No more tinkering, chancellor – it’s time to rip up the entire tax system

With the fiscal black hole only getting bigger, Rachel Reeves has been warned that her autumn Budget must contain more than ‘quick fixes’. But if she can’t raise income tax, how about doing something dramatic, and – while she’s at it – rethinking VAT, asks James Moore

With a tax-raising Budget looming, every think tank and its aunts, uncles and cousins are busy sharing their fever dreams of what Rachel Reeves should and shouldn’t be doing. Chancellor, chancellor! Listen to me…

But if there’s one person she ought to be taking seriously, it’s Isaac Delestre, senior research economist at the Institute for Fiscal Studies (IFS), who hit the nail when he said: “The last thing we need in November is directionless tinkering and half-baked fixes.” What Britain’s faltering economy needs instead is something… dramatic.

Fortunately, the IFS report not only contains good – and dramatic – ideas, but some of them might actually work.

As we know, Reeves is in a nasty bind, with a multibillion-pound fiscal black hole sucking the life out of Keir Starmer’s government. She has to plug it, because if she doesn’t, she risks plunging the nation into a financial crisis. You can’t buck the markets – just ask Liz Truss – and the markets have made it clear that Reeves must stick to her fiscal rules. They hold that the government should not borrow to fund day-to-day expenditure.

The black hole – now estimated to have hit £40bn – has been created because the chancellor isn’t bringing in enough from taxes. A sluggish economy only makes the hole bigger. Her job is likely to be further complicated if the Office for Budget Responsibility (OBR), which marks chancellors’ homework, downgrades its economic forecasts following her second Budget.

The problem for Reeves is that she can’t turn to any of the easiest ways to raise revenue: hiking income tax, VAT or national insurance. Labour promised not to increase them in its manifesto.

There are also significant problems with targeting the next four biggest contributors: corporation tax, business rates, council tax and fuel duties, not least the promises Reeves made not to hit business again after she hiked employer national insurance contributions (Nics).

What about a “wealth tax”, a popular idea with the country at large? In a recent YouGov poll, 49 per cent said they would “strongly support” a wealth tax of 2 per cent on those with more than £10m in assets, with 26 per cent being “somewhat” supportive.

But the IFS cautions against – because it would incentivise wealthy people to leave, or not come in the first place, while discouraging saving. The hard fact is that Britain is heavily reliant on a small number of very wealthy taxpayers – people earning more than £200k, or who have more than £2m in assets. These people account for 25 per cent of the UK’s tax take. Squeeze them too hard and they’ll be buying plane tickets. A wealth tax would do that.

The IFS also worries about changes to the tax breaks for saving through a pension. I can understand this. The UK needs to encourage greater pension saving.

So what would the IFS do? It argues that tax rises should go hand in hand with tax reforms to address an (often) unfair system that hurts growth and is full of perverse incentives. An example of that would be the stamp duty on houses that Kemi Badenoch has promised to scrap. It disincentivises moving.

Reforms to property tax (and capital gains tax) would, says the IFS, be a good place to start.

Council tax, particularly in England, is highly regressive. Poorer people living in smaller houses pay disproportionately more than do those who live in large, comfortable homes. Absurdly, property valuations in England are based on a system dating back to 1991. The IFS argues for a new property tax which would be “proportional, and based on up-to-date property values” to replace both council tax and stamp duty.

Designing such a levy would be a big task. It should be a long-term goal. But Reeves could at least start on the iniquities of council tax by doubling what those in the top two bands pay. So, a mansion tax? Call it what you will. Such a move would net £4bn. Abolishing relief on inheritance tax for main homes could add a further £6bn. All of a sudden, we’re halfway there.

The IFS also thinks Reeves should look at reforming VAT. For a start, there is a sizeable “tax gap” because small businesses don’t pay as much as they should, thanks to cash-in-hand and the like. Yes, this would make some business owners cross – but cheating is costing too much.

Where the IFS gets more radical is with its argument to broaden the VAT base. The UK allows far more exemptions and zero-rated items than other countries. A 1 per cent levy on zero-rated items – which include some basic foodstuffs, prescription medicines, and children’s clothing and textbooks – would deliver £4.1bn, and go some way towards addressing the £80bn-plus that the zero-rated items are costing the exchequer.

I’m afraid this is where the IFS is entering the sort of fantasy land the Institute for Public Policy Research strayed into by arguing that Reeves should raise “sin taxes” – namely, duty on alcohol – a move that would see her dubbed a killjoy by punters and a wrecker by the beleaguered hospitality industry.

Putting a penny on zero-rated items would raise a substantial chunk of change. But it would mean taxing food at a time when inflation is running hot. Supermarket inflation is currently a significant concern, with the latest data showing food and drink prices increasing annually by around 5 per cent.

Scrapping zero rates on some items – say, magazines – would seem easier to swallow. As the IFS points out, why should music lovers pay VAT on a product that brings them joy when those who are fond of reading celebrity gossip sheets get a free ride? The only downside is that the move mightn’t raise that much.

Reeves will likely extend the freeze on income tax thresholds, dragging ever more people into higher bands as their pay goes up, which comes dangerously close to breaking that manifesto pledge to not increase taxes on “working people”. Nobody said this was going to be easy.

However, there is still much in the IFS paper that Reeves should consider. Its prescriptions might even create some winners (previous Reeves tax hikes have left only losers). Careful, strategic tax reform is also surely overdue.

Here’s the problem: the IFS’s employees tend to be strategic thinkers, with their eyes on long-term benefits. People like that are hard to find in the current government, which has lurched from crisis to crisis, responding to each with quick fixes that the think tank decries.

Some of the best IFS ideas – notably, property tax reform – would also require a degree of political courage. It is in part because they so clearly lack it that the political class sometimes appears to be allergic to any good ideas. I’d love to read a paper with some suggestions on how to fix that.