Clement Attlee: “Charity is a cold grey loveless thing. If a rich man wants to help the poor, he should pay his taxes gladly, not dole out money at a whim”.
Tax is low in the UK. The UK has only the 14th highest taxes in Europe as a proportion of GDP. They are some 10% below the average.
International Benchmarks of Tax Including Social Services, 2014 (% of GDP)
Taxes have evolved over many years. They have seen constant adjustment rather than redesign. So the taxes have increasingly moved away from the basics of good tax design.
There are clearly some characteristics to which all tax systems should aspire to:
- support of public services by people or companies should, as nearly as possible, be proportional to their capacity to pay
- tax should be certain and not arbitrary
- every tax ought to be charged at the time, or in the manner, in which it is most likely to be convenient for the contributor to pay it
- every tax should be as low as possible
- the potential negative effects of the tax system on welfare and economic efficiency should be as low as possible
- administration and compliance costs should be as low as possible
- fairness of procedure, avoidance of discrimination, and being equitable are critical features
- taxes need to be simple to understand
These characteristics point to the need for a simpler system than the UK has. This makes tax easier for all to understand, collection costs fall which in turn reduces the tax needed. Simpler taxes also stop avoidance and evasion.
Outside the total tax contribution, there are other issues with UK taxes:
- it is not efficient
- it lacks fairness
- it is complicated
- its rationale is incomprehensible
- it is so complex that it fosters tax avoidance and cheating
- it is costly to run
The Institute for Fiscal Studies is an independent non-political body. In its Mirrlees Review (led by Sir James Mirrlees, winner of the Nobel Memorial Prize in Economic Sciences in 1966), it reviewed the UK tax system. The report identified some fundamental potential changes back in 2011. None of the political parties proposed such fundamental change in their 2015 manifestos. The report identified the political sensitivities of some of the changes. This is almost certainly why the proposals were ignored by any party in the following election.
The parties continue to act on policies that will gain votes in selected areas of the electorate. They show little concern with the harm they can cause to other sections of the public. They are not changing unfair and ill-conceived taxes. They ignore the costs of collection and the wider economic inefficiencies. It represents a further example of parties following policies that ignore the views of industry specialists.
By international standards, the UK raises more than most countries from Income Taxes and less than average from social security contributions. A further feature of the UK system that is unusual by international standards is its degree of centralisation. In the UK, only Council Tax, is locally collected. Only Ireland has a smaller proportion of taxes managed below the national level. Direct tax is high in the UK (at 14.4% of GDP, compared with an average of 13.2% among the EU-28). Income Tax is the primary source of revenues (25.3% of the total taxes), followed by VAT (17.1%) and social contributions (17%).
Comparison of UK Tax composition with EU, 2014 (% of GDP)
Source: EC Europa
Tax is necessary to fund the public services needed to run a complex and civilised society. UK tax is largely in line with European averages with the total exception of social contributions. This leads to an under funding of pensions. It also allows the UK to boast a lower total rate of tax than most of Europe. If that is rephrased, it could read ’those actively contributing to tax are failing to support those who have retired and previously paid their tax’. This does not mean the right people are paying the right taxes within the totals, just the UK is out of line in its social contributions.
Governments continue to adjust existing taxes rather than redesigning them. This leads to timing and level anomalies. A change to some of the anomalies will release funds that can immediately reduce the public debt without any impact on the services provided. Total tax, excluding social contributions, is in line with European averages, but the Government deficit is more than twice the EU average. That deficit incurs interest payments, leaving the UK with less to spend on services than other EU countries. By reducing those interest payments more is available for public services.
Tax should be fair and equitable. Public views of tax focuses on Income Tax and national insurance because these payments are regularly visible. Neither of these taxes is as progressive as politicians tell us. When indirect taxes on consumption and Council Tax are included, there is a far higher tax burden on the lower income earners than the higher earners. Tax in the UK is regressive in large part because of Council Tax. Replacing Council Tax with a Land Value Tax underpins a change to the entire tax system. Tax can then be based on fairness, the ability to pay and one that adds to the efficiency of the economy.
Corporate taxes can strongly affect the economic environment. Therefore any major changes need forward guidance in the same way the Bank of England is now practising with interest rates.
