In the last Quarter of 2023, it was confirmed that the UK had fallen into recession. The picture of the UK over the last decade has been one of stagnation or decline. Productivity has grown by just 0.9% per year since 2008, and as per the Centre for Macroeconomics May 2022 Survey, it is believed that the UK will continue to suffer from low growth in the upcoming decade. This was considered to be a result of UK-specific structural issues, one of which being the UK's tax system, which has been described as “complicated, inefficient and beset with perverse incentives that do little to raise revenue” (Tetlow and Marshall 2019).

For some time now, there has been discussion about tax reform in the UK, whether they truly maximise the revenue the Government could bring in, and whether they are still fit for purpose, with some taxes not seeing true reform in decades. With an election looming, both parties looking to win will require additional revenue in order to enact their policies. With growth in the UK stagnant, it's likely that either party would currently have to rely on either borrowing money or cutting spending. Herein lies the argument for reforming the taxes we currently have in order to increase the revenues the government can earn whilst simultaneously making them less complicated.

Taxing Capital vs Taxing Labour

One of the key battlefields is where the balance of taxation falls in the UK. It can be argued that in the UK, labour is taxed far more aggressively than wealth. This can be best seen by the current Prime Minister Rishi Sunak. Mr Sunak recently published his tax returns in which we learned that he paid £508,308 in the financial year 2022-23 on overall earnings and gains of £2.23m. This is an effective rate of tax of 23%, which is far lower than the top rate of income tax, which is 45%. This is largely due to his earnings in the US being taxed at source, and capital gains tax is much lower at 20%.

Capital Gains Tax

This raises a good question, why is a millionaire able to pay less in tax than for example, a Doctor? The answer is that capital gains tax is very favourable to those with wealth. The capital gains tax is targeted at realised capital gains. Realised capital gains are the amount of profit made after selling an asset, usually real estate or stock investments. The ‘gain’ is the amount earned by the sale minus the original amount. A capital gains tax will then tax the seller on the profit made from the sale. 

For some time now, capital gains tax has been lower than income tax. This has resulted in those who earn in excess of the highest tax bands to re-characterise their income. As capital gains are taxed lower than income tax, a lot of business owners now take small salaries or in some cases no salaries and instead take money out of their company in the form of capital gains.

So, how can we reform this tax to make it more suitable? In 2023 the Economy 2030 Inquiry by the Resolution Foundation released a report suggesting the following reforms:

"The report proposes aligning the tax treatment of these different income sources by increasing tax rates on self-employment and rental income, enabling the rate of employer NICs to be cut by one per cent. Moving towards equal treatment would also mean increases in the rates of Capital Gains Tax, such as from 28 per cent to a top rate of 53 per cent for second homes, and a top rate of 37 per cent for shares. Crucially though, the report argues that this would be combined with a major tax cut, with no tax paid on gains that are merely in line with inflation. The result would be a net Capital Gains Tax cut for many, with anyone seeing an annual capital gain for shares of 8 per cent or less facing a lower net tax rate than the 28 per cent rate that George Osborne oversaw between 2010 and 2016."

National Insurance & Income Taxes

Another area for reform is income taxes. Both National Insurance contributions (NIC) & Income taxes are overly complicated. Both have a series of rules and exemptions that make it difficult to calculate. For example, Resolution Foundation's 2023 report provides the following example:

"A common example of this complexity is the ‘hidden’ 60% effective marginal tax rate that people must pay if their annual income falls between £100,000 and £125,140 due to the loss of personal allowance, despite a statutory income tax of 40%. Similarly, employees face different effective marginal tax rates depending on how their income is structured. For instance, the effective marginal tax rates for employees in the top income bracket (earning more than £125,140) can vary significantly, peaking at 53.4% when employer NICs are included or 54.5% paid on income from dividends, falling to 47% paid on self-employment income, 45% on rental income, 28% on gains from property, and as little as 0% if an employee keeps their income in a company and then emigrates".

In order to uncomplicate this tax, one solution is provided by Broome et al. (2023), who suggest equalising tax rates on different kinds of income and removing very high marginal rates, through higher dividend and capital gains taxes and higher top National Insurance rates for the self-employed, offset by indexing capital gains to inflation, a cut in employer National Insurance, reinstating the personal allowance above £100,000, and abolishing the High Income Child Benefit Charge.

Property Taxes

When we examine property taxes, we see further examples of poorly designed taxes that need updating or reform. Council tax, stamp duty, and business rates which bring in near 9% (£90 Billion) of the UK's tax revenues are all flawed in their own ways.

Council tax is a levy on properties, but it is based on house prices in 1991. In an article in the New Statesman entitled "Britain's Great Tax Con" Harry Lambert wrote:

"If you live in Burnley, where homes are cheaper than many other parts of the UK, you will on average pay 1.1 per cent of the value of your home in council tax every year. If you live in a typical property in Kensington and Chelsea, where council tax has scarcely risen but homes have rocketed in value since QE – leaping from 24 times earnings in 2010 to 38 times earnings in 2022 – you will pay 0.1 per cent. The burden of council tax is ten times as great in Britain’s poorest areas."

A fairer way to tax property would be to replace the tax with an annual proportional property value tax based on up-to-date house valuations. Harry Lambert noted that by setting a flat 0.5% tax on house valuations you would raise the same revenue whilst cutting taxes for 3 out of 4 people and eradicating the need for Stamp Duty Tax. So, whilst it would not increase tax revenue, it would simplify the property tax as well as reduce the increasing economic equality in the UK as well.

In Summary

In Summary, we've outlined several reasons why the UK needs tax reform. Currently, the inequality in wealth is part of the reason that growth and GDP are struggling. By using these tax reforms, the government could free up finances to invest in public services as well as reduce the load on those who rely on those services the most.