Poor tax design is a major challenge; reform offers major opportunities
Helen Miller, Institute for Fiscal Studies
Pick a tax, any tax.
That tax almost certainly needs serious reform. It is probably creating large and unjustified distortions to how much people work, how much businesses invest, or to choices people and businesses make over how to allocate their time and resources. All those things make us less productive and leave us poorer. There’s a good chance the tax is also creating unfairness by giving different tax rates to very similar people.
Did you pick income tax or national insurance contributions? These are our biggest revenue raisers. Together, they bring in almost half of UK tax revenue. There are plenty of issues here, not least why we have two taxes on income in the first place.
But the one that troubles me most is the tax penalty on employment. Employment income is taxed at higher rates than income people get from investments or from running their own business. It’s also taxed at higher rates than capital gains. This set up, often described as lower rates for the self-employed, but is not justified by differences in government benefits or employment rights and is not a well targeted way to boost entrepreneurship. Having different tax rates on different types of income adds a lot of complexity and is unfair in the sense that similar people can face drastically different tax bills depending on how they get their income.
If you picked VAT you might think you’ve picked a straightforward tax. It’s been described as “unquestionably the most successful fiscal innovation of the last half-century” and “perhaps the most economically efficient way in which countries can raise significant tax revenues”. It has certainly been popular with governments. It raises almost a fifth of UK tax revenue, double what it did when introduced 50 years ago. But the UK’s VAT is plagued with zero-rates and exemptions. These are expensive, representing £100 billion in foregone revenue annually, and create a huge compliance burden.
Millions of valuable hours are spent applying and disputing these rules. And the rules don’t even make sense! A gingerbread man is zero rated for VAT as long as the chocolate decoration is ‘no more than a couple of dots for eyes’ – add a smile, and you’ll also need to add 20% VAT. Chocolate Nesquik – no VAT. Strawberry Nesquik – 20% VAT. And these are relatively straightforward examples. What madness is this? And what do we get in return? Zero-rating for goods such as food helps lower income households but in an extremely poorly targeted way. Equivalent support could be provided at much lower cost through the benefits system.
If you’ve picked a tax on housing, you’ve hit on a very troublesome part of the tax system. Council tax in England is based on property values from over 30 years ago. As such, the tax we pay bears increasingly little relation to the actual value of the property we live in. Council tax is also regressive. Not all parts of a progressive tax system need to be progressive; it’s the overall effect that matters. But it’s hard to justify lower tax rates for people living in more expensive homes. Council tax should be reformed.
In contrast, stamp duty should simply be scrapped. It imposes a heavier tax charge on properties that change hands more often. There is no good reason to do this. It gums up the housing market meaning people find it harder to move to where the jobs are, young families struggle to trade up, and older people hold onto bigger properties than they need, because it costs so much to move.
The list goes on. Inheritance tax is easily avoided by the healthy, wealthy and well advised. Corporation tax discourages some profitable investments while subsidising some unprofitable ones. A jumble of environmental levies creates inconsistent incentives to reduce emissions, making it more expensive than necessary to reach net zero.
Most of these problems have been around for decades. People who had my job before I was born were writing about them. Depressingly, it’s likely my successors will say the same thing. But it’s not inevitable.
As the general election starts to come into focus, and political parties prepare for their autumn conferences, there will no doubt be debate about the overall level of taxation. UK tax revenues are historically high. Spending pressures will grow, most notably because an aging population will increase the cost of providing healthcare, social care and state pensions. Without tax rises or a major pick-up in growth, UK public service and benefits provision will either have to be scaled back or it will deteriorate. The level of tax needs serious debate.
But our living standards will be shaped not only by how much tax revenue is raised (and what it is spent on) but also by how it is raised. Taxes could be simpler, fairer and less damaging to our productivity. And if there is one thing that will make our choices over tax and spend easier, it’s productivity. Caring for an aging population, reaching net zero, improving public services or even cutting taxes, would all be easier if we were richer.
Missing that opportunity seems to me to be almost as silly as a tax that applies to marshmallows, unless they are intended to be roasted and eaten from a stick. There’s no shortage of choice on where to start reforming. Pick any tax.
Public opinion and taxation: the surprising reality
Why your assumptions about tax may be wrong
By Ben Szreter and Alexandra Burns
Who wants to pay more tax? Probably more people than you think.
If you were paying attention to the Conservative leadership campaign that played out last summer, you’d have noticed that tax – or rather tax cuts – were the hot topic. It wasn’t the first time that the promise of tax cuts formed a core component of a political campaign and it won’t be the last – both main Westminster parties are already starting to float different forms ahead of the next general election.
Tax is critical: for governing because it affects the balance sheet available for spending on public services, for politics because where the taxes fall indicates differing ideology, and for the public because it affects individuals very directly.
That’s why, working with the Institute for Fiscal Studies (IFS), we are taking a closer look at the tax landscape as part of our UK 2040 Options work. Today, with the IFS, we have jointly published a set of fundamental facts, and we are developing more work together for release next year.
Large demands for public spending are being created by a combination of demographic pressures, high inflation, rising debt costs, sluggish economic growth and weakened public services. The choice for politicians is difficult – there are no easy cuts to make. The major tool for tax increases has been freezing tax thresholds, stealthily bringing in substantial revenue. But if the economy continues to struggle, rather than tax cuts, the government will be forced to consider increasing taxes in a more visible way. The concern for all parties will be whether the public are prepared to pay more.
