Much has been written on the fiscal differences between Rishi Sunak and Liz Truss. Put simply, the former is accused of following Treasury orthodoxy, of prioritising the collection of revenue over anything else – giving us the controversial NIC hike earlier in the year and frozen income tax thresholds. The latter is suggesting that we can commute the repayment of Covid debt, let people keep more of their own money and cancel growth-hampering hikes to corporation tax. If Truss does “understand the economics of growth” as Nadhim Zahawi has said, she will know that she needs more than just an attitude towards cutting taxes and paying debt. She needs a serious plan to reform the UK’s tax system and reduce overall spending.
This is not to say there isn’t an economic and philosophical case for immediately cutting taxes – there is. The tax burden is at a 70-year high, real incomes are stagnant and inflation is soaring. We are earning less in real terms while the taxman takes more. Frozen income tax thresholds will mean that this year the Treasury will collect an extra £30bn in revenue than it had originally forecast, taken from people being dragged into higher tax brackets. This alone will obliterate any reduction felt by reversing the NIC hike. Reversing it would not even be the best way to get support to those who need it most, given those on lower incomes pay less. And yet, it was absurd in the first place that a Conservative Chancellor opted for a tax hike in the face of a cost-of-living crisis.
The first place to look is at unfreezing thresholds and putting an end to fiscal drag. Raising them in line with inflation would be a much better way to offer those on lower incomes support, and would be a genuine signal that she is serious about reducing the tax burden. As the Tory membership has pointed out, the Government has become less Conservative under their tenure. Ending this stealth raid on people’s incomes and guaranteeing thresholds rise with inflation would be a great way for Truss to show she is committed to putting money back into people’s pockets. Folding NICs into income tax, while having no effect on revenue, would also help restore a sense of honesty to tax policy. Not only would it better represent the true weight of the tax burden on individuals, it would scupper attempts to obfuscate tax hikes as then Chancellor Rishi Sunak did in the Spring Budget.
The original justification for the NIC hike (formally known as the health and social care levy) is emblematic of the challenge Truss faces. Justified on the back of the need to fix the NHS backlog and support the social care sector, it is simply throwing cash at broken systems that will continue to produce the same results. Without serious reform, backlogs will only get worse, and the quality of adult social care will continue to deteriorate. The fact is, the government has made massive spending commitments without any attempt at reform, and until this is fixed, a long-term reduction in tax will be all but impossible.
Cutting taxes and investing in reforms do not come without cost. Truss will have to choose how to manage the immediate loss in revenue that cuts would bring. Drawing pandemic debt out into the long term and looking for government efficiencies might help cover some of it. But she will have to either drastically reduce public sector headcount, pay or services if she wants to make short term savings. Given the state of the NHS and commitments made to Ukraine, she will find it difficult to find cuts that the public find acceptable. Nor are there the Thatcherite options of privatisations to generate growth and revenue for the Treasury.
Instead, she must opt for revenue-neutral tax reform to make our system more competitive, more efficient and less burdensome, to generate the growth the country needs. It might not be popular, but removing VAT exemptions would raise additional revenue and shift the taxation from income to consumption. Combined with raising income tax thresholds, this is a roughly revenue neutral way to reduce the burden on those who feel it the most while giving individuals more control over how much tax they pay.
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Liz Truss has pitched herself as the heterodox candidate, as a challenger to the tax-and-spend orthodoxy the Conservatives have adopted through their tenure in government. This can’t be accomplished with Johnsonian proclamations and cash bungs. It requires the tenacity and focus to take on long-beleaguered institutions and lack of imagination.
John Macdonald is Director of Strategy at the Adam Smith Institute. He has previously written on tax cuts and regulatory reform in the Adam Smith Institute report, Pulling Out All the Stops.