Tax system ‘increasingly damaging’ to economic growth – IEA

The British tax system is becoming increasingly damaging to economic growth, the Institute of Economic Affairs (IEA) has warned.

Its research paper, authored by independent policy adviser, Tom Clougherty, looked back at the evolution of the tax system over the past 25 years to determine its role in the country’s economic slowdown.

Clougherty noted that taxes on investment had risen sharply on two occasions in recent years: immediately after the financial crisis and following the pandemic.

He described raising taxes on investment twice at moments of economic weakness as major errors, which likely had an impact on growth.

Higher inflation and less generous tax reliefs had also eroded investment incentives, Clougherty stated.

Looking at income tax, 5.5 million people had been dragged into paying higher rates since the year 2000, while the withdrawal of the personal allowance, which created a 60 per cent rate over £100,000, now affects more than 700,000 people, up from 150,000 when it was first introduced.

Clougherty said the combined effect of these measures had been to shift the composition of the tax system towards personal income taxes, while the share of revenue attributable to consumption taxes had fallen.

The paper argued that economic evidence suggested that taxing income was more detrimental to GDP per capita than taxing consumption.

Although the UK raises more revenue from property taxes as a percentage of GDP than any other OECD country, Clougherty said stamp duty land tax and business rates had become drags on growth, with the top marginal rates for both taxes having risen since 2000.

Corporation tax cuts in the 2010s were ‘undermined’ by offsetting changes to investment allowances, he added.

The report noted that the UK is currently ranked in 32nd place out of 38 in the Tax Foundation’s International Tax Competitiveness Index, with modelling suggesting it would rank 26th if taxes on personal income had remained at pre-financial crisis levels and corporation tax had remained at 19 per cent after the pandemic.

“The tax system didn’t cause Britain’s growth slowdown, but it has made bouncing back much harder than it needed to be,” Clougherty stated.

“Looking back, it seems extraordinary that we have twice responded to major economic crises by sharply raising taxes on investment – but that’s what happened.

“Across the board, we have put politics ahead of economics in designing tax policy, with predictable results.

“My fear is that on current trends the 2020s and 2030s are going to be much worse in this respect than the 2010s.

“The tax system is probably a greater threat to enterprise and initiative today than at any point in the last 35 years.”

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