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On November 26 2025, the chancellor, Rachel Reeves, will present her second Budget. It will be a chastening event, for her and the government. She will have to admit that the attempt to silence questions about her ability to hit her fiscal targets for the rest of this parliamentary term, supposedly achieved in her first Budget last year, has failed. She will have to raise taxes, again, even if she has to violate manifesto commitments. Indeed, she almost admitted that in her Tuesday speech, by stating: “If you’re asking what comes first, the national interest or political expediency, it’s the national interest every single time for me and it’s the same for Keir Starmer too.”
The chancellor should indeed promise a fiscal tightening. This is not so much because of her rules, though such promises should, if possible, be kept. The justification is also not because the UK’s fiscal plight is exceptionally bad. But markets are showing scepticism about the country’s fiscal prospects, the UK is exceptionally dependent on foreign capital and the ratio of net debt to GDP, while far from exceptional by international standards, is uncomfortable. Fiscal cushions need to be rebuilt.
It is clear, too, that this government lacks the will, possibly even the ability, to cut spending. So, raising taxes is unavoidable. The question is whether this can be done without further damaging economic performance. The only chance of doing so is to replace bad taxes with better ones, in the hope that, in the longer term, this can promote the emergence of a more dynamic economy.
As the Institute for Fiscal Studies notes: “Tax revenue as a share of national income is set to reach a UK record high of 37.4 per cent in 2026-27.” But this is not high by European standards. For present purposes, then, I take the spending that drives taxes as a given.
The right approach to taxation is set out in the Green Budget from the IFS, which states that “in general — and unless there are good reasons to deviate from this — the tax system should treat similar activities in similar ways”. Alas, the UK’s does not. “Not doing this usually creates unfairness and inefficiency as people make decisions based . . . on what reduces their tax bill the most,” argues the IFS.
Along with this principle of neutrality comes that of progressivity: the better off should bear a proportionately heavier burden. This is now the case for income tax. According to the IFS, “direct taxes . . . are now lower for middle earners than at any times since the mid 1970s”. A recent paper from the House of Commons Library shows that, in 2022-23, the top 1 per cent earned 13 per cent of income but paid 29 per cent of income tax. In 1999-2000, the latter share had been 21 per cent.
Crucially, non-neutrality is everywhere in the UK tax code. It is in the higher taxation of employees than of the self-employed or retirees; it is in the “cliff edges” in marginal tax rates, when a small increase in income triggers a large loss of benefits; it is, as a report from the Resolution Foundation notes, in the ability of emigrants to avoid paying taxes on capital gains by selling after they have left; it is in the fact that gifts made, arbitrarily, more than seven years before death are exempt from inheritance tax, which allows the heirs of the biggest fortunes to escape the tax completely. It is in capital taxation everywhere. The list of inconsistent treatments goes on and on. Nobody would (or at least should) have designed such an absurd system.
One of the most striking set of inconsistencies is in the exceptionally wide range of goods exempt from value added tax. Economist Tim Leunig has written a fascinating paper on this absurdity for Nesta. Consider, he notes, “the difference between a muesli bar and a flapjack. The former is liable for VAT, the latter is not.” Now suppose all these exemptions were eliminated. Leunig argues that we could levy VAT on food, children’s clothes, toothpaste and so on, and make poor people only a fraction poorer. The reason is that the money could be used to lower the VAT rate from 20 per cent to 10 per cent. Or the rate might be left higher and the money used to fund things that benefit poorer people far more than cheap flapjacks.
Now consider property taxation. It, too, is a mess, with council taxes imposed on the basis of 1991 valuations and the most expensive properties taxed at very low rates. Oxford university’s John Muellbauer proposes replacing council tax in the top two bands, covering around 1.14mn properties in England and Wales, with an annual wealth tax of 0.5 per cent of property value for UK taxpayers, with deferred payment in the case of cash-poor but asset-rich pensioners. He also recommends a land value tax on unoccupied land, which would, among other things, encourage development. I would prefer stamp duty to be abolished. Muellbauer differs.
Next is the question of taxing bads, of which the most important is pollution. Ideally, we would have a carbon tax, instead of fuel duty, since that would accelerate the energy transition, with the money returned to the public. At the very least, we should be thinking about how to make road pricing general.
Then there is the question of business taxation. All forms of current and capital spending should be expensed in the year it occurs. How might this be paid for? One possibility would be to end tax deductibility of interest. This relief encourages use of debt over equity as a source of finance, which creates risks to economic stability. Without that deduction, the rate of corporation tax might also be lowered. Moving towards such an equity-funded economy could be a boon for stability and growth.
This only scratches the surface. The UK’s tax system is a mess. The chancellor should dare radical reform.