Ben Fletcher: The abolition of Stamp Duty is a great first step, but for further tax reform lets talk VAT

Ben Fletcher is the Conservative candidate to be mayor of Cheshire and Warrington. He was previously CEO of Boots Opticians and CFO of The Very Group.

The best Conservative governments have been those that grasped the difficult job of fundamental tax reform to ensure stable finances that allow the economy to flourish. In the 1840s the Peel government ushered in a generation of prosperity through the combination of income tax reform and free trade. Disraeli oversaw significant local taxation reform, and, of course, the Howe/Lawson reforms in the 1980s were crucial to changing the trajectory of Britain’s economic performance.

Kemi Badenoch has rightly said she wants us to create a high growth, low immigration economy. There is a big argument that we need to win before the next general election: to reduce tax rates, we must reform the system. High rates are a consequence of the design of the tax system, and just reducing rates will not cut it. Successive chancellors have, in pursuit of a budget day ‘rabbit out of the hat’, tinkered with the system, creating distortions and anomalies that stunt economic growth. This has created a distorted tax system. There has been little sense of what type of tax system we want, what behaviour do we want to reward, and how do we create the environment for faster economic growth.

Reforming the tax system is going to be controversial. Since 1997 the tax code (as measured by Tolleys) has grown nearly fourfold from 7,250 pages to c.24,000 The tax code is now so long, with so many exceptions, that there will, inevitably, be opposition to almost any major change because there are bound to be losers. The need for reform though is immense. We have a Council Tax system based on 1991 housing values, an Income tax system where the marginal rate of tax rises to 70 per cent at certain income levels, meanwhile tax lawyers debate whether product is a cake or biscuit.

As the famous New Zealand Finance Minister, Roger Douglas, showed and argued, reform succeeds when the changes are big enough to create winners who can champion reform alongside the short-term losers. To sustain a reforming agenda in a way that commands the confidence of markets, fends off the ‘losers’ from any reform, and creates a clear direction of travel, we need a set of principles that can be seen to be adhered to over a series of Budgets.

A good tax system has four elements: There are as few taxes as possible, the base for those taxes is as broad as possible, so that the rate can be as low and least distorted as possible, and there are as few exceptions as possible. Adherence to these principles across the tax system would create one that was simpler, which better rewarded hard work and risk taking, and which was much less onerous for the individual or organisation being taxed.

These can be applied to any tax, but it’s VAT that’s urgent. It has become so distorted that it is now killing critical sectors of the economy, most noticeably hospitality. In Cheshire this is particularly acute as hospitality is 10 per cent of our economy, employing 40,000 people. Reforming VAT would be the tax reform that potentially does most to stimulate economic growth.

The current VAT system breaks all four of the principles I described: it is levied on a narrow base meaning the rate is high, the number of exceptions is high, and it is distortive in key sectors. The threshold is set in such a way as businesses manage with the aim of avoiding it, causing growth to be capped.

VAT is levied on only c.40 per cent of consumption. There is no longer any rationale for why the base remains so narrow. Our consumption habits have changed hugely since the introduction of the tax in 1973. In particular, the percentage of household income spent on food has fallen by two thirds, and the exclusions for books and newspapers speaks to a pre-digital age. We’re having fewer children (another VAT exception) and real wages have risen faster than the cost of products.

This has distortive effects. In hospitality, most of their costs are zero rated for VAT meaning it cannot be reclaimed. The consequence for this is that 20 per cent of their income goes straight to HMRC, an unusually high amount. This puts sustained pressure on their cashflow such that when other costs are raised, they have very little left to manage with.

The narrow base causes the rate to be high. We have the highest rate in Western Europe which drives the second distortive effect: incessant lobbying for exceptions to the rate. Food in a pub? Taxed. Food at home? Not taxed. Plain biscuit? No VAT. Chocolate Biscuit? 20 per cent. Buying a pet? Taxed. A Rabbit, though? Not taxed. No wonder the lawyers are doing well.

The other aspect which narrows the base is the threshold for VAT registration, currently £90,000. Entirely unsurprisingly small businesses manage their revenue to the threshold to avoid the rate. The presence of this cliff edge (a lamentable feature of many taxes) means there are sudden movements in tax liabilities for small businesses which hamper growth as owners seek to minimise their cash outflow. We need businesses focused entirely on growing their income, not managing to an effective revenue cap.

The next Conservative government should go big. Taxing consumption is preferable to taxing income or risk taking. We need people to want to work, and found businesses risking their capital, and for that to be rewarding. What families spend their money on is their business.

Extended VAT to all consumption and radically reduce the rate. Extending the base should allow the rate to come in at c. 8 per cent and still raise the same revenue as today. In the same package of reform, we should cut the threshold from £90,000 to zero, so that every company pays VAT from day one. This removes the growth cap of the cliff-edge and because the rate has been cut makes it manageable for all companies. For new companies there should be a three-year transition where a VAT rebate is provided of 75 per cent in year one, 50 per cent in year two, and 25 per cent in year three to support cashflow in the critical early years.

Big changes always mean there are some losers, such as those businesses not currently paying VAT, and tax lawyers. Others, such as hospitality would have their growth prospects transformed. Our highly competitive retail industry would work hard to keep prices keen for the consumer.

Kemi Badenoch and Mel Stride have shown with their announcement on Stamp Duty that they are prepared to be radical about tax. This willingness to make bold choices will be essential in creating a growing economy.

Reforming VAT in a first Conservative budget would create the basis for accelerated economic growth and be consistent with the reforming approach shown by the best of our predecessors.