Be brave, chancellor, and ignore the devils whispering in your ear

As we move to within three weeks of Philip Hammond’s first autumn statement all the chatter is about whether he will adjust spending plans and what his fiscal stance might be. We have, though, heard very little about tax.

That may be all to the good. After all, the budget, not the autumn statement, is supposed to be when taxes are set and reformed. Not that you’d know that from the evidence of the past few years. Certainly it would be no bad thing if we were to have a break in the creation of yet more tax legislation. No tax announcements at all on November 23 would be a good start to a new chancellorship.

A good start, but not the whole story. Tax policy inevitably will change. It may have to change simply because we will need more tax revenue. Taxes have done very little of the heavy lifting in terms of cutting the budget deficit over the past eight years. But if growth forecasts are cut again, it is doubtful that yet more spending cuts will be found to fill the fiscal hole that this will create. We may be able to live with a bigger fiscal hole for longer than was planned, but not for ever. And longer-term pressures on health and pension spending, in particular, eventually will force some tax rises.

Of course, there are all sorts of other pressures. The chancellor will have angels whispering in his ear asking for more simplicity, efficiency and transparency. He will have devils wanting more tax breaks, special favours and rewards and punishments for the presently favoured or unpopular.

How can Mr Hammond increase his odds of being on the side of angels and reduce his susceptibility to the temptations of the devils? The first thing he should do, but which few recent holders of the office seem to have done, is to develop a view about what he wants to do with the tax system. Ideally, that view should be made public. A clearly articulated plan can provide taxpayers with some degree of certainty about a sense of direction. But even a secret plan is better than no plan. Whether public or not, it should take account of how the various bits of the tax system fit together and how they can be made to fit together better over time.

Simply having a plan can itself help to avoid all sorts of political problems and mistakes. The to-ing and fro-ing on things such as capital gains tax and the 10p starting rate of income tax under the last Labour government and Mr Osborne’s “omnishambles” budget of 2012 were bad policy and bad politics. A long-term strategy creates a much greater chance of getting coherent and efficient policy decisions and of avoiding political bear traps. It reduces the risks of succumbing to the temptations of special pleading.

Second, no chancellor should ever forget just how important the tax system is to the functioning of the economy. More than one pound in every three earned in the economy is taken in tax. It is obvious that the way in which this happens must matter for how efficiently the economy runs, how people and companies behave and what the ultimate distribution of income looks like. Getting it wrong can be incredibly costly, not always in ways that are immediately obvious but in ways that, in the long run, will hinder economic growth and wellbeing. Listening to the devils costs us all a lot in the end.

My third piece of advice is both the most obvious and the most widely ignored. Simply remember that in the end all tax is paid by people. Despite what the devils will whisper, there is no such thing as a victimless tax. In the end, corporation tax has to be paid by a company’s shareholders (often pension funds), its employees or its customers. There isn’t anyone else. The same goes for all taxes. Those who appear to claim otherwise are selling snake oil.

Fourth, beware of another kind of snake oil, that’s the idea that there aren’t trade-offs to be made when setting tax policy. You can reduce inequality though the tax system, for example, but it is rarely costless to do so. The more progressive a tax system, the more effect it is likely to have on behaviour, whether that be work effort, effort put into avoiding tax or decisions about whether to locate investment in the UK.

This lies at the heart of economic analysis of taxation. It is all about trade-offs. Politicians have to make those trade-offs. That, chancellor, is what you are there for. The trouble really starts when you start to believe the devils who tell you that there are no trade-offs, that people will not respond in ways you don’t want them to just because it is convenient to believe that they will not.

One final piece of advice, and this may be the most difficult to take. Be courageous. Tax reform is cursed by a tyranny of the status quo because almost any change will make someone worse off. But the long-run prize from a well-designed tax system, in terms of a more productive and richer country, is huge. And it is possible to make change. Over a long period, governments have been able to implement sensible reforms — the gradual abolition of mortgage interest tax relief, for example. So don’t believe those devils who say rational reform is politically impossible. Changes don’t need to happen all at once. With enough time and direction, reform is genuinely possible.

Masterly inactivity this November as a prelude to a bold, well-thought-through, evidence-based strategy. The tax system is crying out for that.

This article was first published by The Times and is reproduced here in full with permission. Paul Johnson is director of the Institute for Fiscal Studies. Follow him on @PJTheEconomist