Back in June Mark Pack suggested that now is a good time to start debating tax ideas for the next manifesto. So, let me throw in two ideas: one brave, one not so brave.
Ready reckoners published online by HM Revenue & Customs [PDF] make it easier to play the role of armchair Chancellor, so that is exactly what I am going to do.
My first idea is to increase inheritance tax by 5% to 45%, raking in an extra £350m, and then spend £300m of that to cut the reduced rate of VAT to 4%.
What would this mean in practice? Currently, the threshold for inheritance tax is £325,000, so no inheritance below that is taxed and for any inheritance above that, the first £325,000 is tax-free. So, what’s the effect on someone inheriting a house worth, say, £500,000? Right now they’d pay 40% on the value over the threshold, so their bill would be £70,000. Under my plan, they’d pay £8,750 more. Not bad given the fact that the inheritee is getting a windfall.
On the flipside, what would the cut in the reduced rate of VAT mean? Well, it would mean a cut in tax on stuff like mobility aids for the elderly, domestic energy bills, solar panels, wind turbines, the renovation of empty homes, and cycle helmets – good stuff, basically. All this, and £50m left over.
Okay, what about the brave idea? Well, what if we abolished the zero VAT rating on the construction of new homes (bringing in £5.4 billion per annum), reversing the current perverse incentive to build new homes rather than renovate old ones? This could be done alongside – brace yourself – adding 2p to the basic rate (generating an extra £9bn). In total, that would deliver an extra £14.4bn… and bear in mind the basic rate would still be 3p lower than when Thatcher left Number 10.
With that, we could pay the £13bn cost of increasing the tax-free personal allowance from the £10,000 it will be at by 2015 to £12,000, and have a healthy £1.4bn left over. A £12,000 allowance would mean that people on low incomes could earn up to £1,000 every month without the State wanting even a single penny from them in income tax. We must reward work, particularly for those who command the lowest incomes, and this achieves that.
Someone earning a salary of £12,000 would be instantly £400 better off annually, which is the equivalent of a 3.3% pay rise. Someone earning about £42,000 would be £200 worse off per year, the equivalent of a pay cut of less than 0.5%. Overall, by my rough and ready calculation if you earn up to around £32,000 or so a year you would be better off by up to £400 per year, above that you would be worse off up to a maximum of £200.
Now, I’m no economist. These figures might be complete tosh; if they are I’d encourage fellow party members to say so and get stuck into this debate. The policy to increase the allowance to £10,000 is a solid, tangible Lib Dem achievement; we need to work out how we take this radical and progressive shift in tax policy further still.
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16 Comments
I’m not an economist either but the arguments for not raising inheritance tax or even lowering it has never struck me as entirely logical. Ultimately it just enables a tiny minority of people to have a slightly larger inheritance than they would otherwise have. But I also think the 50p tax rate is too high and set at an arbitrary level which sends out the wrong messages. But definately we need to shift away from indirect inflationary taxation.. Another radical suggestion is that we lower the Tax rate on things like smoking because we’re losing losing a lot of revenue to unstoppable illegal importation.
Hell, no, it shouldnt be 50p but 60 or 65. I mean, if this deficit really is the Big Bad Wolf deficit which is going to eat us all up. As we’ve been repeatedly told.
In addition, we could take a really big risk … and hire the staff necessary to chase down all the tax fraud and avoidance that is going on at the top and corporate end. That plus closing the grotesque regime of nod-and-a-wink loopholes would net a fair chunk of cash, I`d say. Job done.
You have a big problem in that we do actually need new homes and lots of them. I’ve heard we have around 700,000 empty homes and whilst I’m definitely in favour of renovating those homes, it’s not nearly enough to reduce the pressure on housing stock. If you consider the fact that we’re estimated to have a population of 77 million in 2050 we probably need to be thinking about new towns rather than just new houses.
People are going to get even more protective about inheritance in future. With most young people not having adequate pensions or being about to afford their own home, parents are going to be even more desperate to pass on as much money as possible. It will probably make raising inheritance tax a big no, no in future.
I’m in favour of increasing the income tax threshold as much as possible but I’m not sure your ideas will be possible. I like the sound of a land value tax but haven’t looked at it in depth to see how feasible it is.
Hello. Author of the post here. Thanks for the comments so far.
@Glenn: personally, I’d always have inheritance tax higher than the highest income tax rate (admittedly my ‘back of the envelope’ ideas above don’t include that), because otherwise the Government is saying that they should take a bigger slice from income that is actually earned through work than they should take from income that just lands in your lap because a generous, affluent relative has died.
@Mike Cobley: goodness knows if my numbers actually add up(!), but from what I could calculate I’d have £1bn+ left over from the money my tax changes would make – enough to recruit an army of tax collectors to, quite rightly, pursue tax dodgers to the ends of the Earth.
@Sam: yes, a good point, but one would hope that this would give real impetus to freeing up the empty homes that exist and finding extra new dwellings within cities, rather than eating up green fields. The problem is that raising the income tax threshold is incredibly expensive (something like £650m for every £100 increase), and very few tax changes can raise that kind of money… and I wouldn’t suggest increasing VAT any more.
