The misguided decision to ring-fence huge areas of spending means this week’s Spending Review is likely to be incoherent and incomprehensive. With the NHS, pensions, per-pupil funding for schools, international aid and defence budgets all protected, over 70% of government spending has been exempted from savings.

New figures calculated by the IEA in an Autumn Statement Briefing show that in the last parliament real spending on health rose by 4.5%, international services by 26% and the huge social protection budget – including pensions – by 4.4%. By contrast, this coincided with reductions in real spending on housing and community amenities of 22%, transport 11% and public order and safety 15%.

Rather than salami-slicing non-ring-fenced departments, the government needs to rethink its job from first principles. As has been exemplified by the tax credits fiasco, without wholesale review, the government risks making cuts in the wrong areas and in the wrong way.

This Spending Review and Autumn Statement should involve a rethink of government functions. Reforms to the tax system must simplify our existing tax code, whilst any decentralisation must see tax-raising powers devolved alongside spending powers.

Key proposals:

Abandon arbitrary ‘as a proportion of GDP’ targets for spending areas. These have perverse results, such as in international aid, where faster-than-expected economic growth led to the department desperately trying to find projects on which to spend the money.

Abandon proposed changes to tax credits. They significantly raise marginal tax rates for the low-paid, meaning the incentive for many to work has fallen, as well as the incentive to work more. Delaying implementation or other minor changes will do nothing to change this.

Create a negative income tax to replace tax credits. A new integrated tax and benefit system should be based on household income with the amount of tax-free income based on tax allowances that would be transferable within households.

Raise work requirements. Alternatively, as a short-term fix, the government could look to blend unconditional welfare payments into working tax credit and raise the minimum number of working hours required to obtain them.

Create a ‘double-lock’ for personal tax thresholds. For too long there has been no consistency in terms of how tax thresholds are uprated.  All personal tax thresholds should rise by the higher of inflation or earnings growth in the coming years to correct years of under-indexation. Further increases at the lower end should focus on raising the starting threshold for National Insurance contributions. The withdrawal of the personal allowance above £100,000 should be abolished, as should the top rate of income tax.

Broaden the VAT base. It is highly inefficient economically to ‘subsidise’ certain products using tax exemptions. Domestic energy attracts VAT at only 5%, but then a host of ‘green’ taxes are imposed on energy to try to ‘internalise’ the environmental impact of energy use. The government should broaden the VAT base and reduce national insurance contributions paid by the least-well-off.

Preserve higher rate tax relief for pensions. The government should commit to maintaining the current system of income tax relief for pension contributions. A move towards a single so-called ‘equalised’ tax relief rate for all income levels would be wrong in theory and unworkable in practice. However, the tax-free lump sum available to beneficiaries of pension funds should be abolished of gradually and severely restricted.

Overhaul property taxation. The government should have a long-term aim of abolishing council tax, business rates and stamp duty to be replaced by a Land Value Tax on commercial land and a tax on imputed rent for residential property.

Commenting on the report, Mark Littlewood, Director General at the Institute of Economic Affairs, said:

“Rather than salami-slicing the budgets of non-ring-fenced departments to hit arbitrary savings targets, the government should completely rethink its approach to closing the deficit. Every area of spending should come under the microscope.

“Currently the government has made unfunded health and pensions promises to future generations, whilst our vast and complex tax system creates uncertainty for households and businesses across the UK. The government needs to put the public finances on a sound long-term footing: tax simplification and fiscal responsibility should be at the heart of its agenda.”

Notes to the editor:

To arrange an interview with an IEA spokesperson, please contact Stephanie Lis, Director of Communications at slis@iea.org.uk or call on 07766 221 268.

The full IEA Autumn Statement Brief by Philip Booth and Ryan Bourne, can be downloaded here.

This briefing is part of the Paragon Initiative – the most comprehensive project ever undertaken by the IEA. This five year programme will provide a fundamental reassessment of what Government should – and shouldn’t – do. It will put every area of Government activity under the microscope and analyse the failure of current policies. Drawing on best practice from around the world, it will put forward clear and considered solutions to the UK’s problems. And it will identify the areas of Government activity that can be put back in the hands of individuals, families, civil society, local government, charities and the markets.  Through a comprehensive and compelling series of books, papers, films, events and more, The Paragon Initiative will provide a clear vision of a new relationship between the state and society.

The mission of the Institute of Economic Affairs is to improve understanding of the fundamental institutions of a free society by analysing and expounding the role of markets in solving economic and social problems.

The IEA is a registered educational charity and independent of all political parties.