What is the purpose of taxation?
22 March 2012
The day after the Budget seems an appropriate time to address such a basic question. Income tax was introduced as a temporary measure in order to fund the Napoleonic wars; its temporary nature is the reason why we still have an annual Finance Act, which necessitates an annual Budget. As society progressed, taxation was used to build a basic infrastructure for the common good, funding such worthy causes as health, education, transport infrastructure and defence. Few would disagree that society is better for having these basics available to all.
But in recent years, something has changed, and that something is reflected in a significant expansion in both what we expect from the state and the taxation system needed to fund it. By far the largest element of government expenditure goes on welfare – some £207 billion out of an estimated total government spend of £683 billion in the next fiscal year. The next largest element, health, consumes £130 billion. The fact that welfare consumes so much of government expenditure is interesting because it demonstrates that a primary use of taxation is now to redistribute wealth from those who have earned it to those who have not.
As government expenditure continues to exceed taxation revenues (in the 2011/12 year, this addition to the national debt is forecast to be £126 billion), we are effectively borrowing money that will be paid by future generations of tax payers in order to fund welfare recipients of today. Those who object to ‘austerity’ need to recognise that we will still be spending more than we earn right up to the end of this parliament; all that the ‘cuts’ are doing is to slow the rate at which expenditure is increasing.
Faced with a continuing deficit, government has only two choices – cut expenditure, or raise taxation. Of course, the UK government is doing a bit of both. The taxation debate is very topical, and it is often just assumed that the ‘rich’ can be taxed to the tune of the extra £126 billion in order to fund the gap, and all austerity can be avoided. But of course this is very far from true; there aren’t enough ‘rich’, and they are both nimble and mobile – they will take action to reduce their taxation exposure, and ultimately they are both able and willing to leave these shores.
We need a countrywide debate about the message we are sending to our entrepreneurs and wealth creators. The tax debate at the moment seems to assume that their gains are ill-gotten and are therefore a legitimate target for redistribution to those who have been less successful. Is this really a recipe for success for UK PLC?
I think that George Osborne has made a courageous decision by reducing the highest rate of tax to 45%, although of course the perverse nature of our tax system leaves much higher marginal rates still in place, including 52% for those with children earning between £50,000 and £60,000, and 62% for those earning just over £100,000. His political opponents will make capital out of a perceived sop to the rich, although some may doubt whether a drop of 5% will be enough to influence behaviour. For me, I applaud his attempt to open the debate about how we view our wealth creators –should they be appreciated and encouraged for the jobs and innovations they create, or taxed to emigration in order to fund our increasingly unaffordable welfare state?
So in the best tradition of not complaining without suggesting a solution, here’s what I would do. Stop tinkering at the edges of our tax system, and engage in root and branch reform. Take the personal allowance to £20,000 annually, which would exempt many, many people from income tax, and beyond that a flat rate of 25% for all. Entrepreneurship, job creation and tax revenues would go through the roof with a simple tax system that encourages and rewards effort and which far fewer would seek to avoid. The only downside? A dramatically smaller HMRC (is that a downside?). Oh, and far fewer accountants.
Regards
Stuart Kellner
Managing Director
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