BTW, @Sam, I’m reading a good book right now – The Pinch, by David Willetts (he of two brains) – which touches on the issues about baby boomer wealth (you mention them being protective of their wealth); well worth a read.
“Ready reckoners published online by HM Revenue & Customs [PDF] make it easier to play the role of armchair Chancellor, so that is exactly what I am going to do.”
Actually, they do no such thing, because they do not take account of dynamic effects in the economy. They simply ignore the fact that taxes distort incentives and, as such, a change in taxation does not lead to a linear change in revenue, but does lead to knock-on effects elsewhere.
Having said that, it’s worth noting that it’s another tax that doesn’t raise very much. The individual is taxed at 40% (on inheritance over a certain sum) and the Exchequer gains just £3 billion. It’s not chicken feed, but it’s less that a 1% rise in the basic rate of Income Tax (which I would not recommend.
I wonder what dynamic effects inheritance tax has. Does it deter high-value elderly people from economic activity? Does it prevent capital formation, which is vital for business investment? I’ve not got the figures but I doubt that it is the costless tax that many people suggest.
@Glenn: The fact that VAT is an “indirect inflationary tax” really says more about how GDP and inflation are measured than about the effect of the tax in real terms. I find it staggering that VAT counts towards GDP for example: how can increasing a consumption tax be considered to increase the size of the economy?
@Tom: I understand the point you are making about the dynamic effects and don’t deny it (although I would deny your argument that it would be easier to cost tax policy options without information), but those dynamic effects can be overstated… weren’t Bush’s unfunded tax cuts in America meant to release so much economic potential that they would raise money revenue even though they were lower (always the cry of the politician who wants to cut taxes without having the balls to pay for it)? Well, it hasn’t really worked out that way.
On IHT, I very much doubt that people will stop trying to accumulate wealth to hand down to their children because an extra 5p in the £ on amounts over £325,000 will go to the taxman. If I was suggesting something much more then maybe, but not 5p.
Cutting the lower rate of VAT is not possible under European law.
The 77k houses are largely in places where demand for housing is very low, and others are caught up in probate when people die, houses people expect to return to after 6 months abroad, etc. We have relatively few empty houses by European standards (its in the Barker Review of housing, if you are interested). This is what you would expect, given that housing is valuable here. The cost of renovation is not the main issue.
If you levied VAT on new housing, you would reduce the number of new houses built. The tax yield would be lower than the ready reckoner figure. Also, many houses are sold to housing associations, and you would need to compensate them for that cost. Finally, section 106 and the like is related to the likely profitability of the site, so if you impose VAT you will cut the amount of money that the local council receives. Finally, if we build fewer houses then prices and rents will rise, and rising rents means a bigger housing benefit bill. For all of these reasons this is not a sensible policy.
@Stuart: I agree that “dynamic effects can be overstated”, but the Treasury tends to understate them – for example, it’s economic models simply do not recognised that lower overall taxes stimulate economic activity, despite a lot of serious academic literature that suggests they do.
The reference to “Bush’s unfunded tax cuts” is somewhat unfair, as there is a significant difference between saying that reducing taxation stimulates growth and suggesting (as some Supply Siders do) that tax cuts are self-funding. I suspect that many are in the long term but all-too-often it is suggested that they almost pay for themselves by magic, or that it is okay to borrow more in the short term. That has been a popular Republican argument but is not one I would support.
What is more, Bush combined his tax cuts with an increase in spending that would make a Socialist proud. He trashed the US Government’s finances, but I think that was less to do with the tax cuts than to do with two wars and a massive increase in the Security State.
“I very much doubt that people will stop trying to accumulate wealth to hand down to their children because an extra 5p in the £”
To quote an economist’s maxim, “everything happens at the margin.” I’m not suggesting that everybody would stop accumulating wealth, but some would stop accumulating as much, and others would adopt the policy that “You can’t take it with you” and so blow the lot. Or maybe they’d realise that they can only take it with them – it’s inheritance tax, after all, not death tax. Perhaps we’d see an increase in the market for large mausoleums.
Here’s a more radical idea. Inheritance tax is a badly designed tax that it is extremely easy for the very wealthy to avoid. It also combines a bizarrely high threshold with a punitive rate, contradicting both of the classic dictums of good taxation, to cut the rate and widen the base.
How about removing the reliefs on agricultural land, and business property, cutting the rate to 25% and cutting the threshold to £200,000. According to their still calculations that would net an extra £0.5 billion but in reality I expect it would net a lot more than that as people stop bothering to avoid the tax due to the lower rate.
Tax cuts do have to be funded. The insane American Republican view that all tax cuts will automatically generate more revenue is precisely that, insane. But it is possible that a tax is on the far size of the laffer curve. And inheritance tax is almost certainly there. Avoidance is easy and the incentive is highest for those with the highest ability to arrange ways of avoiding it. Cut the rate, cut the threshold, cut the reliefs and avoidance becomes harder and there becomes less point.
