Britain’s tax system has become more economically damaging since the financial crisis, says new IEA briefing. The worst may be yet to come.

Taxes on investment have risen sharply on two occasions in recent years – immediately after the financial crisis, and once more after the pandemic. This time, there is little prospect that they will fall again.

Millions more people have been dragged into higher rates of income tax since 2000. Hundreds of thousands more people face the ‘60p tax trap’ than when it was first introduced.

The composition of the British tax system has shifted away from consumption taxes and towards taxing personal incomes. This makes the tax system more progressive, but comes at a cost to economic growth.

The British tax system has become increasingly damaging to economic growth, says a new briefing from the Institute of Economic Affairs (IEA).

The research, by Independent Policy Adviser Tom Clougherty, traces the evolution of the tax system over the past quarter-century, in an attempt to pinpoint its role in Britain’s economic slowdown.

Clougherty finds that the 2000s were a period of relative stability for the tax system – but that did not continue into the 2010s.

Effective tax rates on investment (the product of corporation tax and personal taxes on dividends and capital gains) shot up in the wake of the financial crisis, climbing by ten percentage points. And while they gradually fell back to pre-crisis levels by 2017/18, they have since risen sharply once again post-pandemic.

Clougherty suggests that twice raising taxes on investment at moments of economic weakness was a major error, and likely had a chilling effect on growth. Higher inflation and less generous tax reliefs for saving have also eroded investment incentives.

Another striking change in the tax system is the number of people paying higher and additional rates of income tax – with an extra 5.5 million people facing rates of 40p or higher since the turn of the century. The withdrawal of the personal allowance, which creates a 60p rate over £100,000, hits more than 700,000 people now, compared with fewer than 150,000 when it was introduced.

The combined effect of these measures has been to shift the composition of the tax system towards personal income taxes – which rose from 44.5 percent of tax revenue in 2000 to 51 percent of tax revenue in 2024. The share of revenue attributable to consumption taxes (such as VAT and excise duties) has fallen from 28 to 22.5 percent over the same period. Economic evidence suggests that taxing income is more detrimental to GDP per capita than taxing consumption.

Clougherty also points out that the UK raises more revenue from property taxes (as a percentage of GDP) than any other OECD country. Yet stamp duty land tax and business rates have both become significant drags on economic growth, with top marginal tax rates for both taxes rising significantly since 2000.

Meanwhile, Clougherty argues that cuts to corporation tax in the 2010s were undermined, from an economic growth perspective, by offsetting changes to investment allowances – just as the introduction of full expensing softened the impact of raising corporation tax from 19 to 25 percent in 2023.

The report highlights ICAEW research showing that the volume of British tax legislation has ballooned from 7,250 pages (in Tolley’s Tax Handbooks) to more than 23,500 pages today.

It also notes that the UK is currently ranked 32nd (out of 38) in the Tax Foundation’s International Tax Competitiveness Index. According to Clougherty’s modelling, the UK would rank 26th today if taxes on personal income had remained at pre-financial crisis lows, and corporation tax had stayed at 19 percent after the pandemic.[Text Wrapping Break][Text Wrapping Break]If Britain also abolished stamp duty, reformed business rates, and adopted a comprehensive VAT modeled on New Zealand’s, it could come 3rd in the tax competitiveness rankings – behind only Estonia and Latvia.

This briefing is part of a series published by the IEA on Britain's ‘Great Stagnation’, diagnosing Britain's growth problem. The next briefings in the series will be published in the coming weeks and will be compiled into a full book published in September.

The tax system didn’t cause Britain’s growth slowdown, but it has made bouncing back much harder than it needed to be. Looking back, it seems extraordinary that we have twice responded to major economic crises by sharply raising taxes on investment – but that’s what happened. Across the board, we have put politics ahead of economics in designing tax policy, with predictable results. My fear is that on current trends the 2020s and 2030s are going to be much worse in this respect than the 2010s. The tax system is probably a greater threat to enterprise and initiative today than at any point in the last 35 years.