Why Reeves should still make room for tax cuts in the budget

If we are to believe the advance billing, this is going to be the most depressing budget in history.
Perhaps she really intends to raise tax by £22 billion. Or £40 billion, if we believe some recent reports. Unless this is just brilliant expectation-setting by Rachel Reeves and everyone will wipe their forehead with relief and move on.
All taxes have consequences, besides the obvious one of raising money. Often, those consequences are negative for economic growth.
Which isn’t to say that taxes should never be raised. You may believe that the consequences for society of reducing (or at least not increasing) government spending are worse than the negative consequences of raising tax. Or you may believe that there is an economic benefit from increased (or at least not reduced) spending that overcomes the negative consequences of the tax increase. And of course, you may disagree with all this, and think that taxes should be kept as they are, or even reduced, and that government spending should be cut.
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I’m going to duck all those interesting political and economic debates about whether or not the government should raise tax. I’m going to assume in this article that Reeves really does need to raise £22 billion, and stick to the policy questions that follow. (If you disagree, you probably need to go back in time and change the election result.)
If I were Ms Reeves and thought I needed to raise £22 billion, the first thing I’d do would not be to raise £22 billion.
It is a lot of money, even for a government — but it’s less than 1 per cent of UK GDP. Here’s a bigger number: £500 billion. That’s how much larger the UK economy would be today if our annual GDP growth after the financial crisis had continued at its previous average of 3 per cent and not slumped to 1.5 per cent.
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So, the first thing I would do if I were Rachel Reeves would be to focus on growth and ask the question: are there ways the tax system is holding back growth? And if so, how do we fix this?
Sometimes that means abolishing taxes. Stamp duty on shares raises about £4 billion each year. Abolishing stamp duty would lift the FTSE by between £8 billion and £22 billion. It would reduce the cost of capital for business. It would end a distortion that favours debt, and favours private companies over public. Plausibly it would pay for itself, and drive economic growth. This is that rare tax cut that really could pay for itself.
Sometimes going for growth means reforming taxes. We should start with corporation tax — an important but horribly over-complex tax. We can get a measure of the problem we have by looking at international rankings of the competitiveness of different corporate tax systems. The one compiled by the Tax Foundation, a United States-based non-profit, ranks many countries with similar or higher rates of tax than the UK as having more competitive corporate tax systems: Sweden, Austria, Belgium, Finland … even Greece and Italy, with their famously difficult state bureaucracies. It’s official: the UK is now worse.
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Liz Truss abolished the Office of Tax Simplification, but in truth the organisation, set up to propose reforms to the tax system, never had the political backing it needed to succeed. Its frequently brilliant policy papers languished in a Treasury in-tray, untouched by ministerial hands. We need radical simplification: a new kind of OTS, with heavyweight political support, and a junior minister attached, so that it’s a body with real political weight. Then tax simplification might actually happen.
Sometimes, perversely, we can drive growth by raising taxes. An example is inheritance tax. Right now, if I wanted to avoid inheritance tax on my useful FTSE 100 share portfolio, I’d sell it and buy a much less useful portfolio of Aim shares and commercially managed woodland. Both could become completely exempt from inheritance tax after two years.
The problem for the UK economy is that — and my apologies to tree-huggers and Aim-boosters — in investment terms neither makes any sense. I’d only be investing for the tax benefit. And if the tax system is incentivising people to make economically subpar investment decisions, then the tax system is getting in the way of growth. If the chancellor increases inheritance tax by abolishing these exemptions, the economy will benefit.
Only after a good round of tax reform would I reluctantly turn to tax rises.
The easiest tax rise is the one few people will notice: fiscal drag. Freezing tax thresholds, so that inflation drags more people, and more income, into higher rates of tax, has been astonishingly lucrative for HM Treasury. Rishi Sunak raised £29 billion by freezing thresholds through to 2027-28. Rachel Reeves could raise a further £7 billion by keeping this up until 2028-29.
Then it gets more difficult. Raising employer national insurance would raise a lot of money — £8.5 billion or more — but if you tax employment, that means fewer people get employed, and those who are employed get paid less in the long run. Most people would see that as a breach of pre-election promises to not raise taxes on “working people”.
The other easy route — at least in theory — is to change the rules around pensions. Perhaps by limiting tax relief on contributions. Perhaps by reducing the tax-free lump sum that can be withdrawn. These can raise serious sums, but are not without political and technical complication. A better, but still not straightforward, route might be to charge national insurance on pension drawdowns.
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The trouble is that all the other easy options — VAT, income tax, employee national insurance — were ruled out in the manifesto. That leaves some rather undignified scrabbling around to raise a few billion pounds in a small capital gains tax rise here, a few billion in technical income tax changes there, or even a few billion in technical monetary changes at Threadneedle Street. It ain’t pretty, but it could raise £22 billion.
Nobody’s going to be happy with £22 billion worth of tax rises, no matter how artfully they’re constructed. But the picture will be a happier and more coherent one if the tax rises are accompanied by a story about growth that’s backed by tax reform. And if those include some tax cuts as well as tax rises, it will demonstrate that this is a chancellor acting pragmatically, rather than ideologically.
Dan Neidle is a tax lawyer and founder of Tax Policy Associates, an independent tax think tank