Healey must beware the ripple effects of Britain’s messy tax system

A thriving economy relies on more than just raising revenue through taxes, it must also encourage behaviors like working, saving, investing, and building businesses, argues Harry Bell. With Britain's financial situation under the microscope during the Autumn Budget, Healey's dwindling fiscal headroom may require taxing the wealthy.

However, before seeking additional methods to tax wealth, it's crucial to ensure that such measures don't discourage people from creating wealth in the first place. Encouraging people to work, save, invest, start businesses, and take risks is essential for a prosperous economy. People recognize the necessity of paying taxes, but there must be a reward for actively participating in the country's growth rather than facing penalties.

Tax policy doesn't simply generate income, it influences behavior. The government must carefully consider what behaviors they are promoting, particularly with individual, isolated taxes. For instance, pension savings are crucial to encourage, especially since many people aren't saving enough. Recent research shows that 16% of mass-affluent Brits have either stopped or temporarily stopped contributing to their pension, while 9% don't have one at all.

Continuously altering rules could make people question the attractiveness of pensions in the long run. Capital Gains Tax (CGT) also demonstrates the importance of considering behavior. An increase in CGT might initially prompt disposals to be brought forward, leading to a temporary boost in tax receipts. However, people may choose not to sell, or delay selling until it's tax-efficient, such as until death.

The Office for Budget Responsibility (OBR) acknowledges these behavioral responses to capital taxes. The same applies to entrepreneurs, and the government should incentivize taking risks, building businesses, and creating jobs. The government should also address some of the complex tax traps in place, such as the loss of the personal allowance above £100,000 and the High Income Child Benefit Charge.

These measures can create significant effective marginal tax rates on a relatively narrow range of earnings, and another taper for families. People should be motivated to work hard, progress, and reap the rewards of their efforts, not to avoid arbitrary earnings thresholds. The tax system's complexity and interconnectivity mean that changing one aspect can have ripple effects elsewhere.

For example, CGT interacts with inheritance tax, pensions, and estate planning. The Treasury needs to take a holistic view of the system and consider the potential ripple effects of singular changes, rather than treating taxpayers as isolated data points. Ultimately, a good tax system raises revenue, but it should also foster the behaviors that create a prosperous economy: working, saving, investing, and building businesses, and reaping the rewards of doing so.