Taxes and the Tory Leadership Election

July 27, 2022

The Conservative Party in the United Kingdom is in the process of determining its new leader as Prime Minister Boris Johnson exits the stage. The new Conservative Party leader will be the next UK Prime Minister. The process has narrowed the field to two candidates: former Chancellor of the Exchequer Rishi Sunak and Foreign Secretary Liz Truss. As with many electoral competitions, tax policy is a part of the ongoing debates.

And just as many other economies have been dealing with the challenges of the pandemic in recent years, the UK economy needs to recover lost growth and inflation poses a major threat. Long-term fiscal considerations are also in play.

However, it is critical that the next UK Prime Minister understands the importance of principled, pro-growth tax policy.

As Chancellor, Rishi Sunak had previously proposed increasing the UK corporate tax rate from the current rate of 19 percent to 25 percent starting in April 2023. Additionally, Rishi Sunak had pushed through an increase to the National Insurance Contributions (NICs), a tax that raises roughly 20 percent of all UK tax revenue.

The 1.25 percentage point increase in NICs applies to employers, employees, and investment income.

As a leadership candidate, Rishi Sunak is continuing to support those positions.

It is worth noting that a corporate tax rate increase of that magnitude has been rare among developed countries. It is smaller than the 10-point rate hike in France between 2016 and 2017 when, due to a temporarily higher surtax rate the total rate climbed from 34.43 percent to 44.43 percent. The French corporate tax rate for 2022 is 25.83 percent.

The magnitude is the same as the corporate tax hike that pushed the Greek rate from 20 percent to 26 percent in 2013. Greece‘s rate is currently 22 percent.

Liz Truss has promised to cancel the corporate tax hike and reverse the NICs hike. Canceling the corporate tax hike would reduce revenues by £17 billion each year and reversing the NICs hike would reduce revenues by £13 billion. Together those amounts represent 3.7 percent of total revenues taken in during the 2021-22 fiscal year.

The corporate tax rate and the tax burden levied through NICs are important, but they are only part of the picture.

In 2021, the UK stood at 22nd in the International Tax Competitiveness Index (ITCI). In recent years it has not been tax rates but rather the tax base that have contributed to the UK’s relatively poor rankings. On corporate, consumption, and property taxes the policies on the books punish investment and distort all sorts of decisions.

A lower rate is usually a good thing, so the Liz Truss approach is admirable, but regardless of the outcome of the leadership race the tax base will need much attending to. A 2020 publication from Tax Foundation and the Centre for Policy Studies in London laid out a strategic vision for the UK tax system. The recommendations in that document are as relevant today as they were then, and even more so as the threat of a 1970s-style stagflation looms.

In particular, the next UK Prime Minister will need to adopt policies that remove what has been referred to by the Adam Smith Institute as the “Factory Tax,” which, despite the relatively low corporate tax rate of 19 percent, inflates the cost of investing in machinery and factories.

A temporary and partial solution to this has been in place since April 2021 but is set to expire next April. A long-term fix to this has been analyzed by the Adam Smith Institute.

The consumption tax base is another challenge the next UK Prime Minister should tackle. The UK ranks in last place on its value-added tax (VAT) base in the ITCI. Less than 50 percent of consumption is covered by the VAT. This is due to all sorts of exemptions and special rates which complicate the overall system and distort consumer choices. Consumption taxes are efficient because they avoid penalizing decisions to invest in productive activities or save for the future. A broader VAT base could also create fiscal space for lowering the overall VAT rate of 20 percent.

The property tax base also deserves attention. Business rates should be geared toward allowing property owners to improve their premises without significantly increasing their tax bills. Council tax is still based on 1991 property values and operates via a regressive “band” system. The residential property tax base needs to be brought up to date, and the tax itself made more proportional to property values.

The Tory leadership election comes at a critical time for the UK, and it is important to get the tax rates correct and avoid overburdening a population and business sector facing economic uncertainty. But if the next government focuses on rates and ignores the base, then an opportunity for real reform will have been missed.

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Inflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power.

A surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services.

The tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.

A Value-Added Tax (VAT) is a consumption tax assessed on the value added in each production stage of a good or service. Every business along the value chain receives a tax credit for the VAT already paid. The end consumer does not, making it a tax on final consumption.

A property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services.