I noticed something very odd on my recent move to the UK from Australia. It wasn’t the heat wave. Or the revolving door of prime ministers. (We’re used to both.) Instead it was the massive, humming refrigerators located next to the entrances of apparently every cafe and grocery store in the UK, offering a bewildering array of freshly-packed ‘meal deals’.
At first I assumed this must reflect the time-poor London luncher. Who has time to sit down and eat a meal when trying to navigate tube strikes on an e-bike? But then I checked my receipt. Ordering a refrigerated meal to take-away immediately knocked 20 per cent off the purchase price compared to dining-in.
A quick consultation of the UK’s 23,522-page tax code (apparently the longest in the world) quickly confirmed my suspicion
A quick consultation of the UK’s 23,522-page tax code (apparently the longest in the world) quickly confirmed my suspicion. “Cold takeaway” meals are subject to zero per cent VAT, while cold meals consumed in the vendor’s “designated eating area” are subject to the full 20 per cent VAT rate.
On one level, this was a mildly pleasing way to save money on lunch; on another, my economist brain immediately started calculating the massive economic distortions and fiscal costs caused by a minor clause in the tax code.
Unfortunately it didn’t stop at the humming refrigerators. My economist brain soon started noticing a wide range of counter-productive taxes on many aspects of economic life in the UK, including employment, housing and savings. An attempt to hire a Flamenco dancer for my wedding in Spain led to a full-blown inquiry into the tax treatment of wedding gifts.
Luckily for me, my colleagues at Policy Exchange have now run the numbers on the UK’s entire tax system in their report How to Make Tax Less Taxing. Authored by leading economist Roger Bootle, it argues that the UK tax system is stunting growth and calls for radical reform.
Most strikingly, they estimate that applying a uniform 20 per cent VAT rate on all consumption in the UK would raise £135 billion annually by the end of the decade – more than enough to abolish a range of even more distortionary and productivity-sapping taxes on employment, housing and savings.
The first is the UK’s well-known ‘Manhattan Skyline’ of income taxes rates – a reference to the extremely high marginal tax rates that apply once workers earn more than £60,000 a year in the UK. While many countries have progressive rates of income tax, the UK takes it to an extreme with some workers receiving lower take-home pay as they work more hours. Like the impact of VAT on dining-in, the end outcome is less work and less revenues.
The second is National Insurance paid by employers, which is effectively a tax on hiring workers. The UK is unusual is relying so heavily on taxing employment, with most peer countries choosing to levy broader income taxes that capture non-wage earnings, such as pensions and dividends. The tax is particularly counter-productive against the current macroeconomic backdrop of rising unemployment in the UK, especially among younger workers, as well as concerns around AI replacing jobs. (ChatGPT admitted to me he does not pay National Insurance.)
The third most striking example is the treatment savings through taxes on stamp duties on shares and inheritance tax. These taxes are outdated from an international perspective and simply reduce the incentive to save and invest in the UK. At the same time, they clearly increase the incentive to engage in complex and expensive tax planning, which reduces any fiscal benefit for HMRC. Australia abolished both taxes many years ago – with the abolishment of inheritance tax in 1979 famously leading people to delay death – and has ended up with lower levels of inequality relative to the UK.
Beyond these three areas, which could all be abolished by fixing VAT, Policy Exchange’s report goes further and recommends major reductions in other taxes, such as abolishing stamp duty on residential properties and National Insurance paid by employees, to bring the UK’s overall tax-to-GDP ratio from 36 per cent currently to below the OECD average of 34 per cent.
How can these tax cuts be achieved without major increases in government borrowing? The answer, canvassed in Policy Exchange’s earlier Beyond Our Means report, is major reforms to government spending, particularly around social payments. The largest item is reforming the current ‘triple lock’ indexation of the pension, which is estimated to save around £23 billion annually by the end of the decade. Importantly, pension payments would still grow, but just not at the rapid pace they have over recent years alongside inflation-boosting shocks to global energy prices.
This time next week the UK will have a new prime minister. He will inherit an economy saddled with a distortionary and productivity-sapping tax system. Worryingly, some early indicators suggest he is more likely to raise taxes than cut them. But if he is serious about growth – and wants to unleash the UK’s economy from the proverbial refrigerator – this report provides a clear path forward.
Comments