Talking Taxes

‘In a fiercely competitive global economy, taxes should be lower. So as Chancellor I will approach each Budget looking to see if we can reduce taxes as well as reform them.’

In his new Politeia pamphlet, Taxes in a Global Economy, Irwin Stelzer is right to identify the pressures on developed economies’ tax systems as one of the hardest challenges facing any government.

There is the economic challenge from mobile flows of capital and labour, when the building blocks of our tax systems were largely designed for a much more closed economy. The negative reaction to the Government’s proposals on the taxation of foreign profits is only the most recent example of this tension.

And there is the political challenge from hard-pressed voters who are already struggling with the rising cost of living. The scale of the anger over the abolition of the 10p rate of income tax shows that Gordon Brown’s strategy of raising taxes by stealth has finally caught up with him.

The right way to meet these challenges is with long-term thinking and a solid set of guiding principles. The last few years have illustrated what happens if those principles are missing. Budgets and Pre-Budgets have been driven by the shortest of short-term political considerations with little apparent regard for the longer-term economic consequences. These unfortunate episodes have been catastrophic for public trust in taxation and for Britain’s reputation as a place to invest.

So what are the fundamental principles that should guide tax policy?

Irwin cites Adam Smith in his pamphlet, and I believe the four principles of good taxation that Smith outlined over 200 years ago still provide a good guide for policymakers in the modern age. He said that taxes should be efficient, certain, transparent and fair.

Efficiency is if anything more important now than it was then. These days the realities of the new global economy have significantly increased the dynamic impact of taxes, and particularly business taxes, on international investment. Given the constraints of the public finances, a significant reduction in overall business taxation is simply and sadly unaffordable in the short term. That is why I have pledged to cut the main rate of corporation tax from 28p to 25p, and to reverse the increase in the small companies’ rate from 20p to 22p, paid for by reducing complex capital allowances so that depreciation rates in the tax system are closer to those actually used in accounts.

Adam Smith’s second principle was certainty, a lack of which undermines incentives for investment in a similar way to high tax rates. Much of the uncertainty introduced by this Government over the last 11 years has stemmed from a lack of understanding of the unintended consequences of tax policy.

A Conservative Government must not make the same mistakes — we need to fundamentally change the way we make tax law in this country. That is why I have asked Geoffrey Howe to lead a group of senior tax specialists and experienced politicians to propose long-term fiscal reforms.

These reforms will include a requirement on the Treasury to publish technical changes to the tax system in the autumn before the Budget, to be scrutinised by a new Parliament­ary committee and external experts. By the time the legislation reaches the statute book it will have been scrutinised by the people who will have to implement it. That means no more stealth taxes.

Smith’s third principle, transparency, is not just a good in itself; it is also vital to maintaining trust and public confidence in the tax system. But the biggest enemy of transparency is complexity, and our tax code is probably the most complex in the world. That is why we are working with the experts such as PWC and Grant Thornton to do the long-term thinking on simplification. And it is why the final aspect of the proposals being examined by ­Geoffrey Howe’s group will be so important — the establishment of a new Office of Tax Simplification to examine the existing tax system and make proposals for simplification.

Fairness, Adam Smith’s fourth principle, is as relevant today as it ever was, and is at the root of the anger against the abolition of the 10p rate. It also underpins my pledge to raise the inheritance tax threshold to £1 million, restoring it to a tax on the very wealthy and not on millions of ordinary families. And it was also behind our proposals to levy a simple flat-rate levy on non-domiciles in return for certainty over their status for a Parliament.

The final principle that has been sorely lacking over the last 11 years is a long-term strategy to reduce the overall level of tax. In a fiercely competitive global economy, taxes should be lower. So as Chancellor I will approach each Budget looking to see if we can reduce taxes as well as reform them.

Yet as well as record levels of tax, we currently have the largest budget deficit in the developed world. The way out of this fiscal mess is to share the proceeds of economic growth so that, over an economic cycle, government grows more slowly than the economy does. Over time this will reduce the share of national income taken by the state and provide a stable platform for a sustainable reduction in tax.

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