The UK Tax System - Essay Example

?Running Head: UK TAX SYSTEM Evaluate the UK tax system in the context of Adam's Canon of Taxation Insert Insert Grade Insert Name 26 January 2011 Evaluate the UK tax system in the context of Adam's Canon of Taxation Introduction UK is considered to have a considerable degree of conformity between tax and financial accounts although major exceptions exist, and as such, the ultimate position is one of partial conformity (Wolfgang et al. 2008). This particular circumstance has led to occurrence and existence of gap between the profits stated for financial purposes and the amount of tax actually paid. There still exist no clear outline as to how extend this is an indicator of avoidance activity is actually tied up with the vexing question of what amounts to tax avoidance and the extent to which tax avoidance is undesirable and unacceptable in general (Wolfgang, et al. 2008). In UK today, there exist no published figures on this particular ‘gap’ but statistics from the Tax Justice Network (TJN) indicate that UK’s fifty largest companies have paid an average of 5.7 per cent less corporation tax than ‘expected rates’ from 2000 to 2004 (Wolfgang et al. 2008). This largely depends upon what is ‘expected’ and some of the assumptions made are questionable. For instance, in UK, TJN has associated this with excessive corporate tax allowances given to motivate investment in plant and machinery that in turn result into high levels of deferred taxation (Wolfgang et al. 2008). Today, capital allowances constitute examples of various express tax relief and incentives, which are regarded by most governments as desirable in the context of their economic policies. Recent report findings by the National Audit Office in UK identified that, around 220 of the largest UK 700 companies paid no tax at all in the years 2005 and 2006, which led to concerns being widely highlighted in the media that there were high levels of corporate tax avoidance (Wolfgang et al. 2008). Therefore, this research paper will largely look at and make evaluation of the UK tax system in the context of Adam’s Canon of Taxation. Background to Adam’s Canon of Taxation Adam Smith is considered the father of modern economics and part of his contribution to the field of economics was presentation of four principles of a good taxation system known as Adam Smith’s Canons of Taxation (Smith and Cannan 1976; Smith and Sutherland 1998). The four principles are as follows: Canon of Equity, in the words of Adam Smith, “people of every state should pay their share in proportion to their individual abilities, which means that they should pay tax proportion to that income which they respectively get under the government security” (Jain, Kaur, Gupta and Gupta n.d, p.30). The basic assumption of this law is that, people are supposed to pay taxes according their capacity, while equity in this sense means people should demonstrate equality of sacrifice in paying tax. For instance, since the rich people’s marginal utility of money is less than that for the poor, rich people are supposed to pay more amounts in taxes than the poor people (Jain, Kaur, Gupta and Gupta n.d). Therefore the principle of justice is implicated in this doctrine (Nicholson 1928) and in the words of Adam Smith, “It will be more justified for the rich to contribute to the public expenditure not only what is proportionate to their income but more than that” (Jain and Khanna 2006, p.349). The second canon is that of certainty, where the postulation of this principle is that, there need to be a certainty regarding taxes (Das, 1993). For example, in Smith’s words “the tax which each individual is bound to pay ought to be certain, and not arbitrary and that time of payment, the manner of payment, the quantity to be paid ought to be clear and plain to the contributor and to every other person” (Jain, Kaur, Gupta and Gupta n.d, p.30). These assumptions show that, in any taxation system, individuals must know how much tax they are supposed to pay, at what time the tax is supposed to be paid so that it can be arranged by that time, how many installments the tax is supposed to be paid in, and finally, knowledge of where and to whom the tax should be paid to (Gupta 2001). Certainty of tax is perceived to be essential not only to the taxpayer, but also to the state whereby the government has to ascertain its overall expenditure only after making an estimate about the taxes. The third principle is the canon of Convenience, where the postulation of this canon is that there is also need to put the convenience of the taxpayer in mind. Adam observes that, “every tax ought to be levied at the time and in the manner in which it is most likely to be convenient for the contributor to pay it” (Jain, Kaur, Gupta and Gupta n.d, p.30). The assumption of this canon is that every tax should be collected at the time and in the manner in which there is no difficulty for the taxpayer to pay tax. For instance, if tax is collected at the time and in the manner, which are inconvenient to the taxpayer, even the minimum amount will be perceived by the taxpayer to be burdensome in paying it. On the other hand, if tax is collected at the time and in the manner, which are convenient to the taxpayer, then it will be difficult for such taxpayer to avoid even paying the maximum amount of taxes (Chand 2008). Canon four revolves around the economy, where according to this canon, the costs of tax collection need to be lower, and that any taxation system should not be much expensive (Jain and Khanna 2006). Every tax