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With Britain’s £167bn ($257bn) budget deficit looming, tax is becoming a key election battlegroundBusinesspeople are rallying to the Conservativesafter they pledged to cancel most of the government’s planned rise in national insurance contributions (NICs). Labour blasts that the Tories’ unfunded “tax cut” will have to be paid for through an “unfair” rise in VAT. Liberal Democrats concede that raising NICs would be damaging, but argue that a “credible” prospective government could not afford to reverse it. Are any of them right – or might there be better ways of raising revenue?

None of the parties have spelled out how they would cut the deficit. Since their various proposals will scarcely dent it, whoever wins the election will have to implement further tax rises and spending cuts.

Is raising NICs a good first step, though? Hardly. With unemployment high and incomes squeezed, it is staggering that Labour wants to raise taxes on labour. Hitting ordinary voters’ main source of income is hardly progressive. Worse, it will harm the recovery by raising the cost of labour and penalising effort. That will crimp pay, cost jobs and discourage working – limiting the tax take and raising benefit spending.

NICs and income tax inflate the cost of employing the average worker by half, according to the OECD, while a single person on two-thirds of average wages faces a marginal tax rate of more than 40 per cent. Hiking taxes on hard work is perverse.

While the Conservatives are right to oppose a “tax on jobs”, Labour and the Lib Dems are right to question George Osborne’s scarcely credible claim that nebulous “efficiency savings” will cover the revenue shortfall. But that does not make rescinding the NIC rise “unaffordable”. It just means the parties need to find better ways to raise extra revenue. Here are three.

First, tax harmful things, such as carbon emissions. A levy of little more than £10 a tonne could fill the £5.6bn gap left by the Tories’ rescinding of Labour’s 1 per cent NIC rise. Raising the rate as emissions fell would ensure a steady stream of revenue. It would also stimulate clean-tech industries and the green jobs of the future, without picking winners.

Second, bring forward reforms to encourage people to retire later. As the first baby boomers reach 65 this year, they should bear some of the burden of adjustment, while working longer would also replenish savings crushed by the crisis. Raising the retirement age by three months a year for the next 20 years and removing incentives for early retirement and obstacles to working longer would reduce pension outlays, raise tax revenues and boost growth.

Third, introduce a tax on land values. Whereas taxing work is wasteful – less is produced and no tax is raised on the lost output – land is in fixed supply so a tax on it is less harmful (and impossible to avoid). Shifting the tax burden from labour to land would therefore boost economic growth, according to an OECD study.

Taxing land values could also limit property bubbles, which divert funds from productive investment in booms and then cause terrible busts – without discouraging development (unlike property taxes), mobility (unlike stamp duty) or investment (unlike interest rate rises).

It would also be fair. Whatever the merits of capitalism, there is nothing intrinsically desirable about the initial distribution of property rights. Britain’s history is such that land is distributed more unequally than in Brazil. There, 1 per cent of the population owns 49 per cent of the land; here, 0.3 per cent owns 69 per cent.

Land appreciates not through landowners’ striving, but that of others. As talented and industrious people have flocked to London, the value of the 300 acres of fields – now Mayfair and Belgravia – passed down to successive Dukes of Westminster over three centuries, has sky-rocketed to an estimated £6.5bn. Better, surely, to tax that windfall rather than the work of those who generated it? A land tax would also pay for much-needed infrastructure investments that raise surrounding land values.

Replenishing Britain’s public finances will involve painful choices. But it is also a chance to make tax fairer and less harmful to growth. Wise politicians should seize it.

Posted 10 Apr 2010 in Blog, Published articles

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