Why tax reform is now inevitable

Coronavirus is first and foremost a devastating health crisis, but the measures needed to halt its spread have made it an economic one too. The government has rightly prioritised saving lives and supporting businesses and households while the economy is kept on ice. Additional funding for public services, the government’s economic rescue package and the loss of tax revenues is likely to add over £200bn to public debt, according to the Office for Budget Responsibility. The crisis may also create desire for a permanently larger state—with higher spending to increase resilience in public services and provide a more generous welfare system. All this will increase pressure on the national finances. But the UK’s tax system is poorly placed to raise the revenue that will be needed. After years of neglect, tax reform will be essential. 

Decades of piecemeal changes to the UK tax system have left it complicated, inefficient and beset with perverse incentives that do little to raise revenue or meet the government’s wider economic objectives. Changes in the economy in recent years mean the government is already finding it harder to raise revenue—for example, digital businesses are increasingly prevalent but harder to tax, while self-employment had become increasingly widespread (at least prior to the outbreak of coronavirus) but the self-employed have to date been more lightly taxed than employees. 

Even before the coronavirus crisis, the UK system looked inadequate in the face of the mounting health and social care needs of the UK’s aging population. There has been little public appetite in recent months for paring back public services and, if anything, the experience of coronavirus is likely to increase support for more funding for the NHS and social care. 

Once the immediate crisis has passed, the government will need to take stock of how the state is funded. Tax reform must form part of the solution to help ensure the tax system raises the revenue needed in the most efficient and least distortionary way possible. But changing the system has proved difficult for governments of all stripes. The political risks are high, lay understanding of tax is poor and some aspects of tax policymaking militate against improvements. Some have not tried. Others have tried but failed, most recently Philip Hammond, who attempted to make a first step towards equalising the tax treatment of the employed and self-employed but was forced to backtrack after outcry that the policy breached a manifesto commitment.

There are welcome, if tentative, signs that the current chancellor is willing to put his head above the parapet and make the argument for change—including on the very same issue that caused Hammond such trouble. When announcing the government’s package of economic support in response to coronavirus, Rishi Sunak argued that “we are all in this together” and hinted that the trade-off for providing comparable financial support for the employed and self-employed could be an increase in national insurance contributions for the self-employed. This reform is long overdue, and Sunak should persevere. 

Governments need to seize these windows of opportunity when tax issues are salient, to make the case for change and start an honest conversation with the public about the need for reform. Preparing the ground is critical. As former Treasury minister and shadow chancellor Ed Balls has said, winning “the argument for why” is essential if the public are to be convinced of the need for reform. But doing that will require more than one speech. People will need convincing that there is a serious problem before being sold on any particular reform.

Treasury officials, like tax experts outside government, have long been aware of the issues and regularly brief ministers on them. But this analysis is rarely shared with the public, meaning it should come as little surprise that they are not quite on the same page. Other countries take a different approach: in Ireland and New Zealand, analysis of tax issues and options for reform produced by civil servants are regularly published and debated in the media, helping to improve the quality of debate. If that would be too much of a cultural shift in the UK, a similar result could be achieved by setting up a tax commission to marshal and present the evidence before laying out options for reform. These have proved successful in other countries, and on contentious issues, like pensions, in the UK. 

Parliament can also have an important role to play, but often has not done so in the past. MPs’ interest in the tax system as a whole—as opposed to narrow, high-profile tax issues, such as the loan charge—has typically been limited. As former Treasury permanent secretary Nicholas Macpherson said, this is surprising: “since the House of Commons came into existence because of the King wanting to tax his subjects, I’m surprised it doesn’t take more interest.” It could do more. The Treasury Select Committee can raise awareness of the problems with the current tax system and growing pressures on the public finances, ensuring that the government embarks on much-needed reform. All MPs need to be honest with their constituents about the trade-offs involved and the fact that real reform cannot simply involve taxing the wealthy or multinational companies. 

The coronavirus pandemic will increase public borrowing and debt and could alter perceptions on the size and shape of the state. The UK’s current tax system is ill-equipped to meet the challenges ahead. Reform—long neglected—is now inevitable. 

 

Joe Marshall is a Researcher at the Institute for Government and co-author of Overcoming the Barriers to Tax Reform