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29 August 2023

The Research Brief: why public services will fail without tax reform

Your weekly dose of policy thinking.

By Spotlight

Welcome to the Research Brief, where Spotlight, the New Statesman’s policy section, brings you the pick of recent publications from the think tank, charity, government and NGO world. To see more editions of the Research Brief click here.

What are we talking about this week? Tax and public finances: the fundamentals, the latest report from the Institute for Fiscal Studies, one of the longest-standing and most respected research institutes for public policy, thank you very much. They focus mainly on public finances, matters of tax and spend, that kind of thing, from an “apolitical” perspective. Nesta is also on board for this particular report.

Do they make Kit Kats? No, Nesta. Or the National Endowment for Science, Technology and the Arts. That’s an independent charity, which was originally set up by an Act of Parliament in the Blair years, but is now fully autonomous.

Right. So what are they saying? Well, someone called Benjamin Franklin said that the two certainties in life are death and taxes. This report is saying there are two certainties in the UK: tax rises or the collapse of public-service provision.

Wait, but aren’t we paying more taxes than ever before? Yes, well almost. The tax burden is higher than it’s been since the 1940s, standing at 37 per cent of GDP, much to the annoyance of the Conservative right, of course.

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If we’re paying so much then why is everything falling to pieces? It does feel a bit like that, doesn’t it? According to this report, a lot of that is down to the fact that we’ve got a rapidly ageing population, spiralling health and social care costs, and we’re undergoing a very expensive green transition to wean ourselves off centuries of dependence on fossil fuels. On top of all that, we’ve got a tax system that isn’t fit for purpose. It’s unfair, inefficient, distortive and “not well designed to achieve policy aims”, according to this report.

Sounds like there’s room for improvement. There certainly is. One of the key issues is that income from capital is taxed at a much lower rate than income from work. If I’m a landlord, or a shareholder, or the owner-manager of a small business with a few employees, I’ll pay far less tax on my £40,000 of rental income, dividends or profits than someone simply earning a £40,000 salary at work.

[See also: Mapped: Rising sea levels are reshaping the world]

Seems… fair? Well, the report says that “the returns to wealth tend to be undertaxed relative to labour income”, and “in some cases (including the capital gains made on main homes), are completely untaxed”. That means you could have bought a house in Hackney for the £12,500 average in 1980, then sold it for the £620,000 average in 2022 (a 5,000 per cent increase). Then you can consider yourself very smart (rather than just lucky) and pay absolutely zero tax on your unearned gains.

Are they calling for the gap in tax on earned and unearned income to be closed? Yes, but that’s not all. The rest of the tax system is too cumbersome and complex, the report says. VAT exemptions cost £100bn in forgone revenue, and place a “large compliance burden on firms” who have to fill in mounds of paperwork to scrape back cash. This is of course more difficult for smaller businesses. Council tax is also highly regressive (meaning that those on low incomes pay more in tax relative to their earnings), and is based on property values that are 30 years out of date, meaning they bear “little relation to the actual value of the houses we live in”.

But apart from that, is everything else at least OK? No. The business tax environment is too unpredictable and “uncertainty will hamper business investment”. Exemptions on business investment are too complex and subject to frequent changes. New greenhouse gas taxes “vary wildly”, which “makes reducing carbon emissions more costly than it needs to be”.

Crikey. Does the government know? You’d think it would be high on the agenda, given how important tax is to, well, everything the government does. But many Conservatives want to just reduce taxes immediately, rather than simplifying them, making them fairer or more efficient. The idea of raising capital gains to match income taxes would send many Tory backbenchers into a tailspin.

At least there’s an election soon. Err, hate to break it to you but Labour is extremely wary of being associated with tax at all. This weekend, the shadow chancellor Rachel Reeves ruled out any chance of equalising capital gains income and income from work. She also ruled out any new wealth taxes. No word yet on simplifying the system, or clear, stable rules on investment exemptions.

So will public services continue to deteriorate then? The report says “unless something major changes – such as an acceleration in economic growth – it will not be possible to maintain public services and keep tax at current levels”.

Fingers firmly crossed for some growth then? It’s the least we can do.

Read the full report from the Institute for Fiscal Studies here.

If you have a report, briefing paper or a piece of research that you’d like featured in the Research Brief, get in touch at spotlight@newstatesman.co.uk.

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