Tax reform is more important than tax cuts

by Ed Bowsher on 08 April 2010  |  7 comments
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Tax cuts make no sense when you've got a £167bn deficit, but tax reform should be at the top of the next government's agenda.

Perhaps the most bizarre aspect of the election campaign so far is that there’s been so much talk of tax cuts. As I said last week, if you’re going to cut taxes, national insurance is the best tax to go for, but it makes no sense to cut taxes at all when we’re expecting a deficit of £167bn this year.

However, that doesn’t mean our current tax system should be left unchanged. Too often, our system taxes the wrong parts of our economy too heavily, and it’s also too complex.

In today’s Telegraph, Edmund Conway made some sensible suggestions for tax reform. Here are three:

Merge income tax and national insurance

These are both taxes on wages. You might think that national insurance goes towards pension payments and social security, but the reality is that revenue from national insurance just goes into the general government pot. This became even clearer when Gordon Brown bumped up the tax to pay for increased spending on the NHS in 2002.

It would be much simpler to merge the two taxes. But I suspect it will never happen because a government would have to admit that the basic rate of income tax is actually 31% rather than the current rate of 20%

End the slab tax

Stamp duty on property sales is structured in a very strange way. It’s known as the ‘slab tax.’

If a property is sold for £249,000 stamp duty is charged at 1% on the whole value of the property. But if a property is sold at £251,000, stamp duty is charged at 3% on the whole value of the property. This makes no sense. It would be much better to structure stamp duty like income tax.

Say a house was sold for £400,000. Stamp duty could be levied like this:

£0 to £100,000: 0%

£100,000 to £200,000: 2%

£200,000 +: 3%

Remove the favourable tax treatment for debt

Thanks to the tax system, it’s cheaper for companies to raise finance by borrowing rather than issuing extra shares to the stock market. As a result, in the noughties many companies borrowed extra cash and used the money to buy back shares in themselves. That increased company profits for a while but it also made companies more vulnerable when the financial system crashed.

I don’t completely agree with Conway, however. I suspect that he is keener on cutting back the size of the state than me. But we can both agree that tax simplification makes a lot of sense.

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