Forward Thinking also believes Government should develop alternative incomes to tax. This would reduce the tax bill while supporting public services.
Demographic changes will have less impact on tax revenues than on spending. This is a critical issue going forward. However, in the same way as the ageing population will strongly impact future public spending then so carbon emission issues will influence taxes. Fuel efficient cars have been encouraged by taxes. These are better for the environment. These taxes will lessen as increased levels of electric and hybrid cars populate the roads. Congestion however will continue to grow regardless of these changes.
According to the Institute for Fiscal Studies total UK Government receipts were expected to be £648.1 billion in 2014–15, or 37.7% of UK GDP. This equals roughly £12,400 for every adult in the UK, or £10,000 per person. Income Tax, National Insurance contributions and VAT are the largest sources of tax revenue, together accounting for some 64% of total tax revenue. Duties and other indirect taxes make up around 11% of current receipts, with fuel duties of £26.8 billion the largest part. The only other large category is company tax, which represents 11% of current receipts, mainly Corporation Tax and Business Rates.
Questions on tax can be made at various levels:
- is the overall income too high or low?
- how suitable is each tax?
- is the balance of the taxes correct?
- is the tax fair in who pays what?
Forward Thinking believes that indirect tax (based on consumption) is fairer than bland direct taxes. However, VAT, the major indirect tax is regressive. Any move towards consumption taxes needs to compensate lower paid people. This could lead to major running costs, which would then be counterproductive. However, a FairTax proposal in the USA suggests compensating people with what it terms a ‘prebate’. This could form part of a Basic Household Income. This would then also contribute to simplifying benefits.
The existing tax income is heavily reliant on three major taxes:
Government Income Sources, 2014-15 and 2015-16 Forecast (£ billion and % of Total)
Source: Office for National Statistics
There is a further important issue before an investigation into tax levels: what the HMRC describes as the ‘tax gap’. It is the difference between the tax that should, be paid to the HMRC, against what it collects. It is what most of us consider to be tax avoidance or evasion. The tax gap reflects tax lost for various reasons, from taxpayers simply not taking enough care with their tax returns to criminal actions. The numbers are false at best, but represent the best estimates based on the information available to the HMRC. By definition, there are many sources of doubt and potential error.
The latest data concerns the tax year 2013/14, for which the HMRC estimates the tax gap was £34 billion equalling 5.2% of taxes expected in 2014-15. While the political parties will tell you of their success in preventing evasion, the £34 billion is the same as the previous year. Any Government knows that when tax levels become high it increases the incentive to evade those taxes. Tax affects behaviour (including moving) and there comes a point where simply raising tax has a negative effect on the income potentially gained.
HMRC Estimates of The Tax Gap, 2005/06-2013/14 (£ billion and % of The Total Tax)
Although only an estimate, the tax gap is significant. More importantly it is unfair. One of the ways to address tax evasion is to make it less attractive. It can also be made more difficult by changing the tax. The media and politicians, often portray the nature of these tax evasions in a way that places the blame purely on rich individuals. This is clearly not the case when the numbers are given:
The HMRC make further analysis of these estimates by the nature of the tax:
HMRC Estimates of Tax Gap, by Type of Tax, 2014 (£ billion)
The HMRC further breaks down its estimates by customer:
HMRC Estimates of Tax Gap, by Type of Customer, 2014 (£ billion)
The HMRC also identifies its estimates of the reasons for the tax gap:
HMRC Estimates of Tax Gap, by Behaviour, 2014 (£ billion)
Clearly part of the tax gap is because of company failures. This is partly a result of economic changes. The following table shows the decline in company insolvencies in England and Wales as the economy has improved. When a company becomes insolvent the company may not be able to pay what it owes to HMRC. This can include VAT, Income Tax and NIC contributions as well as Corporation Tax owed. There is a major incentive for the HMRC to become active when the company becomes distressed so avoiding the insolvency.
Company Insolvencies in England and Wales, 2010-2014 (Number)
Source: Insolvency Service and Companies House
It is through a coherent set of policies on all areas of society the true tax underpayment can be resolved. This includes a greater cooperation and support to companies that are struggling to continue.
