Budget tax changes could have mixed impact on growth, comments Kent economist

The School’s Professor Chris Heady, an expert on the effect of taxes on growth, says last week’s Budget could have mixed implications for growth.

He commented: ‘The public discussion of the recent UK budget is likely to continue focussing on the fairness of the budget, in terms of who gains and who loses. However, it is also important to assess its implications for growth, which is primarily driven by investment and productivity.

‘Recent work at the Organisation for Economic Co-operation and Development (OECD), in which I played a part before leaving for the University of Kent in 2009, analysed the effects of taxes on growth, investment and productivity using data from OECD countries since 1970. Its main conclusions were: there appears to be a ‘tax and growth ranking’ with recurrent taxes on immovable property (Council Tax in the UK) being the least harmful tax instrument in terms of its effect on long-run GDP per capita, followed by consumption taxes (and other property taxes), personal income taxes and corporate income taxes; lowering corporate tax rates and top personal income tax rates appears to increase productivity growth; investment appears to be increased by reductions in corporate tax rates.

‘These results suggest that the budget’s proposals to reduce personal income and corporate taxes and increase property taxes could increase growth in the UK.

‘However, the Chancellor’s decision to increase Stamp Duty Land Tax for high value properties is likely to be less good for growth than creating additional bands to Council Tax to ensure that high value properties attract more tax on an annual basis than less expensive properties. This is suggested by the first conclusion of the OECD study, which found that recurrent taxes on property are less harmful to growth than other property taxes (including taxes on the sale of property). The reason for this finding is that taxes on the sale of property – such as Stamp Duty Land Tax – raise the cost of moving. This harms growth by discouraging people from both moving to other parts of the country to find better paying jobs and moving into smaller houses when their children leave home (something that would lead to more efficient use of the housing stock).

‘Stamp Duty Land Tax suffers from two additional disadvantages. First, it is inequitable between people who live in houses of similar value if some people move house (and thus pay the tax) more often than others, perhaps for job-related reasons. Second, the amount of revenue from this tax relies on the level of housing transactions. The disadvantage of this reliance is illustrated by the case of Ireland, which was heavily reliant on such taxes, when the recent financial crisis struck and the volume of house sales was sharply reduced, leading to a damaging loss of revenue.

‘Council Tax is better for growth because it does not raise the cost of moving, is more equitable between owners of similar houses and generates more stable revenues, but it is unpopular. Much of its unpopularity arises from its visibility – in the form of an annual demand for payment – in contrast to the relative invisibility of personal income tax (which is mainly deducted at source) and both VAT and excise taxes (which are included in the quoted price of most goods and services). However, there is also concern about people who would have difficulty paying the tax from current income, so that they might be forced from their homes. The current system does provide some relief from Council Tax for people on low incomes but a more comprehensive system would be for the government to lend money to people who could not otherwise afford their Council Tax, securing the loan on the property – a sort of equity release provided by the government. The loan would be repaid with interest when the owner dies or sells the property. This way, people can be taxed on their housing wealth without being forced from their homes.’

Chris Heady is Professor of Economics and an International Research Fellow at the Institute for Fiscal Studies. He has undertaken consultancies for the World Bank, the National Radiological Protection Board, the Asian Development Bank, the Department for International Development and PricewaterhouseCoopers. He has obtained research grants from the (US) National Science Foundation, the Economic and Social Research Council, the World Bank, the Leverhulme Trust, the Foreign and Commonwealth Office, the Overseas Development Administration and the European Commission.