A DIY approach to tax won’t work – what the UK needs is a structured path

Random tax increases to claw back the deficit is the last thing the Chancellor should be contemplating

Last week the Office for Budget Responsibility gave a sobering verdict on the state of Britain’s public finances. Not that any regular readers of this column should be in need of sobering up.

The OBR said that, on a central view, by 2069-70, the ratio of government debt to GDP would be 425pc. With an air of restrained understatement, it said that “it seems likely that there will be a need to raise tax revenues and/or reduce spending (as a share of national income) to put the public finances on a sustainable path”.

The key to minimising fiscal pain lies with ensuring a strong economic recovery that will allow us to live with the government debt, while both lowering the deficit and reducing the debt as a share of GDP over time. But even this will require continued spending restraint.

Accordingly, in complete contrast to the Government’s current tendency to squirt money around as though there were no tomorrow, it would be a good idea to save money where this can readily be done without incurring large economic costs.

Take the current triple lock on the state pension, under which it is set to rise by either the rate of inflation, the rate of increase of average earnings, or 2.5pc, whichever is the higher. This means that it will go up next year by 2.5pc. With workers’ incomes under extreme pressure, this is barmy.

Meanwhile, the Centre for Brexit Policy (of which I am a fellow) recently published a paper entitled “Replacing the Withdrawal Agreement” which argues that we should negotiate a reduction in our “divorce payment” liabilities to the EU and reduce our financial exposure by withdrawing from the European Investment Bank.

But attention is also already focusing on where the Chancellor can plausibly raise more tax revenue. This is potentially dangerous. It is no use raising tax revenue in the short-term if this reduces our growth potential in the long-term. But raising tax revenue without causing economic damage is easier said than done.

There has been much comment recently to the effect that pensions relief is much too generous and that it benefits the better off. In fact, much commentary on this issue is misguided. Giving tax relief on pension contributions does not represent a “bung” to well-off pension savers. It is the straightforward reflection of a system that makes pension contributions tax free, while making pensions themselves fully taxable.

Admittedly, the current system is especially favourable to pension savers in two respects. First, the granting of a 25pc tax free allowance means that this part of a pension saver’s pot, on which they originally benefited from tax relief, is not liable to tax. Second, the tax rate against which pension savers gain tax relief when making contributions is on average higher than the tax rate that they pay in retirement.

It would be possible to arrange matters the other way around – that is to say, giving no tax relief on pension contributions, but equally making pensions not liable to tax. (This would be similar to the tax treatment of ISAs.) And it would be possible to make other tweaks that raise the Exchequer considerable amounts of money.

Another area of relief which costs the Exchequer huge amounts is the ability of companies to offset interest payments against their tax liabilities. This contrasts with their inability to offset dividend payments. This acts as a strong incentive for companies to finance themselves with debt as opposed to equity. The Government has already moved to restrict the ability of companies to offset interest payments against tax but it could go a good deal further, perhaps combined with a reduction in corporation tax.

Similarly, there is both an efficiency and fairness argument for equalising the rate of capital gains tax with income tax. Yet, with the top income tax rate being 45pc against the current CGT rate of 20pc, that would involve a huge rise in CGT for high earners and would deliver a blow to risk-taking. Perhaps this should be an objective for the longer-term, combined with reductions in income tax rates.

If I had to point to one major opportunity for the Government to raise revenue while improving efficiency it would be the introduction of a nationwide system of road charging. Technological advances now enable the authorities the opportunity to charge motorists for travelling on different roads at different times at different prices – and indeed sometimes free – and therefore to nudge their behaviour towards what is economically desirable.

Governments could either continue to receive the annual revenue from such taxes, or they could sell off the right to collect the revenue and thereby bank a substantial capital sum.

In his coming Budget, the Chancellor will probably produce a new set of fiscal rules, governing the desired rate of borrowing and level of the debt to GDP ratio. Recent chancellors have tended to like such rules, so much so that they have frequently set new ones. Indeed, if Rishi Sunak does come up with new fiscal rules this autumn this will be the sixth set in 10 years.

Yet chancellors have never laid out a forward plan for the tax system that embodies both basic principles and a road map tracing out how and when they intend to get from A to B. We particularly need this now. Given that it is surely premature to be seeking to reduce the deficit radically, there is time to get the Treasury thinking seriously about the desired shape of the tax regime, building on the Mirrlees Review, published in 2010-11.

The last thing we need now is a set of random tax increases designed to raise revenue. More than ever, we need strong economic growth. And maximising growth requires a tax system that is structured to strengthen incentives and boost efficiency.

Roger Bootle is chairman of Capital Economics