Taxes and the UK’s new Prime Minister

September 6, 2022 8:07 pm Published by Comments Off on Taxes and the UK’s new Prime Minister

The UK contest for Boris Johnson’s replacement has concluded: Liz Truss is now the new UK Prime Minister. Her campaign offers clues about what this might mean for UK tax policy, though it is unclear how soon the various plans will be enacted.

Like many other countries, the UK is dealing with challenges caused by the pandemic and a more recent energy and cost of living crisis connected to Russia’s invasion of Ukraine. Liz Truss enters office as the UK economy must recover lost growth and defend against inflation, while balancing long-term fiscal considerations.

Therefore, it is critical that her government understands the importance of principled, pro-growth tax policy.

The previous Chancellor of the Exchequer, Rishi Sunak, had proposed increasing the UK corporate tax rate from 19 percent to 25 percent starting in April 2023. Additionally, he pushed through an increase to National Insurance Contributions (NICs), a tax that raises roughly 20 percent of all UK tax revenue. The 1.25 percentage point increase in NICs applies to employers, employees, and investment income.

A corporate tax rate increase of that magnitude has been rare among developed countries, though it is smaller than the 10-point rate hike in France between 2016 and 2017 when the total rate climbed from 34.43 percent to 44.43 percent due to a temporarily higher surtax rate. The French corporate tax rate for 2022 is 25.83 percent.

The magnitude of the scheduled corporate rate hike is the same as the corporate tax hike that pushed the Greek rate from 20 percent to 26 percent in 2013. The Greek rate is currently 22 percent.

Hiking the corporate tax rate by six percentage points while staring down a difficult economic crisis would be a poor policy choice that would likely need to be reversed in a short time frame. Such a reversal is already in play.

In her campaign, Liz Truss promised to cancel the corporate tax hike and reverse the NICs hike. Canceling the corporate tax hike would reduce revenues by £17 billion each year and reversing the NICs hike would reduce revenues by £13 billion. Together, these represent 3.7 percent of total revenues collected during the 2021-22 fiscal year.

Despite these policy changes working against trimming the budget deficit and tackling debt that accumulated during the government’s response to the pandemic, her approach rightly avoids overburdening companies and workers in a challenging economic climate.

Additionally, Truss suggested that the UK should pull out of the global tax deal, part of which would impose a global minimum corporate tax of 15 percent.

The corporate tax rate, the tax burden levied through NICs, and the global minimum tax are important, but there are other policy issues to consider.

In 2021, the UK stood at 22nd in the International Tax Competitiveness Index (ITCI). In recent years, it has not been tax rates but rather the tax base that has contributed to the UK’s relatively poor rankings. Its corporate, consumption, and property taxes punish investment and distort decisions.

A lower rate is usually a good thing (so the Truss approach is admirable) but the tax base will need much attending to. A 2020 publication from the Tax Foundation and the Centre for Policy Studies in London laid out a strategic vision for the UK tax system that is even more relevant today as the threat of 1970s-style stagflation looms.

In particular, the next UK Prime Minister will need to adopt policies that remove what has been referred to by the Adam Smith Institute as the “Factory Tax,” which, despite the relatively low corporate tax rate of 19 percent, inflates the cost of investing in machinery and factories.

A temporary and partial solution to this has been in place since April 2021 but is set to expire next April. A long-term fix to this has been analyzed by the Adam Smith Institute.

The consumption tax base is another challenge the next UK Prime Minister should tackle. The UK ranks in last place on its value-added tax (VAT) base in the ITCI. Less than 50 percent of consumption is covered by the VAT due to exemptions and special rates which complicate the overall system and distort consumer choices. Consumption taxes are efficient because they avoid penalizing decisions to invest in productive activities or save for the future. A broader VAT base could also create fiscal space for lowering the overall VAT rate of 20 percent.

The property tax base also deserves attention. Business rates should allow property owners to improve their premises without significantly increasing their tax bills. Council tax (a property tax) is still based on 1991 property values and operates via a regressive “band” system. The residential property tax base needs to be updated and the tax itself made more proportional to property values.

In an already-challenging economic environment, new UK Prime Minister Liz Truss must get tax rates correct to avoid over-burdening a population and business sector facing immense uncertainty. Focusing only on rates while ignoring the base misses an opportunity for real, pro-growth reform.

Note: Originally published on July 22, 2022, this article has been updated to reflect the recent Tory leadership election results.


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This post was written by prismatax

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