Be brave, chancellor, and ignore the devils whispering in your ear

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It’s been almost 3 weeks since the famous autumn speech of Philip Hammond. People are discussing what his adjustments to spending plans will be, whether there will be any, and what might be the new fiscal stance. However, we didn’t hear a lot about taxation system changes.

It’s not all bad, as we learn about taxation not from the statements, but from the budget plans. People are tired of new tax laws, so it might be a good idea to give them a break. So no new announcements about taxes will November 23rd is a good thing for a new chancellor to start his activity.

 

However, the hopes for no new rules are minor, as the policy has to be changed at least a bit. There’s a desperate need for larger tax revenue, and this is the simplest explanation. Taxes have done very little of the heavy lifting in terms of cutting the budget deficit over the past eight years. But if growth forecasts are cut again, it is doubtful that yet more spending cuts will be found to fill the fiscal hole that this will create. We may be able to live with a bigger fiscal hole for longer than was planned, but not for ever. And longer-term pressures on health and pension spending, in particular, eventually will force some tax rises.

Of course, there are all sorts of other pressures. The chancellor will have angels whispering in his ear asking for more simplicity, efficiency and transparency. He will have devils wanting more tax breaks, special favours and rewards and punishments for the presently favoured or unpopular.

How can Mr Hammond increase his odds of being on the side of angels and reduce his susceptibility to the temptations of the devils? The first thing he should do, but which few recent holders of the office seem to have done, is to develop a view about what he wants to do with the tax system. Ideally, that view should be made public. A clearly articulated plan can provide taxpayers with some degree of certainty about a sense of direction. But even a secret plan is better than no plan. Whether public or not, it should take account of how the various bits of the tax system fit together and how they can be made to fit together better over time.

Simply having a plan can itself help to avoid all sorts of political problems and mistakes. The to-ing and fro-ing on things such as capital gains tax and the 10p starting rate of income tax under the last Labour government and Mr Osborne’s “omnishambles” budget of 2012 were bad policy and bad politics. A long-term strategy creates a much greater chance of getting coherent and efficient policy decisions and of avoiding political bear traps. It reduces the risks of succumbing to the temptations of special pleading.

Second, no chancellor should ever forget just how important the tax system is to the functioning of the economy. More than one pound in every three earned in the economy is taken in tax. It is obvious that the way in which this happens must matter for how efficiently the economy runs, how people and companies behave and what the ultimate distribution of income looks like. Getting it wrong can be incredibly costly, not always in ways that are immediately obvious but in ways that, in the long run, will hinder economic growth and wellbeing. Listening to the devils costs us all a lot in the end.

Beware of another kind of snake oil, that’s the idea that there aren’t trade-offs to be made when setting tax policy

My third piece of advice is both the most obvious and the most widely ignored. Simply remember that in the end all tax is paid by people. Despite what the devils will whisper, there is no such thing as a victimless tax. In the end, corporation tax has to be paid by a company’s shareholders (often pension funds), its employees or its customers. There isn’t anyone else. The same goes for all taxes. Those who appear to claim otherwise are selling snake oil.

Fourth, beware of another kind of snake oil, that’s the idea that there aren’t trade-offs to be made when setting tax policy. You can reduce inequality though the tax system, for example, but it is rarely costless to do so. The more progressive a tax system, the more effect it is likely to have on behaviour, whether that be work effort, effort put into avoiding tax or decisions about whether to locate investment in the UK.

This lies at the heart of economic analysis of taxation. It is all about trade-offs. Politicians have to make those trade-offs. That, chancellor, is what you are there for. The trouble really starts when you start to believe the devils who tell you that there are no trade-offs, that people will not respond in ways you don’t want them to just because it is convenient to believe that they will not.

One final piece of advice, and this may be the most difficult to take. Be courageous. Tax reform is cursed by a tyranny of the status quo because almost any change will make someone worse off. But the long-run prize from a well-designed tax system, in terms of a more productive and richer country, is huge. And it is possible to make change. Over a long period, governments have been able to implement sensible reforms — the gradual abolition of mortgage interest tax relief, for example. So don’t believe those devils who say rational reform is politically impossible. Changes don’t need to happen all at once. With enough time and direction, reform is genuinely possible.

Masterly inactivity this November as a prelude to a bold, well-thought-through, evidence-based strategy. The tax system is crying out for that.

Paul Johnson is director of the Institute for Fiscal Studies. Follow him on @PJTheEconomist

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