Labour calls it a “change election”. But how much difference might a Labour government make? In this five part series, Gwyn Bevan, Patrick Diamond, Kate Bayliss, Stewart Lansley, and Abby Innes, set out an agenda that could take the country in a fundamentally different direction. 

In this second instalment, Patrick Diamond argues that despite Labour having ruled out a wealth tax, restoring health to Britain’s failing economy and broken society must tackle the question of wealth, how it is acquired, shared and taxed. The next government should move away from relying on the taxation of labour by increasing taxes on consumption, wealth and capital gains in order to improve public services and support productive activity and small business formation.

Of all the structural problems confronting the UK, the systemic underfunding of public services, alongside the financial vulnerability of key institutions – local councils, prisons, universities – will be among the most consequential for the incoming government. The extent of mismanagement is underlined by the fact that personal taxes are at their highest level since the 1940s – if still lower as a share of the economy compared with many other rich nations – yet public services are severely squeezed. Britain needs a radical strategy to escape the “doom loop” of lower economic growth leading to reduced public spending which in turn undermines the UK’s productive capacity, leading to lower growth in the long-term. The disastrous experiment of Liz Truss’ 49 day premiership underlined the dangers of making unfunded commitments to cut taxes or increase public expenditure.

Successive Labour governments, from 1997 to 2010, simplified the tax system. They also implemented a questionable policy of reducing the burden of corporate taxation to promote global competitiveness (based on erroneous assumptions about tax competition between states). Despite the alleged constraints imposed by the globalisation of labour, product and capital markets, national governments can, and do, continue to have discretion to make choices about the structure of the tax system with major implications for equity and efficiency. That argument was eloquently set out by the late Tony Atkinson in his book, Inequality: What can be done?

Labour, it seems, has turned its back on imposing higher taxes on the wealth and assets of the very rich. Yet restoring health to Britain’s failing economy and broken society must tackle the question of wealth, and how it is acquired, shared and taxed.

Of the world’s advanced economies, the UK was among the most exposed to the global financial crisis of 2008. Because Britain’s public finances had by then become over-reliant on tax revenues generated from the deregulated financial services sector, the crash increased the fragility of the UK’s fiscal situation. The financial crisis exposed the vulnerability of the macro-economic and fiscal policy regime, and the failure of Labour governments to develop a tax system more resilient to external macro-economic shocks.

As such, the tax system is not only a means of raising resources to pay for vital public services while redistributing income. It must be designed to strengthen the UK’s stability and fiscal resilience, avoiding boom and the bust cycles. So, what could a new centre-left government do? The Mirrlees Review undertaken by the Institute for Fiscal Studies, among the most influential analyses of tax reform, outlined three broad principles:

• the tax system ought to be integrated closely with social security and the benefits system while ensuring financial stability and resilience;

• it should not distort consumer behaviour, avoiding taxing economic activities differently without good reason;

• and the tax system should ‘achieve progressivity as efficiently as possible’ by setting tax rates and allowances.

Taxing income tends to reduce demand which undermines growth, while, for example, the taxation of property can help to constrain rising house prices, making housing more affordable for the majority.

A vital and urgent political challenge is to strengthen the public’s confidence in the benefit and legitimacy of taxes. This requires a fundamental change in the political climate that was established by the Thatcher governments from 1979 to 1990. Since then, politicians have at times encouraged tax resistance among UK voters, pretending that extra spending on health and education can be financed by cutting waste in the public sector.

For the next government, there is a particular need to broaden the scope of taxation beyond “earned” income to property, consumption, and activities which have a negative impact on the environment. Taxing income tends to reduce demand which undermines growth, while, for example, the taxation of property can help to constrain rising house prices, making housing more affordable for the majority.

The emphasis on reducing the taxation burden on labour is consistent both with promoting employment and raising living standards across the income distribution.

Labour, it seems, has turned its back on imposing higher taxes on the wealth and assets of the very rich. Yet restoring health to Britain’s failing economy and broken society must tackle the question of wealth, and how it is acquired, shared and taxed. There’s an immensely strong case for a new focus on “asset redistribution” – via higher taxes on wealth – to parallel the system of “income redistribution” of the post-war era. This system is now only partially successful in tackling Britain’s level of child poverty – more than double its 1970s’ level. Wealth is much more unequally shared than income. The top fifth take 63 per cent of the country’s wealth, while the bottom fifth have only 0.5 per cent of the wealth. Even a modest rise in capital taxation could help alleviate this growing gap.

The emphasis on reducing the taxation burden on labour is consistent both with promoting employment and raising living standards across the income distribution. What is striking is the relatively low salience of reform principles relating to the distributional objectives of the tax system. Writing several decades ago, economists Richard and Peggy Musgrave concluded that the distributive purposes of the tax structure in the industrialised countries had progressively weakened:

“Attention appears to be shifting from the traditional concern with relative income positions, with the overall state of equality, and with excessive income at the top scale, to adequacy of income at the lower end. Thus the current discussion emphasizes prevention of poverty, setting what is considered a tolerable cut-off line or floor at the lower end rather than putting a ceiling at the top, as was once a major concern.”

Hence I propose four broad principles for the tax reform agenda of an incoming government:

• Increasing the resilience of the tax system to safeguard funding for essential public services.

• Moving away from taxing labour by increasing taxes on consumption, wealth and capital gains (see also Stewart Lansley on inequality). Taxes on “immovable property” are considered least harmful to growth and produce fewer distortions than taxes on property transactions.

• Using the tax system to stimulate productive activity and small business formation.

• Imposing environmental taxes to alter the long-term behaviour of citizens, businesses and key actors throughout the economy to achieve the vital goal of net zero.

Any incoming progressive government should use the taxation system to narrow the wealth divide and finance improvements in the quality and resilience of our public services. That requires the courage to tackle vested interests alongside opposition from the Right and their strident supporters in the national media.

All articles posted on this blog give the views of the author(s), and not the position of LSE British Politics and Policy, nor of the London School of Economics and Political Science.

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