economic problems as possible. If it did we could all be better off.

But there are remarkably few signs that the tax system is treated as the crucial part of the economic infrastructure that it clearly is. You can see that both in the process through which tax policy is made and in the policy that emerges.

By contrast with most other policy areas, there are no strategies, no Green or White Papers. Big decisions tend to be handed down in the annual Budget, with little sense of how they fit with last year’s decisions and often no indication as to how they fit with a longer term direction. There isn’t even a parliamentary select committee with a specific remit to look at tax policy.


What matters, though, is what comes out of the policymaking machine. And it’s not pretty. You can have a reasonable argument about all sorts of features of a tax system. But the current system abounds with features for which it is difficult to think of any good rationale.

We have two completely separate taxes on earnings: income tax and National Insurance Contributions. The latter is no more than another tax. This creates complexity, lack of transparency and additional costs for business. Rates of NI have consistently risen as rates of income tax have fallen thereby, almost certainly unintentionally, increasing the tax on earnings, and workers, relative to the tax on other incomes, and pensioners.

The current government, in spending multiple billions on increasing the income tax allowance, has taken almost no worker out of direct tax because the NI threshold has not risen. Rather than address this, the opposition want to reintroduce the 10p income tax rate they introduced and then abolished when in government. They also introduced, in a completely obscure way, a 60p income tax rate on incomes over £100,000. The current government has extended to £120,000 the range of income affected by that 60p rate.

Other aspects of the tax system which defy rational explanation include a VAT system which is just about the narrowest in the OECD because our system of zero rating is so extensive, a council tax system which is deliberately regressive and still based on 1991 values, and an ever increasing tax on housing transactions – Stamp Duty – designed such that, in the extreme, a £1 increase in price can trigger an additional £40,000 tax bill.


But perhaps the most damaging aspect of the system lies in the rate of change and degree of uncertainty in tax policy. If there is one area where some degree of stability and certainty is vital surely it is in the taxation of pensions. But the tax regime keeps changing. What’s worse nobody has the least idea what will happen next.

In recent years there have been annual changes to the levels and structures of business rates, corporation tax allowances and carbon taxes. Consider the annual investment allowance, which allows the immediate deduction of expenditure on most machinery from taxable profits. The limit was set at £50,000 between 2008 and 2010, when it increased to £100,000. It was cut to just £25,000 in 2012 but increased to £250,000 in 2013. In the 2014 Budget it was raised again to £500,000, but on current plans it will return to £25,000 in 2016. How is that supposed to help businesses?

This matters. It may not be obvious, but the layering of complexity upon uncertainty upon inefficiency increases costs, encourages avoidance, disincentivises work and investment, distorts decisions and creates inequities. We can do better.

The IFS residential conference in September focuses on: “Taxing remuneration: principles and practice” ifs.org.uk/events/1025


Paul Johnson, Institute for Fiscal Studies