But what do the public think about taxes? We’ve used survey data, both existing and new, to try to answer three questions. Firstly, what does existing data tell us about how people in Britain feel about the amount of tax they pay, and how has that changed over time? Secondly, how much does the framing of the question asked about tax matter? And finally, how accurate are the public about what others think about tax? According to our findings, the answers are likely to surprise you.
How do people feel about taxes in the UK overall?
The prominence of tax in the political debate doesn’t seem to match the level of importance the public assigns it. For example, the Ipsos Issues Index in August 2023 shows that only 4% of the public identify tax as one of the most important issues facing Britain today. The highest level this figure has ever reached is 14% and that was in March 1979, a year before our current prime minister was born.
What does the public feel about the level of tax we pay? If you were to consult the British Social Attitudes (BSA) survey for an answer to this question, the answer is that a majority of the British public are in favour of higher taxation, with 52% of survey respondents saying so in 2021. They’ve been reporting on this for decades, and while the “raise taxes” and “keep them the same” options have both vied for the top spot over the years, “reduce taxes” has never come close, staying in the single digits.
This is publicly available information from a nationally representative survey so you might wonder why politicians would be so focussed on tax cuts in this context. One hypothesis could be that different kinds of voters have different views on this issue and therefore those wanting to appeal to a certain group focus on it for this reason.
We also asked this question to people in battleground constituencies in our recent polling for UK 2040 Options. Asking the same question as the BSA, we found broadly similar results. Respondents were divided between those who want to keep tax at current levels (38%) and those who want to raise taxes (36%). Just 12% expressed a preference for lower taxes. Even among people who previously voted Conservative and thus who may traditionally support a smaller state, we found just 15% in battleground constituencies want to cut taxes and spend less.
So, at this level at least, that hypothesis doesn’t seem to hold out. What else could it be?
The answer is in part that these survey headlines mask an important detail – the question asked directly links tax to spend.
Framing makes a difference
The specific question asked in the BSA survey is:
“Suppose the government had to choose between these three options. Which do you think it should choose?
- Reduce taxes and spend less on health, education and social benefits
- Keep taxes and spending on these services at the same level as now
- Increase taxes and spend more on health, education and social benefits.”
The way this question is framed draws a direct link between taxes and spending on “health, education and social benefits” — topics that we know the public care about. What happens if we remove that framing?
We ran a further piece of polling, this time with just over 3,000 people across England. For around 2,000 of them we asked the same question that BSA uses (see left column of the table below). For the other 1,000 we changed the response options to link tax to spend more generally (right column):
With the standard question used in the BSA, the answers from our new polling were close to the other surveys: 35% say they want increased taxes, 41% say they want taxes kept the same and 15% want taxes reduced. But the new framing made a big difference. There was a 15 percentage point drop in those saying taxes should increase, a six percentage point drop in those saying taxes should stay the same and a 22 percentage point rise in those wanting taxes to reduce.
These differences are pretty stark. Framing matters.
Some would argue that the BSA framing is a crucial reflection of reality, being clear that tax cuts mean having less to spend on key public services. But others would say that the impact of tax cuts for the public is dependent on other economic or fiscal choices, that where public spending cuts fall is a matter of priorities, and therefore the framing is too leading.
Our findings do not tell us what’s right or wrong, or give us the entire picture. They do not tell us whether people’s attitudes on tax are a strong predictor of their actual voting behaviour, or what happens to opinion when the rubber hits the road on the campaign trail and tax is made a totemic issue.
Indeed, support for increased tax in a general sense may not always translate into an increased willingness for individuals to pay more tax themselves. But it does show us that framing matters when talking about taxes with the public, and political parties will want to be mindful of it, whichever argument they’re trying to make.
Are our instincts about what others think about tax right?
Pluralistic ignorance, a social phenomenon where people as individuals misjudge the public mood, can be striking. For example, in Saudi Arabia recent research showed that most men personally thought that women should be allowed to work outside the home, but when asked how other men think, the majority (incorrectly) expected other men to be much less accepting of this.
Could this kind of incorrect assumption be at work when it comes to our views about tax? In short, yes.
We asked the same 3,000 people to imagine 100 average adults in the country and guess their collective appetite for tax rises, status quo taxes or tax cuts.
In both of the question styles (with and without the specific spending framing), people consistently thought that others were more likely to want tax cuts than is true. They also thought that people were less likely to want tax increases than they actually were.
On average across all respondents people thought that others were 13 percentage points more likely to want tax cuts than they actually are (39% vs. 26%), eight percentage points less likely to want taxes to stay the same than they actually were (34% vs. 42%) and four percentage points less likely to want tax increases than they actually were.
If looking at this across the whole electorate (using the 2019 general election registered voters of 47.5 million as a baseline) this means that people on average think around 18.6 million voters want tax cuts when actually only around 12.4 million do; an average overestimation of more than six million people.
Death and taxes
“In this world nothing can be said to be certain, except death and taxes” – a phrase most closely associated with Benjamin Franklin. But while taxes (and indeed death) remain a certainty, it seems the perceptions of them are highly influenced by the precise question asked, and our understanding of attitudes towards tax certainly isn’t certain.
This has implications for the way that policymakers of all political stripes should seek to understand and interpret the public view on tax, and also how they then apply that to decision making and communication.