There may be no political space to raise or cut tax – but Labour could reform tax
Rachel Reeves leaves 11 Downing Street, ahead of delivering her spending review, 11 June 2025 (Credit: PA Images / Alamy Stock Photo)
6 min read
Rachel Reeves has pledged not to raise the main rates of tax – but Dan Neidle argues that does not mean she cannot reform the system to remove multiple disincentives and make it a driver for growth
The spending review isn’t about tax – the Chancellor used the word ‘tax’ just twice. With the Institute for Fiscal Studies warning there is “more than a 50/50 chance” of tax rises in the next Budget, however, it’s a good occasion to step back and look at the two big questions facing the UK tax system.
The first is simply: is the level of tax and spending in the UK correct? Such an obvious and fundamental question should be at the centre of our politics. The oddity is that it isn’t.
Yes, there are plenty of people who think that tax is too high – but very few of those people identify specific spending they’d cut in order to reduce tax. After the experience of the Winter Fuel Payment, that seems unlikely to change. And anyone who says tax is too high, but isn’t prepared to specify cuts, is unserious.
There are, of course, plenty of people who think there should be more government spending, and that tax should rise. But it is always tax paid by other people. It’s telling that the only specific reference to tax in the Chancellor’s speech was to herald the abolition of VAT on private schools – the quintessential tax rise on “other people”.
Margaret Thatcher said the problem with socialism is that you run out of other people’s money. The more immediate problem is that you run out of other people. If you want to raise serious amounts of money, the only way to do it is by raising one of the big three taxes – income tax, national insurance and VAT – taxes which most people pay. And, sure enough, if we look around the world, we find that every single country with a higher level of public spending than the UK achieves it by taxing the median worker more than the UK. Every one.
I haven’t heard a politician argue that most people should pay more tax since the Liberal Democrats dropped their pledge to put a “penny on income tax” to pay for education. Back in the 90s, the Conservative Party conducted polling to find out why this policy was so popular – the answer turned out to be that many Lib Dem supporters thought it was literally one penny more tax.
This is quite a serious problem. Most of the public think tax is too high, but no politician can deliver materially lower taxes. And most of the public also think that the quality of public services is too low, but no politician can deliver materially higher public spending. This doesn’t feel a particularly sustainable path.
The second question is the more wonkish one: given the level of tax that we do have, could the tax system raise that tax in a more sensible way?
In a well-designed tax system, those incentives are not significantly distorted by tax. In a poorly designed system, incentives are distorted by tax so that people make decisions they would not otherwise make. Pushing people to make bad decisions causes unfairness, unhappiness and economic damage. And we see this across the UK tax system.
As soon as a business makes £90,000 in revenue, it has to register for VAT and collect 20 per cent VAT – making itself uncompetitive with the business next door making £89,000 in revenue. We’ve created an incentive for small businesses not to grow. Tax Policy Associates has estimated that 30,000 small businesses are caught in this ‘VAT trap’. It’s a consequence of the UK having the highest VAT registration threshold in the developed world, and having the threshold operate as a ‘cliff edge’ that hits immediately when the threshold is reached.
There are income tax cliff edges that are even worse. Many high-earning professionals work part-time, or even turn down promotions, to avoid hitting £100,000 of income. Why? Because at that point their marginal tax rate hits 62 per cent if they are lucky, and potentially 20,000 per cent if they are not (readers of the Tax Policy Associates website know that is not a typo). It’s perfectly sane to believe that people earning £100,000 should pay 62 per cent tax. It is, however, not sane to believe that people earning £100,000 should pay a 62 per cent marginal tax rate, but people earning £125,141 should pay a 45 per cent marginal tax rate. Yet that’s the tax system we have.
Corporation tax has had numerous sticking plasters applied over the last 30 years, so it now consists of more sticking plaster than structure. In international comparisons, the UK tax system is now rated as less competitive than Italy and Greece (which used to be laughing stocks). I’ve personally seen businesses choose other countries over the UK, not because of the UK tax rate, but because of the complexity and uncertainty.
All of this pales into insignificance compared to the triple failure of how we tax our most important asset: land. Stamp duty land tax has become a fundraising crutch for successive chancellors and has now reached a point where it actively deters many people from moving house – from middle earners to the very wealthy. This hinders economic growth both directly and through the impact on the labour market of hindering people’s mobility.
Council tax was hastily introduced in 1992, in the Tory rush to replace poll tax, and everyone expected it would be redesigned within a few years. Not only was it not redesigned but properties weren’t even revalued, with the entire system still operating on the basis of 1991 values.
Business rates actively discourage investment and improvement, penalising businesses that modernise or expand their premises by increasing their tax liability as a direct result. That creates a perverse incentive to let buildings decay rather than enhance them – the exact opposite of what a rational tax system should encourage.
And, unlike almost every other difficult question we face, there is a consensus across the political spectrum that the time is right for tax reform. Whether you ask the Resolution Foundation or the Adam Smith Institute, you’ll hear the same thing: the corporation tax base is a mess, stamp duty is a disgrace, and the cliff edges in VAT and income tax need reform. Tax policy wonks have a wide range of views on the difficult political questions about the overall level of tax and spending, but a remarkable uniformity of view on the tax reforms we should put in place for any given level of tax and spending.
All of which creates an opportunity. There may be no political space to raise or cut tax. But there may be political space to reform tax, and to use the tax system as a driver of growth. Or at least stop the tax system getting in the way of growth.
Here’s hoping we see some of that in the autumn Budget.
Dan Neidle is founder of Tax Policy Associates
