- A mini-budget could turn out to be the most consequential fiscal event in many years
- There are three key things Kwarteng should do to boost growth
- There’s a political imperative for a straightforward tax cutting agenda, and a moral case too
Source - CAPX 22/09/22
Most weren’t expecting fireworks from Friday’s mini-Budget. Experience suggested it would be a straightforward affair, making good on key campaign pledges – cancelling the corporation tax increase, undoing the National Insurance hike – but leaving other big policy decisions for a later date.
If rumours circulating over the past few days are to be believed, however, tomorrow could end up being the biggest day for pro-growth policy that the UK has seen in decades. Reversing the former chancellor’s tax increases may only be a starting point.
Not that changes to National Insurance and corporation tax should be underplayed. Scrapping the short-lived ‘Health and Social Care Levy’ will take 1.25 percentage points off National Insurance rates, and put more than £300 a year back in an average full-time worker’s pocket – very welcome and helpful in the midst of a cost of living crisis.
Cancelling the scheduled increase in corporation tax, moreover, will significantly boost the economy in the long run, relative to the counterfactual. New modelling released yesterday by the Centre for Policy Studies (where I am research director) and the Tax Foundation suggests that GDP will be 1.2% higher in the long run (with investment up 2% and wages up 1%) if corporation tax stays at 19% rather than rising to 25%.
Of course, cancelling the corporation tax hike – sensible and welcome as that is – is really about avoiding a hit to the economy, as opposed to increasing growth. So I can see why the new government, which rightly wants to make growth central to everything it does, might want to go further in its first fiscal event. What else might be on the agenda?
For one thing, I hope that the chancellor will tackle capital allowances – the system according to which businesses write off their investments against tax. As things stand, we face a cliff edge in the spring, when Rishi Sunak’s super-deduction expires and the Annual Investment Allowance falls from £1m to £200,000. Those two schemes allow immediate 130% or 100% tax deductions, respectively, for qualifying investments.
Outside the super-deduction and the Annual Investment Allowance, investment in plant and machinery is written off at 18% or 6% a year, depending on the type of asset. Investment in structures and buildings is written off at just 3% a year. These ‘depreciation schedules’ spread investment tax deductions over time and make them less generous as a result – inflation and opportunity cost erode their value, so that businesses end up recouping far less than the full cost (in net present value terms) of their initial investment.
Most tax systems contain this flaw, which creates a structural bias against capital investment, to one degree or another. But the UK is actually far worse than most of its competitors: the most recent version of the Tax Foundation’s International Tax Competitiveness Index, which was based on the pre-super-deduction status quo, ranked Britain 33rd out of 37 OECD countries for ‘capital cost recovery’. This represents a major drag on our growth prospects – bigger, perhaps, than any other aspect of the tax system.
To his credit, Rishi Sunak understood this, and announced a number of reform options at the Spring Statement, which the Treasury consulted on over the summer. The same CPS/Tax Foundation paper referenced above also modelled the growth impact of these proposals – as well as some more radical ones of our own. Perhaps predictably, we found that the bolder the Government is, the greater the payoff would be. The most ambitious of the Spring Statement options – a watered down version of ‘full expensing’ for plant and machinery – would boost long-run GDP by 0.7%. On a static basis, the fiscal cost would be £1.6bn a year in the long run; because the revenue impact of full expensing is front-loaded, however, the peak year annual cost would be roughly £9.3bn.
The most far-reaching option we modelled, which would extend full expensing – 100% year-one deduction of capital investment – to all plant and machinery and to structures and buildings would have a much greater economic effect. Indeed, our modelling suggests that such a policy would boost long-run GDP by 2.5%, with investment up 4.2% and wages up 2.1%. These are huge numbers for any tax policy change. The problem, of course, is fiscal cost – around £10bn a year in the long run, but as much as £23bn in the peak year. (Other research suggests that macroeconomic feedback could offset a significant chunk of that revenue loss.)
I don’t really expect the Government to go quite that far right now. But I am hoping for three things.
First, for the Annual Investment Allowance to remain at at least £1m; second, for allowances for non-AIA investments to be made more generous, perhaps by uprating ‘carried-forward’ balances in line with inflation and the time value of money; third, that any changes are permanent. We’ve had enough short-term, temporary policymaking in recent years – it’s time to start reforming our taxes for the long haul.
With that in mind, it is great to hear speculation about stamp duty being cut at Friday’s mini-Budget. Stamp duty is without doubt the most destructive tax we have per £ of revenue raised. By deterring marginal transactions, stamp duty prevents the efficient allocation of housing (in other words, properties are not owned by the people who value them the most) and also tends to reduce the supply of new builds.
This has enormous economic and social consequences. Indeed, one (Australian) study found that stamp duty imposed 72 cents of ‘welfare loss’ for each dollar it raised – and that’s over and above the dollar loss to those actually paying the tax. The Taxpayers’ Alliance estimated yesterday that eliminating stamp duty would boost GDP by 0.85% by 2029. I’d expect the Government to permanently raise the stamp duty threshold to at least £500,000 and limit marginal tax rates to no more than, say, 5% above that level.
The other pro-growth reform the Government should look at concerns business rates. They should expand the existing ‘improvement relief’ so that all future investments are excluded from the tax base. As things stand, business rates can be a disincentive to expanding and improving commercial buildings, or investing in infrastructure and certain kinds of plant and machinery. A report by Adam Corlett and others found that completely removing business rates from physical structures would boost GDP by around 0.4% in the long term. My suggestion doesn’t go quite that far, but should produce much of the economic benefit at much lower fiscal cost.
As well as strictly growth-focused tax reforms, it is possible that the chancellor will want to go further on cutting taxes for ordinary workers. There’s a political imperative for a straightforward tax cutting agenda and a moral case too – when people are struggling to make ends meet, the first thing government should do is let them keep more of their own money. The calculation here might revolve around the bumper revenues being delivered by Rishi Sunak’s freeze on various tax thresholds. High inflation means this has turned out to be a much bigger effective tax increase than was ever intended. The Government may want to recycle some of that revenue into raising thresholds now; or they could maintain the threshold freeze but more aggressively cut marginal tax rates in compensation. I’d favour the latter approach, but there are good arguments in both directions.
If the chancellor delivers all, or even most, of the things I have outlined in this article, then Friday won’t really be a mini-Budget at all. It will be the most consequential fiscal event in many years. What’s more, it will be a powerful indication that the new government is deadly serious about cutting taxes and going for growth. And what a welcome change of pace that will be!
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