How to train your deficit dragon 13 July 2013 Last updated at 10:22 In the battle to sort out Britain's public sector deficit, something rather important was said this week. George Osborne told his fellow MPs on the Treasury Select Committee at Westminster that the £23bn hole in the budget after the next election can be filled without tax increases. "I'm clear that tax increases are not required to achieve this," said the chancellor. This can be achieved through spending reductions. I don't think we have reached the end point in reforming welfare. Those comments are important because they lay down a challenge to other parties to say how they would handle that continuing deficit; tax increases, spending cuts or more borrowing? They also lay down a very big challenge to George Osborne, or his Tory successor, to avoid tax increases. It's easier to promise than to achieve. Earlier in the week, precisely this question was addressed by Paul Johnson, director of the Institute of Fiscal Studies (IFS) - a think tank often given the adjective 'respected' as well as 'independent'. He was presenting BBC Radio 4's Analysis programme, on what to do with that hole in the public finances. And he said all the IFS's analysis of the scale of the problem, allied to experience with post-election budgets over the past 30 years draw him "inexorably" to the view that taxes are on their way up, post-election. That includes experience of George Osborne, who put up VAT after the last election. Even after six years of big spending cuts by 2016, the deficit will amount to more than £20bn, confirmed Johnson. That's about £1,000 for every UK household, and that's with an optimistic assumption about a return to economic growth. Left, right and centre He had support from Gavin Kelly, former Labour adviser and now with the Resolution Foundation think tank, who said the outlook for whoever is chancellor after the 2015 election is "unbelievably bleak," and he or she will wish to to get the nasty stuff out of the way early. "The idea we can make all adjustments through spending cuts and precisely none through tax rises seems to me to be a bold and unlikely claim," said Kelly. Johnson and the Analysis programme also turned to Lord (Nigel) Lawson, who was Chancellor of the Exchequer in Margaret Thatcher's government. He's not just Conservative but shares Osborne's economic conservatism in disliking tax. However, he told Johnson: "In the short run, there are going to be some increases in taxation. In the medium term, I think you should aim to do it all on the public expenditure side. But that takes time. Therefore there will have to be increases in taxation, which you would hope then in due time to be able to reduce. So from left, right and the leading independent expert, there's disagreement with George Osborne - not in response to him, but in a broadcast before the Chancellor's comments in committee. Ferrari tax breaks What Paul Johnson also questioned was the best way to increase taxes, if that has to happen. And beyond that, how does our tax system need to change? The IFS has been critical, for a long time, of the complexity of the tax system, and the way in which it's suffered from piecemeal reform, or no reform at all. The strongest criticism is for the regressive nature of council tax. Johnson compares it with putting a much lower level of tax on the purchase of a top-of-the-range Ferrari than you find on a, well, a cheaper car (my attempt not to offend anyone's car pride). And it's based on valuations from 1991, because politicians won't take the flak for the impact of changing it. As a rule, and a very important one, people who lose by reforming tax make a lot of political noise about it, and those who gain don't show much gratitude. The political reality is that easy-to-understand taxes, starting with basic rate income tax, is very appealing to cut, but very hard to raise. National Insurance, however, is something that people notice less, probably because it's more complex. That's what has been ramped up in several ways over the past decade. And it's argued that the hike in employers' contribution loops back to impact on employees. Yet national insurance has ceased to serve its original purpose, as its link to benefits has been eroded. Fiscal drag Tax on wealth is politically attractive, particularly to those who don't have much. But it's relatively easy to avoid. And the main wealth tax, on inheritance, became a focus for voter revenge and the Daily Mail when rising house prices put many more people into the bracket. That's a version of 'fiscal drag', in which thresholds for tax stay the same, as people's income or wealth rises and becomes taxable. The 'higher rate' of tax, at 40%, has had precisely that effect. It used to be aimed at high earners. Now it's for a lot more. And it's been little noticed that the increase in the starting threshold for lower rate income tax, heading towards £10,000, has been neutralised for higher earners by lowering that higher rate and bringing yet more earners into that bracket. The IFS commissioned Sir James Mirrlees to propose reforms. Born in Wigtonshire, he studied at Edinburgh University before going to Cambridge where he won the Nobel Prize for economics. His review concluded: "The level and quality of debate on tax policy is inadequate; there has rarely been any clear sense of direction from governments; and expensive and damaging mistakes have been all too common." An inefficient housing market, distortionary taxation of financial services, excessive reliance on debt finance, employment levels lower than they need be, and distorted and inefficient savings and investment decisions. Pasty tax plus The review asked a lot of difficult questions. Should there be any tax, or stamp duty, on buying a home? There's a tension there. On one hand, there's no obvious reason why that transaction should be taxed and it decreases mobility and flexibility in the housing market. On the other, as other sources of tax become more mobile - notably company profits, personal income and vice taxes such as gambling - then the fixed things, like building and land, become the reliable and more attractive source of income to the Treasury. Mirrlees also suggests putting VAT onto everything. That would include food, pushing up the price at the supermarket checkout by a whopping 20%. It would increase energy bills, and extend to children's clothing, newspapers and books. If you compensate lower earners with benefits to meet the higher costs, that could be neutral for them. But cast your mind back to the failed attempt by George Osborne last year to impose VAT on hot snacks - the pasty tax. Then consider how much resistance a chancellor would find to implementing the whole range of 'zero-rated' goods, not least from newspaper proprietors. Sir James came up with other proposals; replace petrol and diesel tax with congestion charging: tax domestic gas consumption for its climate impact (beyond the hike in VAT): tax on interest from saving accounts should be abolished. It's quite a daunting programme of reform, when you put it that way. Scottish tax reform, or revolution? So now, consider this; Sir James Mirrlees sits on the Fiscal Commission advising the Scottish government. He was one of the authors of a report on a macro-economic framework for an independent Scotland, controversially setting out how it could continue to share sterling as its currency. Part of that team's work is also to draw up a tax framework for an independent Scotland, with Mirrlees in charge. And when you look at his criticism of the UK tax system, it's hard to see how they would not be applied also to the system that would be inherited by an independent Scotland. So when the Mirrlees recommendations are published, let's see if they include a proposal to impose VAT on food, children's clothes, books and newspapers, plus an extra tax on your gas central heating, and road tolls. And if they're not there, why not? Indeed, if you delve further back into the work that led to Sir James getting his Nobel Prize, you find some radical conclusions on optimal income tax rates that are used to back up the case for a flat tax. So if you think the independence debate is not lively enough already, that lot could put a bit more heat under it. I'll be presenting the next in this series of Analysis, asking whether the case being made for Scottish independence is about breaking free or playing safe. It's on BBC Radio 4, at 8pm on Monday 15 July.