Tax and Fiscal Policy

Osborne’s Budget delivers too little bang for the buck

Given the proximity to the election, most commentators predicted a ‘Budget of giveaways’, full of populist gimmicks. Judged against that expectation, the actual Budget was relatively sensible. But insofar as it did involve additional spending, or revenue losses, it delivers too little bang for the buck: By going about it in a more strategic manner, the government could have achieved similar objectives at a lower fiscal cost, or alternatively, it could have achieved more at the same cost.

Take the stepwise increase in the Personal Allowance to £11,000 by 2017, forecast to cost about £1.5billion per year. If the aim is to boost the living standards of the low-paid, a more sensible measure would have been to raise the earnings threshold for National Insurance contributions (NICs), which is currently at just under £8,000 per year, and ultimately, to merge NIC and income tax once and for all. Compared to the plans announced today, this would especially benefit people earning less than the new Personal Allowance, or just above – in other words, people whose earnings are so low that they do not benefit from a higher Personal Allowance, or only minimally so.

There is much to be said for the idea of a national insurance system, in the sense of a system in which people build up entitlements in return for contributions. But in the UK, the contributory principle has long been so thoroughly eroded that NIC is now, for all intents and purposes, just a second income tax. So one might as well merge it with the first income tax, and cut out all the unnecessary revenue collection bureaucracy, as well as the confusion caused by having different income thresholds and rates. Lowering the burden on the lowest paid would also make it more worthwhile to take up work in the first place, which, in the medium term, would lead to savings in welfare spending.

Or take Osborne’s now obligatory penny-off-the-pint announcement, this time coupled with a 2% reduction in cider and spirits duties. This is an improvement over the previous system of automatic duty escalators, but alcohol taxation in the UK is still a bureaucratic nightmare, which distorts the market in numerous ways. Tidying up that mess could produce considerable efficiency gains, and benefit consumers, without necessarily costing the exchequer money.

At the moment, different alcoholic beverages are not just taxed at different rates, they are also subject to different tax structures. Beer duty and spirits duty are ‘progressive’ taxes, in the sense that e.g. stronger beers are taxed more heavily than lighter ones. At the same time, wine duty is a ‘flat tax’, which does not differentiate by alcohol strength at all, or at least not within the range into which most wines fall. (There are special rates for fortified wines and very light wines.) Cider and perry duty, meanwhile, have a ‘step structure’, with higher rates applying when certain alcohol thresholds are exceeded. And just to make it a bit more complicated, rates and thresholds also depend on whether a cider is still or sparkling. This whole morass should be drained, and replaced by one single, source-neutral, per-unit alcohol duty. Ideally, the rate of that duty would be set according to some credible estimate of the ‘social cost’ of drinking (e.g. the cost of treating alcohol-related diseases on the NHS), rather than political whim.

When it comes to cost-effectiveness, the worst measure in the budget by far is the ‘Help to Buy ISA’. Under this scheme, the government will top up the savings of prospective first-time homebuyers building up a deposit. Like the original Help to Buy scheme itself, this is a pure demand-side subsidy, and it is elementary economics that in a market with fixed supply, pushing up demand can only push up prices further. The British housing market comes close to this description. Due to restrictive planning laws, greenbelt straightjackets around the cities with the highest housing demand, and fierce resistance to housebuilding from well-organised ‘Nimby’ groups, housing supply cannot notably expand. Thus, the main beneficiaries of Help to Buy ISAs will not be first-time buyers, but existing homeowners who consider selling their house, because they will be able to sell it at even more inflated prices. If the aim had been to help first-time buyers, the way to achieve this would be to stand up to the anti-housing lobby, and release some greenbelt land (most of which is neither ‘green’, nor is it even accessible to the public) for development. The fiscal cost of this measure would be zero – if pursued vigorously, there could be huge fiscal savings, due to lower spending on Housing Benefit – and it would not just help buyers, but renters as well. But since politicians are terrified of upsetting the Nimby lobby, the chance of that happening is low at the best of times, and zero when an election is looming.

So all in all, given the timing, the budget could have been far worse. But there remain vast untapped efficiency reserves in many areas of public spending, and this budget has done nothing to tap into them.

This article was first published by the Huffington Post.

Head of Political Economy

Dr Kristian Niemietz is the IEA's Head of Political Economy. Kristian studied Economics at the Humboldt Universität zu Berlin and the Universidad de Salamanca, graduating in 2007 as Diplom-Volkswirt (≈MSc in Economics). During his studies, he interned at the Central Bank of Bolivia (2004), the National Statistics Office of Paraguay (2005), and at the IEA (2006). He also studied Political Economy at King's College London, graduating in 2013 with a PhD. Kristian previously worked as a Research Fellow at the Berlin-based Institute for Free Enterprise (IUF), and taught Economics at King's College London. He is the author of the books "Socialism: The Failed Idea That Never Dies" (2019), "Universal Healthcare Without The NHS" (2016), "Redefining The Poverty Debate" (2012) and "A New Understanding of Poverty" (2011).

2 thoughts on “Osborne’s Budget delivers too little bang for the buck”

  1. Posted 19/03/2015 at 21:44 | Permalink

    Kristian – I couldn’t agree more about taxes on alcohol. I have never understood why the tax isn’t proportional to the amount of alcohol you are buying regardless of the form in which you are buying it.

  2. Posted 20/03/2015 at 16:50 | Permalink

    One of the technical problems in merging national insurance and income tax is that under the present arrangements people over 65, as a rule, do not pay national insurance contributions. Thus simply merging the two taxes — which admittedly could bring many advantages and simplifications — could mean quite a significant increase in the new combined tax rate on older peoples incomes. I suppose it might be possible to introduce or increase an ‘old person’s allowance’ to largely offset this effect. The fact is, however, that there are political advantages in being able to play around with the nominal rates of income tax while stealthily increasing national insurance contributions year after year. It seems obvious that politicians see more advantages in complicating the system of taxing incomes than in simplifying it. If it were otherwise, why are taxes on income so unbelievable complicated? We must keep our eye on the ball. The key objective must be to reduce significantly the overall weight of taxation by reducing significantly the overall level of government spending. Simplification must follow that, not precede it.

Comments are closed.