Friday 24 July 2020 4:10 am

We can't tax our way out of the Covid-19 crisis — instead, the chancellor must drive growth

Stephen Herring was head of tax at the Institute of Directors and is a former tax partner at Grant Thornton, Ernst & Young and BDO LLP. He currently serves on the TaxPayers Alliance Advisory Council

There has never been a time to my knowledge when, in the run up to a Budget or other fiscal event, the Treasury has not highlighted the pressures on public finances which made the option for significant (or, indeed, any) net tax cuts unwise. 

Typically, projected shortfalls in the state’s annual budgets have been in the order of £5bn, £10bn, or £25bn, depending upon the year concerned.

In the aftermath of the Covid-19 crisis, what we face now is something of a totally different magnitude for any peacetime British government. Estimates vary and are changing on a weekly basis, but let’s assume that the deficit for 2020/21 might be in the region of £150–200bn.

Read more: DEBATE: Is there any point in members of the wealthy elite calling for higher taxes in response to Covid-19?

Much of the media commentary focuses upon how such a deficit can be addressed by a panoply of tax rises across income tax and national insurance contributions (both hiking rates and slashing reliefs), through capital taxes (capital gains tax, inheritance tax, and potentially new wealth taxes), to expenditure taxes (including VAT, duties and environmental taxes). 

But whatever combination of tax hikes in the areas listed above were chosen, they could neither eliminate the Covid-19 deficit generated in 2020/21, nor be implemented without creating substantial immediate and longer-term damage to the UK economy.

A much better approach is to consider the right combination of fiscal measures which will increase sustainable economic growth for the foreseeable future and thereby generate the tax receipts from both businesses and individuals to repay the government borrowings generated by Covid-19. 

The size of UK economy in 2019 was around £2.2 trillion. If an additional one per cent growth could be generated with the right combination of tax incentives, and 50 per cent of that found its way to the Exchequer though a combination of the existing direct and indirect taxes at their current rates, approximately £11bn per annum would be generated. Neither of these assumptions is excessively optimistic. 

Even if, for example, the necessary tax was to cost, say, £3bn per annum, the Covid-19 debt would be eliminated within 20 years.

So what combination of tax reforms and rate cuts should the Treasury be examining and suggesting to Rishi Sunak? In my view, there are three themes which ought to be prioritised. 

First, in increasingly competing global markets, how should the UK government ensure that we become more tax competitive when measured against not just our European competitors but, even more importantly, the faster growing economies in North America and the Asia-Pacific region? 

Second, which existing taxes, in terms of both their structure and rates, reduce individual work incentives?  

And third, which existing taxes discourage transactions which would benefit the UK economy?

By way of another challenge, I would require any tax cuts introduced to represent a simplification of our overly complex tax system, which has all too often been driven by the short-term political expedient rather than their long-term economic and fiscal effects.

If such reforms spur economic growth, they will have a far greater impact than any of the tax rises being suggested.

It is vital that the chancellor does not automatically go after the low hanging fruit and punish hardworking entrepreneurial businesses and individual taxpayers, particularly after they bore the brunt of the financial crisis in 2008. Instead, he must recognise that a long-term strategy for free-market growth is the only responsible way to cope with soaring debt.

The key question for the chancellor is whether, like his immediate predecessors from both major parties, he wishes to be regarded as a politician tinkering with relatively minor tax changes, or one with the vision to enact significant tax reforms, such as those which were introduced in the 1980s by Geoffrey Howe and Nigel Lawson.

We ought to be able to see the route he is following in the next Budget in theaAutumn. Let us hope he is willing to be as bold on tax reforms as he has been in introducing measures to protect business and employment during the Covid-19 epidemic.

Read more: We can’t rebuild an economy on half-priced meals — we need a productivity revolution

Main image credit: Getty

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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