Direct and indirect taxes

During the course of my recent debates with Matt Sinclair and others about inheritance tax, I started to think more about the distribution of various taxes in the UK and the structure of the tax system. This may well be the first of a series of posts on aspects of the UK tax system and their possible regressive or distortionary effect.

I became concerned about how the UK tax system seems to get a large proportion of its revenue from indirect taxes and how direct taxes seem to have, over the last few decades, been shrinking as a source of government revenue. And, interestingly, tax cuts always seem to be focused on direct taxes – not indirect taxes. As such, each wave of electioneering and pre-election tax cuts reduces the level of direct taxes but does not reduce the level of indirect taxes. And, additionally, those who campaign for tax cuts, such as the TaxPayer’s Alliance seem to always, as you can see from their blog, focus on direct taxes like council tax and inheritance tax rather than indirect ones.

Now, as those who know me will know, I am generally in favour of state provision of good, comprehensive public services and of a redistributionary social security system to assist those with low market incomes. As such, I accept the fact that, were my views to come to pass, the tax burden would have to rise. However, I am concerned that the way that political lobbying from those from the opposite point of view is going is not to reduce all taxes slightly, which would be logical, but to reduce the most progressive and the most direct taxes while not cutting the most regressive ones.

If I was of a more cynical frame of mind, I could well argue that one of the reasons why the Right has focussed on reducing the fairest taxes – like income tax and now is focussing on inheritance tax – is to make the overall tax system more regressive. This then increases public discontent with taxation further (as people feel ‘why should I be paying more tax as a share of my income than a millionaire’) and so plays further into the hands of anti-tax campaigners.

Two figures, I think, show the increasingly regressive nature of the tax system since 1979. In 1979, the basic rate of income tax was 33% and VAT had a basic rate of 8%. In his first budget, Geoffrey Howe ended the differentiation between a higher and a lower rate of VAT and ended up almost doubling the basic rate of VAT to 15%!

And, by 1997, when the Tories lost power, the basic rate of income tax was just 23% while the basic rate of VAT was 17.5%. VAT is now second-only to income tax as a source of government revenue. And it is regressive. The poorest households tend to spend more of their income on VAT and excise duties than the richest do.

However, despite the claims of right-wingers that they want to create an economic situation that assists the poor (in absolute terms if not in relative ones!) they do not seem to have focussed on VAT. All the talk of tax cuts that comes from right-wing lobby groups and from the Tory frontbench always focuses on direct taxes. No one talks of cutting VAT.

I think this is a notable trend in the tax system and one that ought to be noted. It strikes me that, in the next few budgets, VAT may rise further – especially if the parties engage in a Dutch auction to cut income tax in the next election campaign. This would be dreadful and would continue the trend since 1979 of our tax system becoming more unfair and asking more from some of the poorest than from the richest. Any tax-cutting politician who actually wants to help the poorest should prioritise cutting their indirect tax burden rather than cutting taxes for the already well-to-do.