The balancing act of tax reform

Winners keep quiet, losers raise hell

Gordon Brown's 10p tax fiasco illustrates perfectly why mainstream politicians are reluctant to contemplate large-scale tax reform: the losers create one hell of a stink while the winners don't bother to thank you. Millions of families with children, on low and average incomes, benefited considerably from the 2007 Budget, as they did almost throughout Brown's chancellorship. Their gratitude, if it existed, didn't play at Westminster.

Any attempt to restructure the tax and benefit system faces this kind of problem. For example, the arguments for a land (or site-value) tax are powerful. Land can't be hidden, smuggled or moved offshore and, if you can separate its value from the value of what's built on it, you don't penalise people for putting up new conservatories. But governments, fearful of provoking the most powerful and articulate groups in society, stick with the ridiculously regressive council tax.

Almost equally ridiculous is zero VAT on children's clothes. If we are worried about children going around in rags, we should give more money to poor families, not subsidise affluent parents who want to kit out their children in the latest designer gear. But ripping clothes off children's backs is exactly what the government would be accused of if it ever dared to make a change.

A good illustration of the winners and losers problem comes from recent research published by the Institute for Fiscal Studies (see Mirrlees Review, "Means-Testing and Tax Rates on Earnings", by Mike Brewer et al). It tries to tackle some of the biggest weaknesses of the tax and benefit system: that people moving into work from unemployment often face a marginal tax rate of nearly 100 per cent as they lose benefits; that low earners, for similar reasons, can face rates of 70 per cent as they move up the wage ladder; that the multiplicity of benefits deters some from applying while leaving wide scope for fraud; and that entitlement to tax credits is calculated annually, creating uncertainties and risks for families that live almost literally hand-to-mouth.

The authors' answer is to integrate all benefits and tax credits (including housing, council tax and child benefits) into a single allowance, paid directly to recipients by central government. As recipients' employment income improves, it would be withdrawn through the tax and National Insurance system, under which entitlements can be adjusted weekly or monthly. Allowances would begin to fall at higher income levels than under the present system, and they would also fall more gradually.

Though I have some reservations, the system makes perfect sense. The incomes of the poorest 30 per cent would increase by between 4 and 5 per cent, on average, with some among the poorest 10 per cent gaining nearly 12 per cent. Roughly 200,000 children would be lifted instantly out of poverty. Moreover, the work-shy would have ample incentive to get off their butts, as politicians and newspapers so often demand. For that reason, the scheme might ultimately benefit the poor more than the figures above suggest.

So why does it not have the smallest chance of acceptance by either Labour or the Conservatives? Because it would involve not only a penny rise in the basic income-tax rate, but also the abolition of the universal child benefit. For families with dependent children whose incomes are above the median, but who are not among the richest 20 per cent, the financial loss would be between 4.6 per cent and 6.2 per cent. You can write the Daily Mail headlines yourself. The noise from the losers would drown out any modest words of thanks from the winners. This would still be the case if money to finance higher allowances for the poor came from, say, VAT on children's clothes or a revived fuel-tax escalator.

Why does the scheme not impose higher penalties on the richest 20 per cent? Could they not ease the burden on Middle England by paying more, perhaps through a 50 per cent tax band? The authors' answer is that more tax on high earners would raise little or no extra revenue. I am a trifle sceptical, because the economic models used to predict optimum tax rates date mostly from the early 1970s, when western culture and global conditions were quite different. But even if it doesn't make fiscal sense, a top tax rate of 50 per cent may make political sense. It might convince Middle England that it isn't being unfairly singled out for punishment.

Tax policy is always a balance between doing what makes fiscal sense and what makes political sense. Because the latter is so unpredictable (who would have thought unfairness to the poor might threaten to bring down a prime minister?) any attempt to make the tax system work better is bound to involve political risks. We shouldn't be too hard on chancellors who get it wrong. Which, just now, is the best I can say for Gordon Brown.

Peter Wilby was editor of the Independent on Sunday from 1995 to 1996 and of the New Statesman from 1998 to 2005. He writes the weekly First Thoughts column for the NS.

This article first appeared in the 05 May 2008 issue of the New Statesman, High-street robbery