An agenda for change: the UK tax system

With tax seemingly set to shape a considerable part of General Election debate, Francis Chittenden, Hilary Foster and Brian Sloan outline their plans for an overhaul of the UK tax system

The chief contributory factor to the increasing hidden costs of taxation is complexity, both in tax legislation and in the workings of the tax system. There is now a wealth of literature available proposing changes that will reduce the burden on business of compliance with the tax system. Here, we summarise the changes that we believe need to be made to substantially reduce compliance costs, and the distortions they create. The drivers of complexity are:

- The weight of past legislation

- The desire to prevent tax avoidance

- The temptation to use tax to change society

- The pressure on the Chancellor to ‘do something’ on an annual basis

- The desire to raise taxes in a way that will be less obvious to the taxpayer (and thus

minimise the outcry by lobbying factions)

- The lack of scrutiny before tax policy is enacted leading to mistakes and lack of stability and trust in the tax system (if not the political process as a whole).

“The circus of the annual Finance Act should cease. Instead, the government should be required to submit a statement of its tax and fiscal policy for a three- to-five-year period, with rates to be set by normal Budget resolutions, and tax Bills every two or three years.”

To reduce complexity and operating costs, the following broad areas should be addressed.

Major simplification of the existing legislation

The tax law rewrite project should be expanded with a view to much larger-scale simplification of tax legislation. It should be an ongoing process similar in nature to the administrative burdens reduction programme, requiring buy in from government and politicians with the setting of targets for quantified reductions in the tax code to be achieved within a specific time frame. We also believe that true progress can be made only if new legislation is formatted in the tax law rewrite style from the outset. There should be a review of the current legislation, carried out by specialists reporting to a multiparty, multidisciplinary advisory board. Once this has been achieved, any proposed changes should be subject to a defined process prior to enactment in order to identify any anomalies before they reach the statute book.

The legislative process

The circus of the annual Finance Act should cease. Instead, the government should be required to submit a statement of its tax and fiscal policy for a three- to-five-year period, with rates to be set by normal Budget resolutions, and tax Bills every two or three years. This will help halt the annual increase in complexity by allowing more scrutiny to ensure a coherent overall structure for taxation, with the Budget resolutions simply setting the rates within this structure. More effective pre-legislative scrutiny of tax policy could involve bodies such as ACCA, CIOT and ICAEW, which have made representations on this issue.

“Consequently a more stable tax regime subject to fewer changes will be much less burdensome on the private sector of the economy and on government.”

Reducing complexity in business taxes

We readily concur with the recommendations summarised by Boys Smith et al:

- Alignment of accounting and taxable profits: the government should adopt the principle that the taxable profits of a business (whether operated by an individual or a company) should normally equal its accounting profits. To illustrate this the whole area of assets used in a business should be examined with a view to removing distinctions between and giving consistent treatment to fundamentally similar items, such as hire purchase contracts and finance leases. Similarly, the area of capital allowances versus accounting depreciation is another area for simplification.

- Employed and self-employed taxation: policymakers should look at the differences in tax treatment and abolish any distinctions that do not have a strong justification. As previously noted by Crawford and Freedman, the tax system should treat all taxpayers equally. The present system only encourages the distortion of commercial decision-making. The differential NIC treatment of employees and the self-employed is an example of this.

“In the current economic circumstances, a figure equivalent to 3p to 4p on the basic rate of Income Tax is currently absorbed by the hidden costs of taxation indicates the scale of the savings that could be made.”

Capital and income: the distinction between the two is not justified in many instances. Where it is the government needs to make sure that it is sufficiently clear. Indeed, a case can be made for abolishing or limiting Capital Gains Tax to very specific circumstances. Investment returns that are disguised as capital gains should be taxed in the same way that income is taxed. This would reduce the tendency to engineer financial instruments to avoid tax on income. Reviewing reliefs: policymakers should cut unnecessary reliefs and develop a way to make sure that new ones are not adopted when not needed. Tax reliefs are really a form of government planning or picking winners – it is believed that economic outcomes will improve if certain forms of economic behaviour are treated relatively favourably by the tax system. A considerable reduction in the availability of reliefs will come about only if there is a change in government philosophy about government’s ability to pick business ‘winners’.

General recommendations

In addition, we have a number of general recommendations for future tax policy.

- The use of common definitions and procedures across taxes reduces costs by decreasing the number of calculations that have to be made. Therefore we recommend that there should be consistency of definitions and procedures across all taxes. The obvious example that springs to mind here is the case of Income Tax and National Insurance. For several years now, many have been calling for an alignment of the rules for calculating Income Tax and National Insurance. As a minimum, remuneration packages should attract the same amount of tax and National Insurance no matter how they are structured.

- We suggest a review of those taxes, which generate minimal revenue in return for high administrative and compliance costs such as Capital Gains Tax and Inheritance Tax. It might be better if these taxes were scrapped completely.

- Where compliance costs represent a burden that cannot be reduced, government and the tax authorities should consider compensation for the costs incurred.

Taken as a whole the proposals made here are radical, especially the proposed move from annual Finance Acts to a more stable fiscal policy that would emerge from rigorous analysis and consideration of fiscal needs rather than the pressure for Chancellors of all political persuasions to ‘pull rabbits from the hat’ in each Budget speech. As we have argued above, studies of the costs of complying with tax laws and regulations indicate that it is the need for businesses to adapt to continual change and to cope with complexity arising from the volume of laws and regulations which is responsible for the majority of compliance costs; the same must be true for HMRC. Consequently a more stable tax regime subject to fewer changes will be much less burdensome on the private sector of the economy and on government. Acknowledgement that, in the current economic circumstances, a figure equivalent to 3p to 4p on the basic rate of Income Tax is currently absorbed by the hidden costs of taxation indicates the scale of the savings that could be made. More careful political and administrative management of taxes could surely release between one quarter and one third of these costs.

Image provided courtesy of: http://www.flickr.com/photos/howardlake/3466157425/

This is an extract taken from Taxation and Red Tape: The Cost to British Business of Complying with the UK Tax System. It is published by The Institute of Economic Affairs and is available for download here http://www.iea.org.uk/record.jsp?type=release&ID=172