Having been walking 6 1/2 miles each way to the office on and off for the past 9 1/2 months, I have recently discovered the delights of digital radio, and in particular rediscovered Radio 5 Live’s breakfast and drivetime programmes. These are proving to be a rich source of material for this blog, and this morning was no exception. I apologise for the fact that the details on this story are a little sketchy, but at the time I heard this story I was contemplating a dead fox in the Bridgewater Canal and wondering how it got there, so my initial concentration was lacking.

As far as I could gather, an American right-wing think tank (I believe the Manhattan Institute for Policy Research, but I could be wrong – I can’t track the story down on the BBC News website) has carried out a comparison of US and UK government policy in respect of the economic downturn, and has come to some rather surprising conclusions. In particular, it has strongly criticised the decision to increase the main rate of UK VAT to 20% with effect from January 2011, on the grounds that this had a profoundly depressing impact on consumer spending in a time of economic slowdown.

This is particularly interesting because, in admittedly simplistic terms, increasing indirect taxes such as VAT might be characterised as a right-wing fiscal policy, and tends to be associated with calls for reductions in direct taxes (such as income tax and corporation tax) and in particular the current 50% higher rate of income tax. This is all highly topical, as the Chancellor is due to present his Budget in a week’s time against this background of advice and lobbying.

Trying to be even-handed, I will try to elucidate each side of the argument as best I can.

The arguments for increasing indirect taxes

1. Indirect taxes target spending, which is discretionary, as opposed to income, which is not.

2. In the UK in particular among EU countries, many essential goods are zero-rated, reduced-rated or exempt for VAT purposes, such as food, children’s clothing, domestic heating etc. Thus a VAT rise does not impact on the pricing of such essentials.

3. Increasing direct taxes makes the UK relatively less attractive as a base for business and in particular stifles enterprise among the business community, to the extent that a reduction in tax rates can actually result in an increase in tax revenues due to an increase in economic activity.

4. Indirect taxes are in general more difficult for taxpayers to avoid.

5. As the classic self-assessed tax, VAT is an efficient generator of revenue and cash for governments.

6. A VAT increase will tend to stimulate saving, which can be seen as a desirable economic objective in many circumstances.

The arguments for increasing direct taxes

1. Direct taxation is progressive, in that it collects more from those who earn more, particularly where a band of increasing rates is applied as income rises.

2. The compliance costs for business of changing VAT rates are significant, as point of sale computer systems etc have to be amended each time the rate changes. This does not apply to direct tax changes.

3. As identified by the Manhattan Institute, a VAT rise will tend to depress consumer spending.

4. As Karl Marx put it “from each according to his ability, to each according to his need”; i.e. those who can afford to pay more should do so. Because, in general, the more income a taxpayer has the more of it he or she will be in a position to save as opposed to spend, the impact of VAT is thus regressive, in that it impacts proportionately more on those who have to spend all of their income, who tend to be the lower income groups.

5. There are currently powerful disincentives to saving to counteract any encouragement as a result of increased VAT rates, notably derisory rates of return on investments. In any case, spending rather than saving is required to extract the UK from the downturn.

6. Higher rate direct tax reductions tend to stimulate luxury imports rather than the UK economy. As my father used to simplistically put it:

“The well-off spend tax reductions on buying a bigger boat”.

The pressure on the Chancellor from his own party is, not surprisingly in view of the above analysis, on reducing the 50% higher rate of income tax to stimulate economic activity and investment, and presumably also to make the UK more attractive as a base for wealthy individuals from elsewhere in the world. I have to say that the current regime of taxation of non-domiciles already does a pretty good job of the latter, whilst also being possibly the most regressive direct tax innovation introduced in this country in modern times.

I should also point out that the Conservative governments of 1979 to 1988 were quite happy to tolerate a top income tax rate of 60% before Nigel Lawson cut this to 40%, a level at which it stayed for many years until the advent of the current crisis.

I think it is fair to say that it is a difficult argument to make in times of economic hardship that the better off should obtain the greatest benefit of tax reductions, or that being allowed to keep 55% or 60% of their income rather than 50% is going to massively stimulate those people to invest greater sums in the UK economy. After all, having a top income tax rate of 40% did not save us from the economic consequences of the 2007 banking crisis at the time.

If I could propose a third alternative, some really effective action to combat large scale tax avoidance and tax evasion in general would be much more likely to attract the approval of the UK population in general than either of the alternative strategies outlined. A significant number of high profile banks, mobile phone companies and other major corporate entities continue to pay ridiculously small amounts of UK taxation given their profit levels, often as a result of using highly artificial structures which might meet the letter of the tax law but not its spirit. A campaign to ensure that such companies paid appropriate amounts of tax, preferably featuring a robust general anti-avoidance rule, should be both popular and effective in raising revenue.

Coupled with this needs to be an effective drive to tackle tax evasion. HMRC continues to bring forward specific disclosure regimes to entice the denizens of the black economy out of the shadows (electricians being the latest target), but in order to do so feels constrained to offer penalty rates way below those that would be expected for deliberate tax evasion under the normal penalty regime.

I would like to see a much more pro-active approach by HMRC to this issue, but of course wholesale staff cuts in HMRC have hamstrung the organisation in any serious pro-active attempt to get to grips with the black economy. This seems completely counter-intuitive to me, and my view is that a co-ordinated and well-resourced attack on the black economy would both yield significant tax income and send out a clear message that tax evasion will not be tolerated in the UK.

Thus. if we truly are ‘all in this together’, should we not make sure that all of us are doing our fair share to help the country out of the current crisis?