Integration of Income Taxes and Benefits Systems Into a Single System in the UK - Case Study Example

Evaluate the recommendation to integrate both the benefit and income tax systems into one system Introduction In UK, whether or not to integrate income taxes and benefits systems into a single system has been a bone of contention for decades. The supporters of this integration argue that it would assist the government to reduce administration and compliance costs. They also add that the proposed merger would improve the transparency of the UK tax system and assist people to understand of what they pay. At the same time, opponents claim that the suggested merger is against the contributory principle. In 2006, the Institute of Fiscal Studies (IFS) performed a major review of the UK tax system known as the Mirrlees review (Institute for Fiscal Studies). This review particularly evaluated the potentiality of integrating personal taxes and benefits and proposed some models to promote the merger of these two systems. This paper will specifically evaluate the recommendation to integrate both the benefit and income tax systems into one system. Description of the current system Currently, the United Kingdom imposes two types of taxes on income such as income tax and National Insurance (NI) contributions (HM Treasury). The tax rates depend greatly on the level of earnings and whether an individual is employed or self-employed. Although these two types of taxes are different in purpose, they are almost similar. Naturally, UK citizens are required to pay income tax on wages. Without paying any income tax, an individual can earn some amount of money each year (HM Revenue & Customs). This tax-free amount is termed as Personal Allowance. Naturally, individuals who earn more money need to pay higher amount of income tax. In contrast to income tax, national insurance is paid with intent to gain state pension and some other benefits (HM Revenue & Customs). If an individual is employed and earns above a certain level, he/she is required to pay Class 1 National Insurance. In contrast, if an individual is self-employed, he/she needs to pay Class 2 National Insurance contributions weekly and also a Class 4 National Insurance contribution as a percentage of his/her taxable profits (ibid). Under the current benefits and income tax system, one tax has to be assessed on earnings realised in each individual pay period whereas the other tax needs to be assessed on income over the whole year (Tax by design). A brief overview of the proposed recommendation The Mirrlees review particularly suggests that the proposed integration must be performed in a careful and thoughtful way. It is possible to make the integration process easier by publicising the intended changes prior to implementation. This strategy would allow earnings to adjust in accordance with the shift. Furthermore, this practice is better for the government to suggest employers and employees what changes to earnings are necessary to offset the reform. In order to attain the integrated benefit system, some comprehensive changes are required. First, offsetting the elimination of 12.8% employer NICs would not be simply covered by a 12.8% increase in employee NICs. Considering the way employer NICs fit into the current regime, it needs “changes of different sizes to several rates and thresholds” (Tax by design, p.131). Second, other modifications such as changes to minimum wage structure and some state benefits also have to be considered. There are many proposals for the administrative integration of taxes and benefits. The common feature of proposals seems to be the “withdrawal of means-tested support through the tax system” (Tax by design, p.139). Although benefits withdrawal is continued until benefits are exhausted and tax would be payable thereafter only, both the processes may be integrated administratively. Some proposals suggest providing all claimants with maximum entitlement for their circumstances and then deploying the tax system to manage the means test (Mirrlees 2011). This practice would assist the government to claw back the benefits provided in excess from those earning income high enough to decrease their entitlement. “Other proposals involve using the tax system not just to withdraw excess benefits but actually to pay out benefit entitlements, netting off income tax and benefits so that employers pay wages with a single addition/deduction reflecting a net contribution from/to state coffers” (Tax by design, p.139). There is still lack of consensus among UK policymakers regarding how to integrate the taxes and benefits systems without causing troubles to taxpayers and general public. Purpose of merging It is a very expensive task for the government to administer taxes and benefits whereas it becomes difficult and costly for taxpayers and benefit recipients to deal with the separated taxes and benefits system. According to some recent estimates published by the UK government, the government incurs nearly 1.24p and 0.35 for each £1 collected respectively in cases of income taxes and National Insurance contributions (Tax by design, p.122). Keuschnigg (2011) opines that integration of personal taxes and benefits is an effective strategy to keep those administration costs as low as possible. Policy makers point out that merging of taxes and benefits is useful to eliminate tax evasion, benefit fraud, and other innocent errors by the government or individuals. Another purpose of the proposed merging is that it would improve transparency. Under the current taxes and benefits system, people are less informed about different payment mechanisms due to their increased complexity. In this context, the planned merging would be beneficial for people to clearly understand the consequences of their decision. As scholars point out, the increased transparency in turn would make work incentives effective (Tax by design). In addition, policymakers strongly hold the view that a simple and integrated taxes and benefits system would assist the government to achieve coherent policy design easily; and they point the fact that separated taxes and benefits system may cause even well designed reforms to create anomalies and an irrational rate schedule (ibid). By integrating and simplifying the taxes and benefits system, policymakers try to achieve two main benefits including low administration and compliance costs and greater level of transparency. The Mirrlees review clearly states that “the integration would underline the illogicality of most