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By Hugo Dixon

LONDON, April 6 (Reuters Breakingviews) – The UK should not

waste its fiscal crisis. As Britain embarks on its election

campaign, this is a perfect opportunity to engage in radical tax

and spending reforms designed not just to restore the country’s

fiscal balance but to boost its long-term productivity and

competitiveness.

It is, of course, necessary to cut the deficit, which is

currently running at an unsustainable 12 percent of GDP. It is

also important that spending cuts rather than tax rises bear the

brunt of the belt-tightening. Otherwise, the UK will find that

companies and rich people are increasingly driven off-shore.

The two main political parties — the Labour government and

the opposition Conservatives — broadly buy into this. However,

neither party has spelt out what spending it would cut and where

it would raise taxes. Nor have they given any inkling of seeking

to take advantage of the crisis to push through deep-seated

reforms. They are unlikely to do so during the coming campaign,

fearing that too much detail will scare the voters.

GUIDING PRINCIPLES

Nevertheless, the next government, faced with the immensity

of its fiscal challenge, will be forced to slaughter at least

some sacred cows. What then are the principles that should guide

it?

First, simplicity. The current tax system is a patchwork

quilt of loopholes, allowances and special arrangements. This is

an incentive to engage in elaborate contortions to avoid tax.

While perfectly legal, such activity is socially wasteful. Tax

lawyers and accountants benefit — as do the rich who are the

only people who can afford their expensive advice. Everybody

else loses out.

A second principle should be low headline tax rates. The

highest earners have just started paying 50 percent tax on

income above 150,000 pounds. This is a bad advert for the UK. Of

course, there are lots of ways for high-earners to cut their

effective tax rate. But it would be far better to close the

loopholes and limit the allowances — and compensate taxpayers

with lower tax rates.

Yet another principle should be that the government should

have no business subsidising the lifestyles of the middle class,

let alone those of the rich. Sure, there is a vital role in

helping out the poorest members of society. But many benefits

and tax breaks also help those in the middle and at the top of

the economic tree. Cut these, and tax rates can drop

substantially.

Finally, government needs to think long-term. Some action

does need to be taken to rein in the deficit in the short run.

But not all the belt-tightening has to come through in the next

parliament, which could last up to five years. Slow-burn reforms

that cut spending or bring in money over a horizon of 5 to 10

years — or even longer — are extremely valuable.

What would applying these principles mean in practice?

DON’T BE RETIRING

The current matrix of pensions policies have crimped the

UK’s productivity, created a government liability that is

unsustainable, and don’t even provide a good pension for the

people at the bottom of society.

There are three main culprits. First, the official

retirement age is too low. Men can collect their state pension

at 65, while women can still do so when they turn 60. This is

despite the fact that life expectancy keeps rising and many

people are living well into their 80s and beyond.

Second, the state gives generous pensions for public-sector

employees. The net present value of this liability is now 65

percent of UK GDP, according to actuaries Towers Watson — and

it’s not even included in the official debt figures.

Third, tax perks for pension saving benefit the fairly well

off who don’t really need an incentive to save for their old

age.

There are three solutions:

* The official retirement age should be raised to 70 for

both sexes over the next 20-30 years. Thereafter, it should be

further increased automatically as life expectancy improves.

This wouldn’t just save the state money; it would encourage

people to work for longer, so increasing the economy’s

productive capacity. Both the Conservatives and, to a lesser

extent, Labour are planning to increase the pension age. But

neither is nearly as radical as this.

* The government should close final-salary pension schemes

for both current and new public sector employees. That way, its

liability will at least stop rising.

* The raft of costly tax incentives for private-sector

pensions should be swept away. Instead, there should be a simple

incentive focussed more on those at the middle and bottom of

society. My colleague, Neil Collins, has proposed an excellent

plan for achieving this: the buy one get one free pension. Under

‘Bogof’, any money put into a pension scheme (up to an annual

limit that is meaningful for the poor but peanuts for the rich)

would be matched pound for pound by the state.

CAPITAL IDEA

The capital gains tax (CGT) regime is another perk for the

wealthy. The rate is now only 18 percent, way below the new top

rate of income tax of 50 percent. Not surprisingly, high-earners

are using their ingenuity to turn income into capital gains

wherever possible.

This distortion in the tax system is unsustainable. The best

solution would be for people to pay the same CGT rate as their

income tax rate. To make this palatable, though, the top rates

of income tax should simultaneously be cut.

Another useful reform to CGT could be to modify the annual

tax-free allowance, currently 10,100 pounds. Oddly enough, this

is higher than the 6,475 pounds tax-free allowance under income

tax, which matters more to ordinary people. It wouldn’t be fair

to abolish the CGT tax allowance completely, as some people live

largely off capital gains. But one option would be to have a

single allowance of, say, 8,000 pounds, covering both income and

capital gains. Combine this with the equalisation of income and

capital gains taxes and the two taxes would essentially be

unified. Over time, it would also raise a significant sum of

money.

AN ENGLISHMAN’S HOME

The biggest middle-class perk of all is the generous fiscal

treatment of housing. The best element of this is that people do

not have to pay tax on the capital gains they make on their

homes. They are also no longer taxed on the imputed income they

receive from living in their homes. And there isn’t much of a

local property tax either. Local government rates used to be

roughly proportionate to the value of homes. But Margaret

Thatcher abolished those and replaced them with the poll tax.

Although that was ultimately killed off, the current council tax

is only loosely linked to property values.

The result of all this is the British love affair with

houses. Unfortunately, the infatuation is unhealthy. Young

people leverage themselves up to get on the housing ladder,

fearing that, if they don’t, they’ll find themselves priced out

of the property market. Not surprisingly, housing booms and

busts have featured prominently in each of the last two

recessions, with a knock-on effect on banks, which sometimes

have to be bailed out.

But the damage doesn’t stop at macro-economic instability.

The tax advantages of housing have distorted people’s savings

decisions. The bulk of the British people’s savings goes into

their homes. Not much is left over to recycle to investment in

industry.

What’s more, the whole system gives people a very odd idea

about the work ethic. During the last upswing, some homeowners

were regularly making more money from the annual capital gains

in their homes (which are untaxed) than from what they made at

work (which is taxed). This is unfair on those who either can’t

get onto the property ladder or don’t want to run up excessive

debts.

There are various ways in which housing’s fiscal

featherbedding could be mitigated. The government has just made

a modest move by raising stamp duty on properties worth 1

million pounds or more from 4 percent to 5 percent. The Liberal

Democrats, the UK’s third largest party, have proposed an annual

mansion tax of 1 percent on properties worth more than 2 million

pounds. The best way of dealing with housing’s peculiar fiscal

advantage, however, would be to charge people CGT on future

gains made from property sales. This wouldn’t just remove a

major economic distortion; over time it would also generate

significant revenue.

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