Why we need lower, flatter taxes to pay for Covid-19

Now we are returning to work, the bill for Covid-19 has to be paid. Eamonn Butler of the Adam Smith Institute believes he knows how

Covid-19 policy hasn’t come cheap. The furlough scheme, extra intensive care beds, millions of jabs – it all adds up. Meanwhile, with businesses closed, workers laid off and less spending, tax receipts plummeted too. So the Government has ended up borrowing maybe an extra £500bn over 2020-22.

Rishi Sunak entered office promising to balance the books, so it’s no wonder that he has edged up taxes.

Income tax allowances have been frozen, businesses will pay more corporation tax, and National Insurance has gone up.

In September, when the National Insurance rise was mooted, there was outrage at how regressive this would be – falling mainly on poorer workers rather than richer investors. So to make the plan pass muster, convoluted new rules were added onto the convoluted old rules. That’s how the UK tax code got to be long and complex. Great for accountants, but a waste of energy and a drag on growth.

Do we need to raise taxes to clear the Covid-19 debt? Maybe we should treat it as a once-in-a-century aberration, park it away from everyday finances and create a new bond to extinguish it over 30 years. Then move on.

We should still accept that debt is bad. Interest and capital repayments are money you can’t spend on schools and healthcare and pensions. So, we need to tackle the Government’s chronic overspending.

Let’s start with a blank piece of paper, work out what we really need the Government to do, and ditch the rest. My guess is we could easily save £100bn a year doing that, with no loss in public benefit. Then go for growth – not by printing money as the Heath government did in the 1970s, and not by raising taxes, but by cutting taxes.

High taxes throttle economic activity, raising the debt/GDP ratio. The IMF found that tax rises create “large and long-lasting recessions” lasting “several years” – a rise equivalent to 1% of GDP, reducing growth by 2% of GDP. Spending cuts, by contrast, produce “very small downturns in growth” that “typically lasted less than two years” before upturns.

Let’s reform our taxes. Today, we tax the wrong things. When you tax something, you get less of it. We tax work (income tax), jobs (National Insurance), enterprise (corporation tax), saving and capital formation (capital gains tax). It’s madness. Let’s shift the burden onto bad things, like pollution and congestion.

And let’s make taxes flatter and simpler. For instance, our complex income tax exemptions and concessions are designed to make high rates remotely bearable but mean that high earners don’t pay anything like 45%. Let’s remove all the hiding places and have a simple, low-income tax rate (of around 22%). And let’s take everyone on the minimum wage out of tax (and National Insurance) entirely.

Under flat taxes, surprisingly, the rich pay more. In 1979, the richest 10% paid 35% of income tax revenues. After Geoffrey Howe slashed the top rate from 83% to 40%, they paid 48%. There is simply no point in trying to avoid a low tax. QED. 

Eamonn Butler is Director of the Adam Smith Institute one of the world’s leading policy think-tanks. He has degrees in economics, philosophy and psychology, gaining a PhD from the University of St Andrews in 1978.

AAT Comment offers news and opinion on the world of business and finance from the Association of Accounting Technicians.

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