Real tax reform is an impossibility until we shrink the size of the state

EVERY year about this time, as the daffodils start blooming there is a call from some think tank, academic or economist for major tax reform. This year, it was Andrew Sentance, writing in The Forum.

There are two responses that a politician can make to this. The wise but cautious one pays lip service to the idea and then ignores it. The rash but principled politician sometimes follows the advice and always suffers. The reason is simple, in any tax reform where you are adjusting the rules for relief allowances and taxes there will be winners and losers.

The iron law of politics is that the winners generally keep quiet for fear of losing their tax privileges and the losers will make a huge noise; so it has proved once again in George Osborne’s recent Budget. The winners are those who gain from raising the personal allowance or the cut to the 50p rate and the losers are pensioners whose age allowance will be eroded over time – not to mention pasty-eaters.

A neutral observer might point out that the pensioners’ reform was fairly timid, there was no sweeping abolition of the age allowance. Yet the storm of protest paints the picture that Osborne has cut the widow off and taken all her money, rather than the cut amounting to 1 per cent of her income.

Osborne’s experience isn’t new. Tax commission after tax commission has come up with proposals that may seem logical and consistent but are the equivalent of kamikaze politics.

For example, the idea of extending VAT to food defies a century of consistent public opinion on this subject. The last time the Conservative party tried it was in Joseph Chamberlain’s tariff reform of 1903: they lost the subsequent election by a landslide. Another chancellor who tried to extend the scope of VAT (Norman Lamont) to domestic fuel not only found that he was defeated in the House of Commons but that this measure caused more opposition and unpopularity to the government than any other tax-raising proposal.

What seems logical on paper is often disastrous in practice. A tax commission headed by Lord Forsyth suggested the abolition of the 10p tax rate and the abolition of tax relief on termination payments, share schemes, relocation allowances – all of which would make sense if the rate were going down to 15 per cent, but otherwise it was just a recipe for huge dissatisfaction and rebellion. Something Gordon Brown found out when he tried to implement a couple of the proposals.

Finally, even if you manage to establish a new lower tax rate on the back of the abolition of allowances, the public will be naturally suspicious that this new tax rate will disappear after a decent or indecent period of time. For example, the capital gains tax rate was set by Alistair Darling, in one of the few genuine Labour tax reforms, at 18 per cent. This was funded by the abolition of a substantial number of valuable reliefs such as indexation and taper relief, which recognised the time you held onto the assets. However, the coalition government judged the 18 per cent rate too low. The fact that it was arrived at by abolishing a number of reliefs was overlooked and the rate went up to 28 per cent. A lower VAT rate could be achieved by its extension to all sorts of essential items, but how long would it take to creep to 20 per cent?

The only chancellor who was successful in genuine and sustained tax reform in recent years was Nigel Lawson, who abolished a substantial number of income tax reliefs, allowing him to reduce the basic and top rates of income tax as well as corporation tax. Lawson benefited from previous measures by Sir Geoffrey Howe to balance the budget and also from a recovering economy. He was therefore able to cushion the effect for losers by reducing the general amount of taxation. There were also a lot more reliefs and allowances that could be abolished at that time.

Now, however, the cupboard is nearly bare. The only way to reduce taxation is to tackle the size of the state and make some radical changes to what the state does and how it is funded. Otherwise there will always be losers who will cause a politician seeking re-election inordinate amounts of grief.

Jeremy Mindell is a senior reward and tax manager who has worked in accounting firms and in-house in the City for over 20 years.