Most budget amendments make the tax system worse. These five don’t

The tired metaphor is that the Chancellor will try to pull a rabbit out of the hat on Budget Day. The trick is usually less delightful: he stuffs frozen shrimp behind the radiator and poo under the couch, and hopes to get away before anyone notices the stench.

The game is so predictable and so useful to the government (and the press) that it’s easy to lose sight of the absurdity. Every budget day, the chancellor shuffles taxes, tweaks laws, secretly changes allowances, and promises to come back and do the same in 12 months – or sooner if we’re unlucky. This is not the way to run a tax system.

Endless tinkering has a political logic, but it is both a symptom and a cause of a chaotic patchwork of taxes. This patchwork is unfair, distorts the economy and promotes the crime of tax evasion and the level of formality that should also be considered a crime. “It’s hard to imagine a tax that doesn’t require major reform,” says Helen Miller, vice president and head of the tax department at the Institute for Tax Studies. One common problem is that essentially similar things end up being taxed differently. Eye-catching examples – are Jaffa Cakes biscuits or cakes? — are less important than distortions in the way we all make money. A person can do almost the same job under the same conditions whether they are employed, self-employed or registered as a small business, but the tax implications are very different.

There is no excuse for this (including whispers of entrepreneurship) and accountants trying to figure out how to help clients squeeze through this income tax loophole are wasting considerable effort and HMRC is trying to figure out how to stop them. With some reasonable allowances for capital investments, it is possible to tax all income on the same basis. But we don’t. And this is just one of hundreds of examples of inefficient taxation.

A government with a brain and a stomach would scrape off decades of rocking and rebuild the tax system on a firmer footing, but such a government has not been seen here for a long time.

For a painfully nerdy vision of what a better tax system could be, check out “Tax by Design”, the findings of a review by the Institute for Fiscal Studies led by Nobel laureate James Mirrlees in 2010 (Mirrlees died in 2018 seeing his review almost completely ignored by the government).

“Tax by Design” argues that a good tax system should strive to be as simple and neutral as possible between similar activities, such as buying cakes or biscuits, or obtaining income from various sources. It should also be progressive in the sense that the rich should pay a larger proportion of their income.

But – and this is something almost everyone gets wrong – having a progressive tax system in general does not require progressivity in every detail. For example, in a gesture to promote social causes, the UK system has a long list of VAT exemptions and discounts on everything from food, baby shoes, tampons to helicopter charter.

Regardless of the helicopters, many of them seem attractive. Who wants to tax a poor family’s efforts to buy potatoes? However, if we honestly ask how the entire tax system could help the poorest in society, the answer would not be cheaper food and children’s clothing for everyone, but more generous benefits and better public services.

Moving down the list of products and exempting those that seem to be Good Things – from “a magnetic tape adapted to record speech for the blind with a camera to create and play back the adapted tape and some aids for the visually impaired” to, um, helicopters – it is not the basis of a just and progressive society. You might think that a progressive tax system with a broad, high VAT rate is impossible, but Denmark seems to be able to handle it.

Not that Denmark or anywhere else is perfect. US income taxes appear to be designed to maximize the pain of compliance, which suits tax preparation companies and small government propagandists, but is just plain ridiculous. Miller told me that Britain’s chaotic system is no exception.

There are several radical ideas for tax reform. A land value tax is an age-old idea, and for good reason. What about the universal marginal income tax rate of 50 per cent, rotating on income of £10,000 a year? If you had earned nothing, you would have been £10,000 below your pivot point and would therefore have received 50 per cent of that amount, or £5,000, as negative income tax. If you earned exactly £10,000, you wouldn’t pay income tax. If you earned £110,000, you would pay £50,000. Same marginal tax rate for all, but overall progressive system. Cute.

But you don’t have to be cute to make the system fairer, simpler, more transparent, and less distortive. And while the list of possible reforms is long, the list of prudent principles is devastatingly short:

  • Apply VAT on as many products as possible

  • Combine National Insurance with Income Tax and tax all income on the same basis, regardless of source

  • Reform council tax to be less regressive and based on property valuations from the current century

  • Automatically update thresholds and allowances for inflation

  • Spend the proceeds from all these reforms to help those in need.

Will it happen? Simplification reforms are sometimes introduced, from the introduction of universal credit to the introduction of VAT. But not often. Instead of discussing the general principles of fair and effective taxation on Budget Day, we’ll try to sniff out those shrimp before they start to rot.

Tim Harford’s new children’s book ‘The Truth Detective’ (Wren & Rook) is out March 15

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