Edward Troup Former head of HMRC, senior Treasury official and adviser on tax to Chancellor Ken Clarke

Fuzzy logic of “fair”

In 1997, Labour pledged to deliver fair taxes by cutting VAT on fuel to 5 per cent and imposing a windfall tax on the privatised utilities. Both policies were immensely popular. And both were based on false assumptions about the workings of the tax system: that VAT is borne entirely by the customer and that profit taxes are borne entirely by the shareholder. Wrong. All business taxes are ultimately borne by shareholder, customer or employee. Market forces and business choices determine where tax actually falls.

And even if electricity bills had fallen after the windfall levy and VAT cut, how can a single tax ever be said to be fair? Fairness is both relative and cumulative. Paying more VAT (or less income tax) than the next person is meaningless in isolation. So what, then, are we to make of current calls for a fairer business tax system—that businesses should pay more tax (the digital tech giants) or have their tax bills cut (business rates for struggling retailers)? What role does fairness play in making tax policy for entities that have no physical form and are owned by ever-changing and often anonymous shareholders? Perhaps the fairness of a business tax should be judged on whether the shareholders or customers are plutocrats or pensioners.

Fairness has no relevance except to living, breathing people—be they workers, customers, shareholders or simply citizens. To claim fairness or unfairness for a business tax requires an understanding of how that tax falls on individuals alongside all the other tax costs that they bear.

Who does bear the burden of a business tax? Conveniently for politicians, economists have no definitive answer. The fact that half next year’s NICs increase of 2.5 per cent is raised through the employer’s charge allows the government to claim that the tax rise on individuals is “only” 1.25 per cent. Time will tell—or at least economists will endlessly debate—whether the NICs rise results in lower take-home pay, higher wage costs to businesses or increased prices for customers. And even if, say, higher corporation tax did indeed fall on shareholders, that is not the end of the story: in our open financial markets the cost of capital for UK businesses will rise, inhibiting investment and job creation.

The reality is that the costs of all taxes are borne by people: there ain’t nobody here but us chickens. The ultimate unknowability of how the tax burden falls on individuals once the impacts on prices, pay, resource allocation and jobs have worked their way through the economy makes determining the fairness of any particular tax a lost cause.

“The reality is that the costs of all taxes are borne by people”

This is not to wash our hands of fairness: it is important. Even if the fairness of any particular tax is unknowable, the perception of fairness really matters. In a modern society where only a minority of tax is collected by enforcement, a broad acceptance of the tax system, and a perception of its fairness, supports the crucial willingness to pay.

A system that does not raise tax from the big economic players effectively will be perceived as unfair—however much economists may argue that what matters is the impact on individuals.

Far from a counsel of despair, this is a guide to making the lives of policymakers easier. Taxes need to be seen to be fair to command support, but business taxes should be gauged on their aptness for the job of raising money for the state in the most efficient and effective way. Adam Smith rules, OK?

Real fairness for individuals can only be delivered by tax, welfare and social policy acting together. In the meantime, we should tax businesses in any way that works.