needs to be levied in such a way that the government does not have to make much expenditure on its collection and the tax-payer at the same time does not have to spend much while paying for the taxes. The understanding of this canon is therefore, heavy income tax does not satisfy the canon of economy but on the hand heavy taxes for drugs and intoxicants can be justified. Hence, economy in this case means that there should be a minimum expenditure in collecting taxes and tax should not have an adverse affect on the production of the society and people’s will to save and invest in turn (Jain, Kaur, Gupta and Gupta n.d). UK Taxation System UK tax system has been described to evolve over many generations, and today, it is used for various purposes that transcend beyond its historical role of functioning mainly to raise revenue (Ashenfelter, 2007). Currently, this tax system has graduated into an effective economic tool that promotes efficiency, a political tool to achieve distribution of income and wealth, and as a social tool to encourage welfare and development (Wales 2008). More and more calls have been made for the tax system to deliver fairness among the people and become a competitive framework for the business community. However, the overall observation has been that the system is largely complex and one that exhibits elements of interaction between various parts hence making it difficult to model and from this change is seen to take time before real ad genuine changes and adequate efficiencies can be realized (Wales 2008). UK Tax system has operated within the precepts of Adam canon principles. Characteristics of these aspects will be explored in the following discussion. First on the Adam’s canon, taxation system is the canon of equity, which requires people to pay tax proportionate to their income and ability. Today, in United Kingdom, the poor are taxed less as compared to the rich (Irvin 2011). This aspect has led to UK’s Chancellor George Osborne to describe this canonical VAT tax system as progressive TAX (Irvin 2011). What convinces the Chancellor that this kind of tax is progressive is the fact that the poor people continue to pay less in absolute terms than the rich do. Nevertheless, such position has been disputed by some economist who view this system as largely ‘mild progressive’ and not purely progressive (Irvin 2011). Progressivity of UK taxation system is regarded to have lost its progressive amour it had in early 1980s. It is believed that the ‘progressivity’ of the income tax system in the country has been reduced over the years where before 1979, the top rate of income tax stood at 83 per cent with another 15 per cent supplement for investment income (Riley 2006). However, this situation has steadily changed today where most taxpayers face similar marginal tax rate of 22 per cent as compared to top rate of 40 per cent. Nevertheless, on top of the basic tax rate, there is another insurance contribution of 11 per cent and 1 per cent more for NIC and this affects high earners, which on overall, makes the tax rate to be 33 per cent and 41 per cent, and this cannot be regarded as great progression (Riley 2006). The second canon has to do with certainty, where the basic assumption is that the timing and amount to be paid in terms of tax must be certain to the payer. In UK, the recent instances have violated this canon as more and more people discover errors in their tax reports (Alm, Vazquez and Rider 2006). For example, report by Accountancy Age Group in 2010 revealed that UK tax group was about to contact around six million people in order to let them know that the tax they had paid was wrong (Accountancy Age 2010). According to the report many people had either overpaid or underpaid and as a result many of these people will need to be refunded with up to 5,000 euros while another group of people about 1.4 million will need to pay more amounting to about 1,400 euros in order to re-settle the underpaid tax (Accountancy Age 2010). These gross errors were exposed by the new computer system, which, apart from making the above discoveries, also found out underpayments in the PAYE system had occurred totaling to about 2 billion euros (Accountancy Age 2010). More so, these discoveries found out that around four million people were eligible for rebates due to over-payments (Accountancy Age 2010). Further, uncertainty within the UK taxation system has been compounded by the fact that there is no clear information and direct information people receive from Revenue and Customs (HMRC) group, which can be helpful in correcting some of the tax mistakes being, realized (Cowie 2010). There have been many inconveniences arising from HMRC and this particular situation is continuing to result into systematic errors in so many cases that need verification and proper calculations before payment can be made for, and this work is ineffectively being carried out by HMRC (Lang 2008). The third principle of Adam’s canons has to do with convenience, convenience in the sense that timing of payment must be convenient to the payer. Looking at UK Taxation system, many literatures postulate on the fact that it is complex hence does not provide the adequate and necessary convenience to the taxpayer (Whiting 2010). Two aspects of complexities have been identified within the UK, tax system, they are complex laws that lead to people taking a long time and effort to comply with and complex laws that are largely difficult to interpret and create uncertainties (Whiting 2010). These two aspects have generated prolonged debate that