Reforming wealth tax will raise revenue
4 Jan 2019
An ageing population and rising public service costs are putting a strain on the Treasury’s coffers. Torsten Bell and Adam Corlett of the Resolution Foundation argue that the Chancellor could generate £7bn a year by 2022-23 with adjustments to five wealth taxes and subsidies
4 Jan 2019
Raising taxes is never easy. Raising taxes with the government’s slim parliamentary majority is harder still, and raising taxes on wealth in those circumstances, given our diverging senses of fairness, is not a walk in the park. But that does not mean it does not need doing, and the good news is that significant progress can be made despite these constraints.
There are three reasons it is needed. First, one of the biggest challenges facing our country is how to fund the rising cost of public service provision as the population ages. This demographic headwind and wider health cost pressures are set to increase the price tag of the current welfare state by £36bn a year by 2030, and £84bn by 2040.
Crucially this is the cost of paying for what we have already got - not all the extensions to our welfare state, from extra childcare to badly needed social care provision, that are often called for.
This is not just an issue for the future - managing these cost pressures and demand for new services, against the backdrop of a decade of austerity, will be exactly the challenge the late 2019 Spending Review will have to wrestle with (and changes to the accounting of student loans will certainly not help the Chancellor).
Second, we need to manage those pressures while avoiding the danger of further suppressing living standards growth for the working age population, which has already been the main victim of both the financial crisis and the long-lasting productivity slump that has followed.
By way of context, delivering the additional funding required by 2040 via income tax alone would be equivalent to almost doubling the basic rate of income tax, from 20p to 39p.
Third, wealth in the UK has grown significantly in recent decades while tax on it has remained completely flat. Since the 1980s wealth has surged from three to nearly seven times our GDP (or £13 trillion). It is simply a bigger feature of the modern UK, relative to income, than our political economy likes to admit.
Taken together these arguments mean we need a wider debate about the role of wealth taxes. We have previously set out the strong case for scrapping council tax and inheritance tax altogether, and replacing them with a genuine property tax and a ‘lifetime receipts tax’.
Even if the politics of Brexit and a governing party without a majority make wholesale reform of headline wealth taxes difficult, significant progress can be made across five big areas of current wealth taxes and subsidies with changes that are desirable on both efficiency and equity grounds.
Even if the politics of Brexit and a governing party without a majority make wholesale reform of headline wealth taxes difficult, significant progress can be made across five big areas
Limit entrepreneurs’ relief
Entrepreneurs’ relief has cost £22bn over its first 10 years, giving a very small minority huge capital gains tax cuts with no evidence of anything to show for that huge bill.
Worse still, new figures from the Office for Budget Responsibility (OBR) show that the annual cost is now projected to rise from £2.6bn in 2018-19 (more than is spent on school sixth forms) to £3.9bn in 2023-24.
The latest stats suggest that 73% of the cost in 2016-17 went to just 5,000 claimants, each getting £320,000 on average. The Budget did make minor changes to the relief, but they will save the Treasury only around £100m a year.
With a tough Spending Review coming up, the relief’s value-for-money should be under serious scrutiny like any pro-growth spending programme would.
While the general public are unlikely to shed a tear if the relief were scrapped entirely, another option would be to lower the cap on the maximum capital gain that can be relieved. New modelling shows that lowering the cap back to its original level of £1m of lifetime gains, rather than the current £10m, would (conservatively) cut the cost roughly in half.
Entrepreneurs’ relief has cost £22bn over its first 10 years, giving a very small minority huge capital gains tax cuts with no evidence of anything to show for that huge bill
Tweak council tax
Everyone knows council tax is in need of reform or replacement, being more like the poll tax it was meant to replace than a genuine property tax. In Scotland the Green Party has said that (further) reform of the tax would be the price of their support for an SNP Budget.
Indeed, Scotland has already made baby steps in the direction of a fair (proportional) property tax, with increases for the top bands of council tax and an increase in deductions for low earners.
England however is stuck with the most regressive system in the UK. Even just copying the marginally improved Scottish structure in England and Wales, would have raised an extra £1.1bn in 2015-16, while £700m could be raised by removing the single person’s discount from the top bands.
If those options are too scary, councils could also be given their own flexibility to increase the relative taxation of more expensive properties in their area (with some power over the multipliers that determine council tax rates for different bands of properties).
Tighten up IHT
Inheritance tax (IHT) manages to be a hot potato despite only a tiny minority ever having to pay it: one of the reasons why we have suggested replacing it entirely. But some changes could be made in the here and now without affecting most people.
