We need to improve tax policy to reduce inequalities and increase social investment

The economic and social crisis engulfing the UK is all too visible and needs government intervention. Homes and public buildings built with reinforced autoclaved aerated concrete (RAAC) are crumbling. Some 7.6m people in England are waiting for hospital appointments.

Due to government imposed austerity, the UK is the only economy among G7 countries which is still smaller than what it was in 2019. The cumulative economic growth in the period quarter 4 of 2019 to quarter 2 of 2023 is -0.2%. 

Inequalities have depleted spending power of the masses and ability to rebuild the economy. The wealthiest 10% of households hold 43% of all the wealth, in comparison the bottom 50% holds only 9%. In 2021/22, 37% of total disposable household income went to the richest fifth of individuals, while 8% went to the bottom fifth. Real average wages are lower than in 2005 and a further decline is expected. 14.4m people are living in poverty.

The ‘leaving it to the markets’ policy has failed and wealth has not trickled-down. A different approach is needed. Governments can create money as supporters of modern monetary theory advocate, but that has no traction in political circles. It can create money through quantitative easing to fund investment, but the policy lacks support. Government can borrow money to rejuvenate the economy, but all major political parties want to reduce public borrowing. They are also opposed to increases in general taxation. In effect, major political parties are proposing more austerity and misery, which is untenable.

The current and next government will have to use tax policies to reduce inequalities and increase social investment. Progressive taxation and elimination of tax perks for the rich is the way forward. Here are some suggestions:

1. Currently wages are taxed at the marginal rates of 20%-45%. Wage earners also pay national insurance contributions (NIC) at the rate of 12% on annual earnings between £12,570 and £50,270, and 2% on income above £50,271. In contrast, capital gains are taxed at rates ranging from 10% to 28%. Dividend income is taxed at the rates ranging from 8.75% to 39.35%. Recipients of capital gains and dividends do not pay NIC even though they use the National Health Service and social care. Indeed, no NIC is levied on investment income, which includes bank interest and rental income. All income provides identical access to goods and services and therefore needs to be taxed at the same rate. By taxing capital gains at the same rates as wages and charging national insurance, up to £25bn of additional revenues a year can be raised. Applying the same logic to dividends can raise another £6bn-£10bn. Equalising the tax rates also eliminates opportunities for tax avoidance.
   
2. National insurance is a regressive tax. It is charged at the rate of 12% on earned income between £12,570 and £50,270, and a 2% rate is applied above that. This means that the rich pay a lower proportion of their income in NIC. By extending the 12% rate of NIC to all earned income, more than £14bn can be raised each year.
   
3. Tax needs to be simplified. The rate of income tax and national insurance needs to be combined. All income and windfall gains, regardless of the source, must be aggregated and taxed at the appropriate marginal rates.
   
4. The net cost of pension income tax and NICs relief is estimated to be £48.2 billion in 2020 to 2021. About two-thirds of this goes to wealthy individuals paying income tax at the marginal rate of 40% (on income between £50,271 and £125,140) and 45% (on income over £125,140). People with annual incomes below £12,570 get no pension tax relief. By restricting tax relief/credit to everyone at the rate of 20%, the government can generate £14.5bn a year.
   
5. The purchaser of shares pays a tax or duty of 0.5% on the transaction. This ought to be extended to all marketable securities, including derivatives. Even at very modest rates it could raise nearly £4.7bn a year.
   
6. Britain’s 50 richest families hold more wealth than the entire bottom 50% of the nation’s population, and must make additional contributions. A wealth tax of 1.7% on people with more than £3m in assets could yield £2.7bn. On assets above £5m the tax rate could rise to 2.1%, raising another £3.2bn. Above the £10m threshold the rate could rise to 3.5 % and raise £4.6bn. That is a total of over £10bn from 140,000 rich individuals.
   
7. A higher rate of VAT (30%) on luxury goods could raise £1.6bn a year.
   
8. More than 93% of the UK estates have zero inheritance tax liability. In 2022-23, 41,000 estates paid inheritance tax amounting to £7.1bn. Too many are able to avoid it by using trusts. A clampdown on that is long overdue.
   
9. The government hands 1,180 tax reliefs costing billions to the public purse. Too many, such as those relating to research and development, are abused. A former head of HMRC has urged the government to abolish the “entrepreneurs’ relief”, one of the many tax reliefs, because it is just a tax perk and has provided “no incentive for real entrepreneurship”. All reliefs are not costed and the government has little idea of the economic benefits. A revision is long overdue and will save billions.
   
10. HMRC has been starved of resources and has been unable to chase the rich and big corporations. Since 2010, between £450bn and £1,500bn of tax revenue has been lost due to avoidance, evasion and error. For every £1 of investment into large business investigation HMRC has yielded £69 in extra tax revenue. So, greater investment in enforcement is needed. This would also enable HMRC to challenge offshore tax dodges which are costing the world, including the UK, $4.8 trillion over the next decade.

A conversation about using progressive taxation to rescue and rebuild the UK economy is long overdue. The above is a small sample of the ways in which additional tax revenues can be raised without increasing the rates of income tax, corporation tax and basic national insurance contributions. A large proportion of the population will see no increase in their taxes. One estimate is that people in the bottom decile pay 56.81% their income in direct and indirect national and local taxes, and their burden must be reduced.

The additional tax revenues can be used to reduce poverty. For example, by abolishing VAT on domestic fuel, increasing tax free personal allowance and social security benefit rates, all of which will boost spending and stimulate the economy. The revenues can also be used to increase public investment in infrastructure and new industries, which the private sector is always calling for.

Prem Sikka is an Emeritus Professor of Accounting at the University of Essex and the University of Sheffield, a Labour member of the House of Lords, and Contributing Editor at Left Foot Forward.

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