The pandemic led to a severe recession, followed by a strong recovery. This briefing examines different aspects of the economic impact of the pandemic to date and outlines the key issues for the economic outlook.
The Treasury Committee’s Tax After Coronavirus inquiry report, published on 1 March, called on the Government to publish a tax strategy. This would set out the broad principles that should inform tax policy. The UK Government has not published a strategy covering the tax system before.
The UK Government’s response was published on Wednesday (2 June), but it did not contain a commitment to produce such a strategy. The Treasury Committee has invited the Government to provide a fuller explanation of its position.
This Insight explores different approaches to taxation that might appear in such a strategy, including the 2011 Mirrlees review on tax reform.
The Welsh Government’s tax policy
The Welsh Government published its tax policy framework in 2017. It states that taxation should “raise revenue to fund public services as fairly as possible … It should be simple, clear, progressive and stable, with legislative and administrative clarity and efficiency.”
The Welsh Government highlights the importance of taxes for raising revenue. But why is a tax strategy needed at all? Taxes may change from Budget to Budget to meet immediate revenue needs. These revenue needs might be deemed more important for understanding tax reforms than any general statement of principles.
Modern Monetary Theory
Recently, some unorthodox economists have also questioned whether taxes are really needed to raise revenue. Modern Monetary Theory (MMT) claims spending precedes taxation so governments typically ‘spend and tax’ rather than ‘tax and spend’.
For MMT, the constraint placed on public spending by tax revenues is artificial. Governments with their own sovereign currency can always finance spending by printing money. According to MMT, the main constraint on spending is inflation and not tax revenues. MMT has caught public attention because of the interest shown in it by politicians such as US Democrat Alexandria Ocasio-Cortez.
MMT is heavily contested within economics and remains on the fringes of economic opinion. If its tenets are true, then taxation is not needed to raise revenue. It proposes that public spending should guarantee full employment and taxes may have role to dampen any inflation prompted by this spending. Taxation might also have other aims.
For example, it might be used to try and change behaviour, such as a sugar tax to deter people from consuming sugary products. A strategy might therefore be useful in co-ordinating different objectives.
If MMT is rejected, and revenue raising is deemed the most important aim of taxation, then the pressure to do so might override any other principles set out in a tax strategy. A strategy might still be useful to shape the general direction of reform to ensure policies are consistent and do not conflict.
Strategies for tax reform
One influential approach towards tax reform comes from a review of taxation done at the Institute for Fiscal Studies in 2011 This review was chaired by the Nobel prize winning economist Sir James Mirrlees and staffed by tax experts.
The Mirrlees review claims that the “core – though not the entirety – of our proposal is for a progressive neutral tax system. Each of the three key words of that formula – ‘progressive’, ‘neutral’ and ‘system’ – is important.”
The Mirrlees review argues that the tax system ought to be progressive. By progressive, it means that as the tax base rises, so does the average tax rate. A progressive tax system does not mean that every single tax must be progressive. What’s important for the Mirrlees review analysis is whether the tax system as a whole is progressive.
This emphasis on the whole system draws on the theory of optimal taxation. This theory considers taxes fitting together as an interlocking whole, rather than treating taxes individually and split off from each other.
A progressive neutral system?
The review also looks at neutrality, meaning that similar economic activities should be taxed similarly, to simplify the tax system. Simplicity is thought to help stabilise the tax system as people and organisations should find it easier to comply with taxes.
The Mirrlees review says that meeting different tax objectives means it may be important to vary taxes. It adds that this comes at a cost of adding complexity to the tax system and increases the costs of complying with taxes. This is because as people have to spend more time and resources to understand and monitor the extra complexity.
The Mirrlees review only offers one approach to tax strategy – that it should support a progressive neutral system. There is room for debate about whether the review captures all relevant ideas. What its preferred principles mean in practice can also be debated at greater length. These discussions could feed into any government tax strategy.
About the author: Dr Rajiv Prabhakar is a Senior Lecturer at the Open University and Parliamentary Academic Fellow at the House of Commons Library.
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