In 2020-21 people will be able to pass on £1m tax-free. Stopping there rather than continuing to increase the thresholds with inflation would be very sensible and raise £200m a year by 2022-23.
Going further and making the tax less voluntary for the wealthiest would also be a good start towards increasing public support for the tax. Tightening hugely abused agricultural and business property reliefs, which together cost £1.2bn a year, is long overdue.
For example, a ‘farmer test’ could be introduced to ensure agricultural relief concentrates on helping small family owned farms rather than allowing the very richest to dodge inheritance tax by simply buying land; or the minimum ownership periods for both reliefs could be increased to make avoidance harder.
The Office of Tax Simplification (OTS) are set to report on IHT in Spring 2019, and if there are opportunities to simplify the system while also raising revenue then the government should leap at the chance.
Some problems with IHT have been with us for some time. But we have recently seen the birth of a totally unjustifiable new risk to the Exchequer, related to pensions.
The introduction of pension freedom reforms that allow individuals to hold pension pots right through their lives rather than being required to use them to buy a guaranteed income for life (an annuity) has been combined with a new rule that allows those pension pots to be passed on totally free of inheritance tax (or even income tax too if someone dies before 75).
This has the ludicrous effect that people will perversely be encouraged to spend all other assets in retirement before touching their pensions. This problem is not costing huge amounts as yet, which is why it should be closed now: before huge costs from its use, and the directly linked political opposition to scrapping it, build.
There is a well-trodden case for completely reforming pension taxation, such as moving to flatten rates of tax relief
Fairer pensions tax relief
There is a well-trodden case for completely reforming pension taxation, such as moving to flatten rates of tax relief or looking at the £17bn employer national insurance tax break for pension contributions. A smaller change would be to reduce the maximum generosity of the tax-free lump sum.
The current ability to take over £250,000 tax free is worth up to £119,000 to an additional rate taxpayer, £105,000 to a higher rate payer, £53,000 to a basic rate payer and nothing to lower income pensioners who would be below the personal allowance each year anyway. That is very generous, very regressive, and a strange incentive not to stagger your retirement income.
Capping the tax-free lump sum at £40,000 would raise £2bn a year while leaving three quarters of future pensioners unaffected.
Remove expensive wealth subsidies
While wealth taxation gets most of the headlines, it is worth remembering that we have some active subsidies for those already lucky enough to have wealth. A government serious about saving money to address the welfare state challenges of the coming decades in a fair way would certainly look at the Lifetime ISA and Help to Buy ISA (together projected to cost around £1bn a year by 2022-23).
These allow young people with savings to get up to £1,000 of cash from the government each year, through a kind of reverse means-testing - the support only goes to those lucky enough to already have quite a bit to save.
While the objectives of elements of these schemes (such as encouraging youth home ownership) can be desirable, the reality of their operation is absurdly generous and mistargeted. They should be scrapped.
Finally, there is a serious lack of scrutiny of the Treasury spending £3bn a year on ISA tax relief - we want to encourage lower income families to save, but the scale of the current reliefs go well beyond that, exempting huge amounts of better off individuals’ savings income from tax.
At a minimum the government should avoid any further increases in the £20,000 per year tax-free savings limit - and ideally go further with a lower annual or new lifetime cap.
The Chancellor could raise £7bn a year by 2022-23 just by making tweaks to these five wealth taxes and subsidies ahead of his Spending Review. This would help him navigate the significant challenges to maintaining our welfare state in the years ahead.
Yet this need not just be about higher wealth taxes overall. Any regressive and distortionary tax perks should also be weighed against the possibility of using that money for better - not to mention more popular - tax cuts, and there are a range of good options.
Council tax is unfairly high for less valuable properties, and should also be deferrable for cash-poor, asset-rich households. Stamp duties are bad taxes. A capital gains tax holiday could be introduced for those selling additional properties to first-time buyers (though this should be alongside scrapping capital gains tax forgiveness on death). Pension tax relief, for both income tax and national insurance, could be increased for low and middle earners.
Raising more tax revenue from wealth is far from easy, but it is not the impossible task that some like to claim it is. Fairness is a strong driver of tax reform, and many existing parts of our wealth tax structure are straightforwardly unfair.
Even without comprehensive reform of our main wealth taxes, loopholes can be closed, fairness improved and billions raised to fund the needs of an ageing society without hitting the pockets - or votes - of the majority.
About the authors
Torsten Bell is director of the Resolution Foundation. Adam Corlett is senior economic analyst.