Forward Thinking Policies
Major changes to the tax system are proposed:
Simplifying tax has various benefits, it:
- reduces compliance cost for individuals and companies
- lessens collection costs for the Government
- cuts evasion and avoidance
- brings significantly greater equality between rich and poor including both individuals and companies
- stops the negative effect of tax on economic efficiency
- becomes easy to understand
The complexity of the UK tax legislation has led to the Chartered Institute of Tax having more than 17,000 members. This is because the British Tax Code runs to more than 17,000 pages. Hong Kong has a tax code covered in just 276 pages. That complexity leads to huge inequality favouring those with money to identify low payment routes. Corporation Tax is one of the most distorted by these rules. It legally allows large companies to distort their tax commitments. This creates huge inequalities for small companies compared with the large international companies.
Forward Thinking supports a wide range of tax changes. These unite the population as well as make tax fairer and simpler. The most significant developments proposed are:
- abolish Income Tax and integrate it with Capital Gains Tax while the process is taking place
- reduce employee National Insurance contributions to 5% of earnings (from the 12% earners pay up to £41,865). Redirect this saving to their own Workplace Pension
- replace Council Tax and Business Rates with a Land Value Tax
- replace Corporation Tax with a much lower Turnover Tax
- standardise VAT with exceptions only on products or services with a financial implication for public services
The UK has the sixth highest proportion of direct tax to GDP in Europe. As a proportion of all tax income the UK is third highest in Europe.
International Benchmarks of Direct Tax, 2014 (% of GDP)
Longer term trends in the role of direct tax in the UK are inconsistent, reflecting policy changes:
Historic Trend in UK Direct Tax, 2000/01-2014/15 (% of GDP)
Direct tax is important to Government revenues:
Proportional Importance of Direct Taxes, 2014-15 (% of Total)
Source: Office for National Statistics
Forward Thinking Policies
Direct taxes remain largely independent of the economic performance of the country. They do however decline with lower employment levels. They do not reflect use of a specific item. The consumer has no choice in their payment, other than the wages they earn.
In the USA there is a movement proposing a FairTax. The proposal replaces:
- all federal income taxes (including the alternative minimum tax, corporate income taxes, and capital gains taxes)
- payroll taxes (including Social Security and Medicare taxes), gift taxes
- estate taxes
It replaces these with a single national consumption tax on all new goods and services for personal consumption. The proposal includes a monthly payment to all family households of legal US residents as an advance rebate of tax on purchases up to the poverty level. It terms this a ‘prebate’.
Except for the prebate, the tax is similar to VAT.
There are strong arguments to support placing tax on consumption rather than incomes or corporate profits. One of the largest is that all taxes have deadweight costs and consumption taxes have lower ones than income or corporate taxes. A deadweight cost is the economic activity that does not happen because of the tax. Lower deadweights therefore lead to greater economic growth for any tax rate.
The proposal offers a simpler tax regime, with low collection costs. It makes avoidance more difficult and with the prebate removes poverty. It has significant appeal at many levels.
As defined in the proposed US legislation, the tax rate is 23% for the first year. This percentage is based on the total amount paid including the tax ($23 out of every $100 spent in total). This would be equivalent to a 30% traditional US sales tax ($23 on top of every $77 spent making a $100 total). The rate would automatically adjust each year based on federal receipts in the previous fiscal year. While consumption taxes can be regressive, this is offset by the prebate.
If UK taxes are considered, there is already a 20% VAT tax which raises income of £110.7 billion. If there were no exempt items VAT income would increase to £177.3 billion. If the tax is increased to 30%, it would gain a public sector income of £266 billion. Currently VAT and Income Tax realises £277.2 billion. So a similar level in the UK would not be enough to replace all other taxes. The USA model assumes it would include National Insurance, Council Tax, Business Rates and Corporation Tax. Neither would it provide for the prebate that forms an essential part of the policy.
Forward Thinking believes taxes on consumption are fairer than direct taxes. The regressive nature of VAT could be offset by a prebate. Applying VAT to all products would help consistency and redistribute the tax load. The argument against this is that it would reduce the tax burden on high-income earners and increase it on the middle earners. This would be addressed by using the Land Value Tax to replace Income Tax.