A warning to Reeves: These tax rises will damage UK competitiveness
Not only is the UK tax burden at record levels, but we are raising money in a more damaging way than our competitors. And the Budget could be about to make things even worse, says Daniel Herring
Next week, Rachel Reeves needs to try not to make the UK’s tax system worse. Yesterday the US-based Tax Foundation released the 2024 edition of the International Tax Competitiveness Index (ITCI), an annual ranking of how pro-growth the tax systems of 38 OECD economies are. It’s dire reading for the UK, which comes 30th overall.
Importantly, the Index is neutral about the size of the overall tax burden, which has been raised to a 50-year high. Rather it’s about the way countries raise taxes – whether the overall tax system is efficient at raising revenue and avoids causing economic harm as it does so.
That means that, not only is the UK’s tax burden at record levels, but we are raising the money in a more damaging way than most other OECD countries. There ar
e several culprits. While the last government introduced permanent full expensing (without which we could have fallen even further down the ITCI), corporation tax rose from 19 per cent (fourth lowest in the OECD) to 25 per cent (now 16th highest). We have many distortive taxes on property, such as inheritance tax and stamp duty on both land and shares. The VAT regime is full of exemptions, meaning only about half of all consumption is subject to VAT, whereas in the OECD it’s closer to 60 per cent.
Falling down the rankings
But while we’re in a bad place, unfortunately, it can get worse. The Chancellor is planning a range of spending cuts and tax rises for the Budget next week which could push the UK further down the rankings table. The Centre for Policy Studies, with the Tax Foundation, modelled a series of decisions Rachel Reeves could make.
A tax rise on capital gains seems the most likely. This would push the UK further down the rankings. For example, raising the capital gains tax rate to 33 per cent would mean the UK would fall from 30th to 32nd overall. Raising it to 39 per cent would see the UK have the third highest rate in the OECD (it currently has the 16th lowest rate) and fall to 33rd overall. A more extreme option – equalising it with the top rate of income tax at 45 per cent – would see the UK fall to 34th. It’s also unlikely to raise much revenue – in fact the Treasury has estimated that raising the capital gains tax rate by 10 percentage points would lose the government £2bn.
However, given the future spending pressures the government will face, and Labour’s ideological inclinations, this is unlikely to be the only damaging change. Introducing a wealth tax, which many on the government benches have previously called for, would see the UK fall to 34th, while raising very little revenue. Raising the rate of dividend taxation to equalise it with the top rate of income tax would see the UK fall to 32nd.
Combining these changes (with capital gains tax being raised to 33 per cent), the UK would be 35th, above just France, Italy and Colombia.
Furthermore, the Index can’t model other changes that we know will damage the UK economy. Potentially raising stamp duty on homes, increasing the cost of labour through employer National Insurance Contributions rises, or raising inheritance tax are all changes which could be included in a Labour Budget. All would add to the damage the tax system is already causing.
The UK’s tax system is a quagmire that damages incentives, blocks innovation, and slows down productivity
These changes are particularly damaging for London, the gateway for capital and people into the UK. The UK’s tax system is a quagmire that damages incentives, blocks innovation, and slows down productivity. For businesses and people that are mobile, these changes make the capital even less attractive as a place to work and invest.
There’s another way, which this Labour government has seemingly closed its mind to: pro-growth tax reform. This is not just about the overall tax burden (although we need to take that seriously as well). It means raising more money from less damaging taxes, and using those funds to abolish or reform more harmful ones. The benefits of taking this comprehensive approach is that we can begin to solve a range of problems at once: keeping and attracting wealthy investors, drawing in the world’s top talent, reducing the friction in the housing and share markets, lowering the barriers to investment and rewarding innovation and enterprise. While not the whole answer to the UK’s economic problems, tax reform is a necessary part. But it requires ambition, vision and courage, all which have been lacking in the Treasury for a long time.
Daniel Herring is researcher for economic and fiscal policy at the Centre for Policy Studies