of the current differences between the two taxes and provide and an opportunity to remove them” (ibid, p.126). Another important purpose of the proposed integration is to make the combined rate schedule meaningful and straightforward. Strengths and weaknesses The Mirrlees review has already stated that the proposed integration would not necessarily result in a higher or lower cost to the government, or create any specific group of winners or losers (The principles of tax policy). However, integrating taxes and benefits can definitely be an opportunity to make the structure of the whole system simpler and more coherent. In addition, the integration strategy would greatly assist the UK government to more effectively address issue like tax evasion and benefits fraud. According to Adam (2011, p. 127), increased transparency is a major strength of the proposed integration process. The improved transparency may benefit the government to particularly tackle anomalies and to rationalise the whole system. In addition, the transparency intended by the integration may aid the common people to obtain a clear view of the overall system. The lack of transparency in the current system is often considered as a positive factor by the government. For instance, the Labour Party’s 2001 general election manifesto pledged that they will not increase income tax rates; but no such guaranty was given in case of NICs (Tax by design, p.137). Labour Party won the election and announced an increase in INC rates in the first Budget after the election (ibid). Hence, the lack of transparency in the current system aided the government to mislead people in a clever way. Supporters of the proposed integration argue that it is beneficial to improve transparency of the whole system and thereby abolish such government-sponsored confusions. Another potential strength of the suggested integration is that “it removes the need to separate out means-tested benefits as a special mechanism whereby poor people must suffer the hassle and perceived dignity of asking the state for a handout” (ibid, p.137). As discussed already, the most promising feature of this integration is that it would greatly assist the UK government to trim down administration and compliance costs. It is clear that the government needs to maintain separate mechanisms to deal with income taxes and NICs under the current system. Under a combined system, the government can use common procedures to manage taxes and benefits and thereby make its operations more cost effective. Seely (2012) suggests that the integration would benefit employers, particularly small employers to avoid an extra administrative burden and thereby improve operational efficiency. However, the recommended policy has some weaknesses too. Even though the proposed taxation regime is simpler than the current one, restructuring activities required to implement this system successfully would not be so simple. In addition, many regulators claim that the proposed integration is against the contributory principle, which reflects the idea that National Insurance has to represent “a form of social insurance in which contributions create rights to benefits” (Tax by design, p.126). According to a study conducted by Lawson, one of the notable weaknesses of this integration is the combined negative effect of income tax and NI rates on marginal tax rates in the context of income increases. Marginal tax rates increase significantly with the earnings under an integrated tax-benefit system (Seely 2012). Potential beneficiaries and losers Goodall (2011) reports that the government has already admitted that the merger will have winners and losers even if the taxes and NICs are integrated partially. Evidently, the government can be the most potential winner of such a move because this practice is better to cut down the costs of keeping two separate systems in order to manage taxes and benefits. In addition, employers are other major beneficiaries of the planned integration. Taxpayers are also the beneficiaries of the recommended integration because this process would improve the customer experience of personal tax system and they may get a well picture of what they pay (ibid). It is also identified that self-employed persons need to pay less than employed persons under this plan since self-employed individuals are eligible for fewer contributory benefits. At the same time, some individual earners will be potential losers of this integration if implications of any change affect them. Experts point out that some people need to pay more and other less under this suggested merger. Conclusion From the above discussion, it is clear that the proposed recommendation is sensible and adds to the operational efficiency of the UK tax system. The major strength of this integration is that it would increase the transparency of the whole system and therefore make taxpayers well informed. In addition, the government can eliminate the administration and compliance costs of keeping two separate systems. It is identified that the government, taxpayers, and employers can be the potential winners of this recommendation if the integration is performed in a thoughtful and meaningful manner. However, implications of the changes intended to the current system may cause some troubles to some people. To conclude, the suggested integration recommendation is greatly beneficial for the UK tax system. References Adam,S. (2011) ‘Tax By Design: The Mirrlees Review’. Oxford University Press. Goodall, A. (2011) ‘Winners and losers in operational integration of tax and NICs’. [Online] Available at http://www.taxjournal.com/tj/articles/winners-and-losers-operational-integration-tax-and-nics-36141 > [Accessed 21 Mar 2013]. HM Treasury. (2011) ‘Integrating the operation of income tax and National Insurance contributions’. London. [Online] Available at [Accessed 21 Mar 2013]. HM Revenue & Customs. ‘Paying UK tax and National Insurance - an introduction’. [Online] Available at [Accessed 21 Mar 2013] Institute for Fiscal Studies. Mirrlees Review [Online] Available at [accessed 21 Mar 2013]. Keuschnigg,C. (2011) ‘The Design of Capital Income Taxation:Reflections on the Mirrlees Review’. University of St.Gallen. [Online] Available at [Accessed 21 Mar 2013]. Mirrlees. (2011) ‘Tax By Design:The Mirrlees Review’. Oxford University Press. ‘The principles of tax policy’. [Online]Available at [Accessed 21 Mar 2013]. Seely, A. (2012) ‘National Insurance contributions : An Introduction’. [Online] Available at [Accessed 21 Mar 2013]. Read More