Martin Wolf: Britain needs a better tax debate

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Two weeks ago I bemoaned the absence from British politics of a party arguing for a radical reduction in the size of government ("The case for a low-tax system", April 7). But nobody is brave, or mad, enough to offer such a programme. What is on view, instead, is a broad consensus on what the state should do. Under Labour's current plans, public spending will reach 42 per cent of gross domestic product in the course of the next parliament. The Conservatives plan to reduce this to 40 per cent. The difference is not negligible. But it is hardly dramatic.

So what is there to debate? The obvious answer is the structure of taxation and the organisation of spending. Radical change is always costly. But policymakers should have some idea of the direction in which they wish to go. Here, then, is mine.

A sensible system of taxation would try to minimise harm. So the first principle is: tax "bads", such as pollution, congestion and smoking. The second principle is: tax rent, by which I mean returns above those needed to bring a good or service to market. Taxation of rental value merely transfers unearned wealth from the owners of resources to the state. As my colleague Samuel Brittan argued last week ("A tax idea that cannot be buried", April 14) and I have also argued previously, there is a powerful case for taxing the site value of land. Land cannot move abroad!

The third principle is: minimise distortions. The normal structure of income taxes in high-income countries, with high marginal rates and copious deductions, is the wrong way round. Eliminate the latter and lower the former, instead. This can be combined with a fourth principle, simplicity, to justify the flat income taxes now being used in a number of central and eastern European countries.

The tax system is, on its own, an ineffective way to redistribute income, since those with no taxable income benefit not at all from penal taxation at the top. Redistribution can be achieved either by combining high average tax rates with universal benefits or by combining lower average tax rates with means-tested benefits. The former means high marginal tax rates for the well-off, while the latter means high marginal tax rates for recipients of benefits. The Labour government has chosen the latter course. That is the least bad choice, in part because of resistance to higher taxation.

The classic public services of health and education also redistribute income or, more precisely, spending. The big questions in the public services are not who should pay, since that decision has already been made, but how they should be organised.

As the Labour party manifesto rightly says, "competition is a driving force for innovation". That applies just as much to schools and hospitals as it does to cars and cameras. One of the better discussions of the issues is by the think-tank, Reform.* There is, it notes, vast room for the operation of market forces in provision of public services. It is not obvious why the state should directly employ any teachers or medical personnel. They could all work in independent institutions.

Education is the obvious case. The government's decision to finance fees or subsidise research can be separated from the operation of institutions of higher education, to take a salient example. That was one of the biggest arguments for the introduction of top-up fees, which the Conservatives and Liberals, to their great shame, continue to oppose.

The principle of independent provision of publicly financed services can be extended far more widely, however. In Sweden, for example, parents can use public money to send their children to any school that meets certain minimum requirements. The expansion of independent schools in the state system has been dramatic. Since choice was introduced in 1992, the number of independent schools has risen from 90 to 1,000. A government need do no more than provide the resources and insist on certain standards and procedures. The rest can be left to competition. Similarly, private providers of healthcare services can provide what the public sector has decided to pay for.

None of this is excitingly new. But it does define an agenda for public policy in the years ahead. Like it or not, the UK has broadly decided what to pay for through the state. But that consensus leaves room for vigorous debate on the least costly ways to raise the money and on the most effective ways to spend it. By shifting taxation on to "bads" and on to rent, by making taxation simple and transparent and by encouraging choice and competition in the public services, the cost of financing spending can be reduced and its effectiveness greatly increased. This is the challenge confronting all parties. None fully recognises it, as yet. The party that deserves to govern is the one that is closest to doing so.

* Manifesto for Reform,
www.reform.co.uk

martin.wolf@ft.com

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