calls for reforms within the UK tax system in order to bring convenience in the system. Taxpayers both business organization and individuals need to have a system that is easier to deal with. According to Ilona Bartyzel, the author observes that the current UK tax system is more complicated than it was during the times of Adam Smith and it has become difficult to follow all the maxims Adam suggested and postulated. The essence of the taxation system being complicated has drained it the aspect of convenience and taxpayers have to operate within deadlines and set time frames upon which punishment and penalties has been set for those who fail to comply (Bartyzel, 2010). The fourth canon has to with economy, in which an effective economic environment needs to be created and established which in turn will lead to an efficient taxation system. Taxes have been associated with significant effect on the intensity with which people wok and their overall efficiency and productivity (Riley 2006). Although little empirical evidence exists on these aspects, observation made is that they positively correlate. Taxation should correspond with business investment decision whereby there need to be lower rates of corporation tax and other related business taxes, which in turn can stimulate increase in business fixed investment spending (Mukherjee 2007). Subsequently, when planned investment increases, the nation’s capital stock can rise and the capital stock per worker employed go up (Riley 2006). At the same time, government has to encourage and promote the use of tax allowance that when put in place has the ability to stimulate increases in research and development hence boost more business start-ups. In order to spur and institute an economy that that supports appropriate taxation system, there should be a favorable and conducive tax regime that encourages and attracts inflows of foreign direct investment that is viewed as a stimulus to the economy. This in turn might benefit aggregate demand and supply (Great Britain: H. M. Treasury 2007). Another suggestion is that the economy needs to be boosted by substantial increase in real spending on the transport infrastructure. When this is undertaken, the overall effect will be an improvement in transport system, which eventually will lead to addition of aggregate demand and at the same time, provide boost to productivity and competitiveness (Canto and Laffer, 1990). A healthy economy in which people are able to enjoy higher incomes has the potential and abilities to accommodate and promote an efficient taxation system in a country like United Kingdom. Conclusion Taxes are compulsory which everybody has to pay (Kabra, 2008). United Kingdom taxation system has evolved for a long time and today, it functions based on some of the set objectives (Slemrod 1999). these include: to ensure the burden of the tax is kept low as possible; paramount objective of improving incentives, where the belief of the government is that by bringing down tax rates on income and business profits will greatly sharpen incentives to work and at the same time create wealth in the economy as a way of realizing long-run growth (Institute for Fiscal Studies 2010). Other objectives of the taxation system in UK include, to shift the balance of taxation away from taxes on income towards taxes on spending; and ensuring that taxes are applied equally and fairly to all people without discrimination. Lastly, there is objective to use taxes to make markets work better and at the same time, use tax system as an instrument of correcting market failures (Riley 2006). It should be noted that, no taxation system could be purely perfect (Rolfe 2007). However, to borrow the ideas of Adam Smith’s canons of taxation, United Kingdom taxation system should be reformed and enhanced in order to operate under the certain principles. First, efficiency, where the taxation system should be able to raise enough revenue to facilitate government spending without creating negative distortion which may be in the form of minimizing work-incentives for individuals and investment incentives for companies (Riley 2006). Further, the taxation system should function on the principle of equity, where the system should be reformed to reflect fairness that put into account people’s ability to pay. Another principle should be that of ‘benefit principle of taxation’, where the understanding is that taxes paid by individuals should reflect the benefit accrued to the person paying the particular tax specifically from the government. To achieve this, government can introduce tax to boost the existing one with aim of realizing redistributive goals (Checkland 1983). This principle further calls for reduction of relative poverty among the people and broad goal of allocative efficiency rather than equity. Lastly, the taxation system should exhibit aspect of transparency and certainty, where the people need to have adequate knowledge and understanding of how the system works. At the same time, the system should be able to encourage tax payment with reasonably degree of certainty (Riley 2006). Reference List Accountancy Age. 2010. Six million pay the wrong tax. London, Incisive Financial Publishing Limited. [Online]. Available from: http://www.accountancyage.com/aa/news/1809689/six-million-pay-wrong-tax [Accessed 25 January 2011]. Alm, J., Vazquez, J. M. and Rider, M., 2006. The challenges of tax reform in a global economy. NY, Springer. Ashenfelter, O., 2007. Handbook of labor economics. London, Elsevier. 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