The Labour government came to power with a promise to sort out public services, while ensuring that “working people” do not pay more in tax.
That is a tall order, since changes to the tax rates of the biggest taxes – income tax, national insurance Contributions (NICs), VAT and corporation tax – have all been ruled out.
But it isn’t impossible. Here are five sensible reforms that would be good for growth and would comfortably raise £22bn – the size of what Rachel Reeves has termed the “black hole” in the public finances this year.
Equalise capital gains with income tax – along with other changes
Reforming capital gains tax (CGT) is the first and most important change Reeves should make. Only 3 per cent of the population pay this tax over a 10-year period, but some of those that pay it pay a lot.
Rachel Reeves should follow her predecessor chancellor Nigel Lawson, who in 1988 equalised income tax and CGT rates, while introducing an allowance for inflation.
Equalising rates made it much less attractive to work through your own firm just to get a lower tax rate, reducing tax avoidance.
There is also merit to bringing forward an investment allowance, which would typically be more generous than only allowing for inflation, and would actually reduce the effective rate for many people, increasing investment incentives.
Most CGT payers are actually better off from this reform. Following Australia, Canada and the US in taxing all gains that are built up in the UK, even for individuals who leave, and removing the anomaly that gains are wiped out at death, would reduce scope for avoidance.
The overall effect? We’d make the tax fairer, better for growth, and raise £14bn in the bargain.
Charge landlords national insurance
While someone working full-time on the minimum wage pays income tax and national insurance (NI) to earn the money to pay their rent, landlords pay income tax but not national insurance on that rent.
This seems pretty obviously unfair, and difficult to justify. We don’t apply NI to dividends because – in theory at least – firms have paid corporate tax on the profits first.
But similar considerations do not apply to landlords. A reform of this sort should be combined with removing the restriction on mortgage interest deductions against rent: these are a real cost for landlords, and while some may not like the giveaway, we should be trying to make the system better, and taxing landlords on revenue not profit is bad design.
It would make the Treasury somewhere along the low single digit billions, alongside a tax regime that makes more sense. I’ll leave it to the linguists and political hacks to judge whether or not this expansion of NI meets the Chancellor’s tax pledges.
Expand employer NI
Most people get their earnings from being employed with NI levied on them and on their employer. If you are lucky enough to be working for a partnership, there is no employer NI to be paid. This is again hard to justify: why should two people making, say, £400,000 for their organisations end up having different levels of take-home pay just because one organisation is structured in a lower-tax way.
Organisations can still decide whether a partnership or company structure is more appropriate for commercial reasons, but now wouldn’t do this just to lower their tax bill. This would again add billions to the total.
Carried interest changes
Carried interest is the bonus that private equity (PE) executives get paid if they make enough profit.
While bankers and hedge fund managers are taxed marginally at 47 per cent on their earnings – 45 per cent income tax and 2 per cent NI – PE executives pay only 28 per cent.
This kind of effective subsidy seems particularly galling to an industry that is supposed to be at the forefront of market capitalism.
Previous work by the Centre for the Analysis of Taxation suggests that while equalising the rate with income tax would lead a few individuals to leave, the reform would still be expected to raise £800m annually. It would also even up the playing field across workers in different parts of finance.
Close inheritance tax loopholes
Lastly, I would recommend closing some of the loopholes in inheritance tax. I use the word loopholes even though many in the tax profession take offence at it. But the purchase by wealthy individuals of huge areas of agricultural land to be able to pass it on tax free was not the intention of Agricultural Relief.
The official purpose is to stop farms being broken up. Buying up agricultural land is certainly allowed, but it is not the intention of the relief and drives up the cost of land for genuine farmers. The benefits of the relief go to a tiny number of people: two thirds of the value goes to just 200 estates a year, each claiming more than £1m of relief.
Less than half of recipients had any trading income from farming in the previous five years. Business Relief is similarly concentrated, with two thirds going to the top 400 estates.
And again, the deceased’s connection with the business is not always strong: only a quarter had been involved in management of the business as a company director at any point in the five tax years prior to death. Capping these reliefs at £500,000 per person, on top of existing reliefs, could raise up to £900m.
Increasing the ordinary tax-free amount (“nil rate band”) to £500,000, by expanding the special relief currently given to residential property, would pretty much offset this, but even out regional inequalities that mean equally wealthy estates in London and the South East tend to pay lower IHT than in the rest of the country.
Cap the spouse exemption at £10m, to ensure that a small number of surviving spouses can’t pass on tens of millions to the children after the first spouse dies, avoiding IHT altogether, and we raise another £500m.
Taken together these reforms are remove distortions that hinder growth, make the system fairer by treating similar people similarly, and can break the laws of physics, by closing the so-called “black hole”.
Arun Advani is the Director of the Centre for the Analysis of Taxation (CenTax) and an Associate Professor in the Economics Department at the University of Warwick
