Britain’s economy needs lower and flatter taxes to flourish

 
Allister Heath

TAX and spending remain far too high in the UK, dragging down our economy. We still suffer from a bloated state, from an inefficient, low-productivity govern-ment sector, from a large budget deficit and from a tax system that is no longer fit for purpose. Resources are misallocated, incentives damaged and prosperity held back.

It is important, however, to give the coalition government its due: it is now clear that there has been more progress in some key areas than many people realise, albeit with lots left to do. Public spending peaked at a catastrophically high 50.8 per cent of GDP in 2009 under Labour at the height of the financial crisis, according to the OECD’s internationally comparable statistics. It will fall to 46.5 per cent this year and 45.2 per cent next year. We are still very far from the 38.6 per cent seen in 1999, when the effect of the previous Tory government’s fiscal restraint was still visible and Gordon Brown had yet fully to turn on the spending taps.

But while George Osborne should have gone further and faster, he will have presided over a 4.6 point drop in spending as a share of GDP in five years, a good step in the right direction. He has also cut the top rate of income tax from 50p to 45p, a good move for which he was unfairly demonised; while he should have gone the whole hog and taken Britain back to the 40p rate in place since 1988, it was nevertheless a positive reform. The reductions to corporation tax have also made a real difference, and entrepreneurs now get to keep more of their own capital. Last but not least, pensioners’ pots are finally truly theirs: they no longer have to purchase annuities.

So much for the good news. The bad news is that the tax system is even more broken today than it was a few years ago. A large number of taxes have been hiked, from VAT to capital gains tax; especially appalling ones such as stamp duty have been increased to daft levels, with Osborne introducing a cripplingly high seven per cent top rate. Too much of the fiscal consolidation during Osborne’s early years consisted of tax hikes; far too little from actual, real-terms spending cuts.

So what, in a mythical ideal world, would come next? The UK desperately needs a supply-side revolution; one of its central components ought to be the adoption of completely new, ultra-simple tax system, with as much of the present set-up as possible junked.

My favourite way forward remains a flat tax, levied at the same rate on income from labour and income from capital. Workers earning the minimum wage would pay no direct tax at all; income after a generous personal allowance of £11-12,000 a year would be taxed at the same, single rate of 30 per cent. This new tax would replace the current income tax as well as national insurance of both kinds. Corporation tax and capital gains tax would be abolished, replaced by a 30 per cent tax on all distributions of capital – be it via interest payments, dividends or share buy-backs. Inheritance tax would be scrapped.

For the sums to add up, public spending would be need to be brought down, over time, to around 33 per cent of GDP – the sort of share seen in Switzerland and Australia, two superbly well run countries. These changes would dramatically boost the economy’s long-term rate of growth by improving incentives to work and invest, and by allocating a greater share of the economy’s spending to the private sector.

A simpler tax system would also allow companies and individuals to waste less time on paperwork, and many of the loopholes and opportunities for avoidance that cripple the present rulebook would be eliminated.

There is, sadly, little hope of anything this radical being adopted any time soon. Britain has made some progress since 2010; but sooner rather than later we need to find it in ourselves to be even bolder.

allister.heath@cityam.com
Follow me on Twitter: @allisterheath