Revenue will almost certainly increase dramatically as a result.
I would just say be careful about assuming that a 55 rise in taxes would mean a simliar rise in revenue it doesnt work that way, so if you want to raise tax a to pay for tax cut b, leave a margin in case tax rise a doesnt generate the revenue you want….
I think the idea of rewrading people to repair old houses rather than buld new ones is curious, its designed to keep power away from developers who buy banks of land build nothing until the market is bouyant enough that it suits them to build, this means they can effectively restrict supply, force prices up and then buld…by making it easierand cheaper for people to repair an exisitng property you are enticing individuals and amsll companies to do it…this means thaat supply of properties for sale is kept slightly higher and pushing the makrtket somehwta closer to equilibrium, resttriciting the power of the biggest developerrs and achieivng the very liberal idea of having many more smaller buyers and sellers rather than just a few big seller acting in their own interests…..I do think that if a way could be found to reduce the lower rate of VAT its an equitable thing to do……..one has to be wary regarding the reduction of personal tax allowances for the lowest paid…eventually this will stop making economic sense as negative propensity takjes effect…
but overall the ideas are hugely constructive and along the right lines
@Stephen: “Tax cuts do have to be funded. The insane American Republican view that all tax cuts will automatically generate more revenue is precisely that, insane.”
I agree. Tax cuts will eventually generate more revenue. The insane part is that tax cuts should be financed by running deficits rather than by cutting spending.
I’m so glad to see this debate on tax including the idea for increasing rather than reducing inheritance tax as I posted a comment on the 50p income tax rate debate which suggested the party examines this as a serious option. I’d also like to say that I’m a baby boomer who believes that inherited wealth is the most important factor in polarising the wealthy and the poor which is what has happened in the years since Thatcher came into power. I have yet to see wealth trickling down to the poorest sector as the monetarists on both sides of the Atlantic said it would even though academic economists have theories showing that it does.
I would like to see a much tougher inheritance tax policy than Stuart suggests in that I think a much higher rate should be paid on sums over a certain level. I’m not able to do a detailed study into what level would be most effective in terms of tax yield versus negative impact on investment. I think there should be IHT breaks for those who donate to charity or who invest in British companies.
I would like to see any tax generated for the Government used to provide social housing and linked apprenticeship schemes. This would give a Keynesian kick to the economy in the building sector which I have always understood to be vital to economic growth. In my opinion improvements to IHT would encourage the wealthy to spend more and buy gold less. Perhaps buying British could also be used to avoid some IHT though that would be rather complicated to calculate. If necessary inherited wealth above a certain amount say £10million could be taxed at 75%. This would only affect the very rich. The last time the country had high inheritance tax and large investment in social housing was in the 50s and the Tory PM of the day (SuperMac) was very fond of telling us all that we’d never had it so good. I’m going to try to do some research to see if he was correct.
Sorry – I forgot to say that while I agree that existing properties should be renovated there are not nearly enough to house the people on all of the waiting lists in the UK. There is another problem that some of this housing will be in the wrong place – not near enough to jobs for example. Existing social housing already suffers from this problem.
On Inheritance Tax a friend once made an intriguing suggestion. He argues that it was wrongly conceived from the outset; that instead of being a tax on the donor it shoul be a tax on the recipient.
In this view everyone would have a lifetime allowance that they could receive free of IHT. Amounts less than this free allowance would attract no tax bether from a single large inheritance or several smaller ones. However, once the total received went above the lifetime allowance, they would pay the full marginal rate on all subsequent bequests.
It would have a very different impact than the current tax.
@Tom Papworth & Stephen W… maybe you’re right and I am pleased, @Stephen W, you’ve answered my call for more armchair suggestions, but I just believe that inheritance is an unearned windfall based, in most cases, on an unearned/untaxed rise in house prices; income, which is earned, should not be taxed more than unearned inheritance, which is currently the case.
@David Thorpe, thanks for the comments and the guarded welcome… on your point about leaving a margin, I left about £1.4bn in my more radical idea.
@Sue Sutherland – I agree with you that IHT shld go up, in my opinion it shld always be higher than the highest income tax rate, although as I also think that no tax rate shld be above 50% then that means I must think the 50p rate shld come down.
@Liberal Eye – an interesting idea, and thanks for also contributing some suggestions.
Finally, I was fearing a comment from @tim leunig… oh well, back to the armchair for this Chancellor!
Liberal Eye – I should be willing to hear more about taxing recipients of inheritance but I don’t think it would help to encourage investment and speding in the same way as inheritance tax which would be anticipated over more years by the donor than the recipient. I have in mind that providing venture capital, loans to British companies and donations to charities would enable the donor to avoid some inheritance tax and thus help the economy.
I am also interested in the concept of enough money. This could be arrived at by finding out the average inheritance or the mean. It could also apply to earnings as well as capital, including bonuses. There seems to be an attempt at doing this in the press by comparing the salaries of executives with that of the Prime Minister.
I also think this would provide a wide and stormy ocean between us and the Conservatives!