Over the next fortnight, the Legatum Institute will be publishing a series of essays and reports on priorities for the new Prime Minister. In the first piece in the series, Legatum’s Daniel Herring outlines where Liz Truss should focus her tax reforms.

Liz Truss presented herself as the pro-growth candidate. She is right to be seeking to rationalise and reduce the tax burden. But now that she is in No10, the temptation politically might be to focus on reversing the tax rises introduced by her rival, the former Chancellor, she could find better tax cuts to catalyse productivity growth.

There is a live debate about the fairness of Truss’ proposed policies outlined in the leadership debate and how they would be balanced with help for the most vulnerable. From energy subsidies to providing additional stimulus to Universal Credit, there are a range of policy levers that this debate covers. But these arguments have been well rehearsed so that is not the subject for here.

Instead, this article will look specifically at Truss’ proposed tax cuts on their own terms: as an engine for kickstarting productivity growth. Truss’ central pitch to Tories is that the current level of taxation overly disincentivises growth, and that reducing or reforming taxes will lead to more economic growth, either by raising demand or encouraging investment.

But if the objective is economic growth, there are arguably tax reforms that would have a greater impact on productivity. There is broad consensus that two of the defining reasons for stagnant productivity are the lack of business investment and an inefficient housing market. These are at the root of the problem; we must focus here.

There are at least three taxes that are ripe for reform: deductions for investment in corporation tax, business rates, and stamp duty. First, corporation tax. Keeping the rate low will help incentivise investment; however, the problem with the UK corporation tax regime is not just its overall rate, but the fact that the full cost of investment is not deductible. This raises the cost of capital for businesses.

To be fair, the government have tried to stimulate investment with a temporary “super deduction”, where, from 1 April 2021 to 31 March 2023, companies can claim a 130% deduction on qualifying plant and machinery. However, this has not had a major effect on investment, owing to considerable uncertainty businesses face and its temporary nature. The most effective long-term solution, although also the costliest, would be to implement a permanent 100% capital allowance, which could boost business investment by £40 billion by 2026.[1] It would also simplify the tax code and make the UK more competitive.

Second, base business rates on underlying land value. Business rates are currently levied on the overall value of a property rather than the underlying land value. This means that businesses face a tax hike when they improve the value of their land, which discourages investment. This means there is a disincentive to improving the land by, for example, building a factory.

By contrast, many other countries tax the value of the underlying land. By basing business rates on underlying land value, this would encourage investment, and would help capital intensive industries, many of which are outside the Greater Southeast.[2]

Finally, abolish stamp duty on land. According to the US based Tax Foundation “stamp duty land tax is probably the worst tax on the UK statute books”.[3] An Australian study found stamp duty to be four times as economically damaging as income tax.[4] The reason it is so damaging is that it raises the cost of selling a home, and therefore reduces the number of housing sales. This makes the property market much less efficient – with more people staying in homes that are too large or too small. People make choices that do not make economic sense because the cost of moving into an appropriate home is too high. It’s also harder for people to move for new job opportunities. Abolishing it would remove barriers to growth.

We welcome Liz Truss’s emphasis on the tax system’s role in driving productivity. The UK’s long term prospects rest on increasing productivity of businesses and workers. However, if Liz Truss is determined to achieve her goal, she could choose a stronger package of tax cuts. With limited money her choice should be determined by the highest impact reforms. Income tax cuts for workers, while desirable, can wait.

[1] CBI “A super deduction successor could trigger £40bn-a-year boost for UK business investment”, February 2022. https://www.cbi.org.uk/media-centre/articles/a-super-deduction-successor-could-trigger-40bn-a-year-boost-for-uk-business-investment/

[2] For an example of how this could work in practice, see “Replacing business rates: taxing land, not investment: Introducing the Commercial Landowner Levy,” September 2018.

[3] Tax Foundation and Centre for Policy Studies, “A Framework for the Future: Reforming the UK Tax System”, October 2020. https://taxfoundation.org/uk-tax-reform/

[4] Australian Treasury, “Understanding the economy‑wide efficiency and incidence of major Australian taxes”, April 2015. https://treasury.gov.au/publication/understanding-the-economy-wide-efficiency-and-incidence-of-major-australian-taxes