United Kingdom Tax: Switching taxation to spending has its merits

One of the big mistakes Gordon Brown made as Chancellor and Prime Minister was to assume the Government's income was predictable and that he could afford to ramp up spending. When income turned out to be very unpredictable in the financial crisis, it left us with a bigger hole in the public finances than most other countries.

Britain's revenue is very geared towards taxes on income — both personal and corporate — which are much more volatile than taxes on spending. And the UK tax take was particularly vulnerable because of the importance of the City.

With luck, the City will be a big contributor of tax revenue in the future. With luck, there will not be another boom-and-bust cycle for a while. But we shouldn't count on it.

The new Government should take this opportunity to put Britain's tax revenues on a more stable footing — and that means a rise in Value Added Tax (VAT).

The most powerful argument against raising VAT is that it is a regressive tax, disproportionately hurting the poorest. But this can be offset by changes to income tax credits and allowances. And of course, the Government is committed to just such a change — the Lib Dems' plan to raise the income tax threshold to £10,000.

The obvious course would be to pay for this by increasing VAT. Britain's VAT rate of 17.5 per cent is well below the European Union average of 19.5 per cent, and the sums involved are very chunky. Increasing the rate to 22 per cent, which would still be below Denmark and Sweden, would raise more than £22 billion a year.

Most economists would back such a move. And indeed George Osborne, the Chancellor, was privately arguing for a shift from taxing income to taxing spending before the financial crisis. It would allow the pressure to be taken off the taxation of profits and pay, which is seriously undermining the UK's international competitiveness.

The model is Geoffrey Howe's 1979 Budget, when income tax was cut and Value Added Tax raised from 8 to 15 per cent. It was highly controversial. But it worked.