Hamish McRae: So complicated, even the taxman can't cope

Economic Studies

The Institute for Fiscal Studies (IFS) has achieved almost totemic status in matters fiscal in Britain. When people refer to it they usually preface it with the word "authoritative" or "independent".

It has provided the head of the watchdog over the Government's finances, as its former director Robert Chote is head of the Office for Budgetary Responsibility. Its judgement on the annual budget is regarded as the one against which everyone else calibrates their own assessment. And most recently, its view that the 50 per cent top tax rate raises, at best, very little money and, at worst, may actually cost the Government revenue, has made people sit up because everyone knows that the IFS is not playing silly politics but trying to make the best independent judgement.

Up to now, however, it has been analysing the fiscal world as it is, rather than as it might be. That has changed with the new Mirrlees Review of the British taxation system, the most thorough look for a generation at how we raise tax revenues.

It is not so much about how big government should be within the economy; rather it is about how to have a tax system that does not distort or harm the economy and yet raises whatever level of revenues our society chooses to collect.

The overall level of taxation in Britain seems to be pretty much set. For the past 30 years no government has been able to raise more than about 38 per cent of GDP in taxes. Every time a government tries, something happens – most probably a recession – and revenues fall back. The previous Labour government was not a high-taxation government, just a high-spending one.

Within any given level of taxation it is possible to do the job well or badly and other international comparisons of Britain, by for example the OECD, do not redound to our credit. We don't have a really bad taxation system, not as bad for example as the US, but it is not, by international standards, a good one either. Now, as the Mirrlees report demonstrates there are many ways in which it could be improved.

It is a big report and impossible to do justice to here, but a few points stand out. One is that we have a very complicated system; so complicated that the tax authorities themselves can't cope. Another is that having separate tax and national insurance schemes makes no sense. Others include the narrow and arbitrary scope of VAT, the nonsense of stamp duty, and the way in which company taxation encourages corporations and banks to raise debt capital rather than equity.

No tax system is optimal and what is appropriate and acceptable changes with time. My own view would be that right now two things really matter: certainty and simplicity. But in the medium-term Britain ought to aspire to a system that follows global good practice rather than one that's at best mediocre. I suppose the sooner we set that as a target the sooner we get there. Meanwhile, a thank you to the IFS.

The eurozone crisis turns really ugly

The eurozone nightmare continues but it is interesting, is it not, that even over a week the tone of the debate has shifted. A week ago it was not really possible for senior politicians in Europe to acknowledge that a Greek default was inevitable. Now the issue is much more whether it should be orderly or disorderly and how the subsequent mess can best be cleared up.

This is all moving so fast that it is hard to keep recalibrating what is happening. But a north/south split is becoming ever clearer. You can see that in the widening gap between the rates on German bonds and on Spanish and Italian bonds of the same maturity. But the thing that I find most interesting is not what is happening at the public level – what price Italy has to pay for its next tranche of debt – but what is happening under the radar.

For example, most German banks are being flooded with deposits because they are trusted, while Spanish banks and even French banks are finding that depositors are taking their money away. The banks, for their part, are cutting back on loans as they are uncertain of their ability to fund them. The situation is already quite ugly and will become more so.

Bank lending will be a casualty of Vickers

That leads to our own banking reconstruction, following the Vickers Report and the debate about it, which sadly has generated much more heat than light. So to try to shed a little light, consider this. There are two fundamental problems with re-regulating the banks, something that everyone accepts has to be done.

One is that it is not at all clear that retail banking, at least in Britain, is less risky than investment banking, notwithstanding the characterisation of the latter as "casino" banking. What brought down the Royal Bank of Scotland was a dreadful takeover, coupled with bad conventional lending. With HBOS it was bad property lending. In Northern Rock the same, coupled with relying too much on money-market funding.

The other is that a "safer" banking system will lend less money. It will be harder to get a mortgage; harder for businesses to raise loans; harder to get consumer credit.

Now that is probably what has to happen, and you can argue that the shift will be not be that great. But it may, and that of itself is a good argument for going cautiously.

h.mcrae@independent.co.uk