Should the UK Tax System be Simplified - Research Paper Example

A good indication of how complicated the present tax system in the UK is, is learnt from the size of the most authoritative guide to the subject. Tolley's Yellow Tax Handbook, which is being published every year since 1983 is getting bigger each subsequent year. To give an example, it totalled close to 6,000 pages in its 2001 edition and has nearly doubled this number in its most recent edition. This is a clear indication that the tax system in the country is becoming cumbersome and complicated with each passing year. Henceforth, there is a strong case to be made for simplifying the prevailing system. One of the reasons why the system has remained complicated is the half-hearted measures undertaken by policy-makers in reforming/simplifying the system. While Chartered Accountants have thrived in this climate, their clients, including common people, have often ended up with confusion. Furthermore, the complexities inherent in the current tax system can be attributed to the functioning of the political system. “No Government can continually tinker with the system, adding bits here and there, without getting things wrong. And everyone knows what the Chancellor announces in the annual Budget is only scraping the surface. The devil, as they say, is in the detail - and the detail only emerges after accountants have waded through the "red book", and worked out the implications. Sometimes, even then, it can take months before people realise the impact. No wonder when it comes to taxing non-domiciled residents, changes to capital gains tax or "income-shifting" between husband and wife, the full effects can only be guessed at.” (The Birmingham Post, July, 8 2008) It is in acknowledgement of the deficiencies in the existing system that noted politicians such as former Conservative Party Chancellor Lord Howe have supported an overhaul of the system. Lord Howe also proposed the setting up of an Office of Tax Simplification. By simplification, the former Chancellor also meant announcing tax changes in advance, so that the community of Chartered Accountants in the UK can understand and assimilate the changes, while also giving opportunity for the latter to make constructive suggestions. In this regard, setting up a Parliamentary committee makes sense, for “as taxpayers, we need to know where we stand, what we have to pay, and we need to be assured the rules aren't about to change again so what was tax-efficient today won't become tax-disastrous tomorrow. And confidence is an essential element in taxation. Businesses need security over how much tax they pay. We need a clear and effective tax system, as well as an inexpensive one, to remain internationally competitive. If that doesn't happen our clients will disappear abroad. Because the more the tax system changes the less confidence businesses have”. (The Birmingham Post, July, 8 2008) And following on the advice of Lord Howe, Her Majesty's Treasury has inaugurated the Office of Tax Simplification (OTS) last month. In the official website of the said office, it is stated that the Office is independent of political affiliation and is meant to attract inputs from professionals in the field of taxation, accounts, business and law. Rt. Hon. Michael Jack and John Whiting will head this Office till a long-term successor is found. The key objectives of the Office are three fold. Firstly, it will offer apolitical, independent advice to the Chancellor on the process of simplifying the tax system, thereby making the process of tax filing easy for both businesses and individuals. Secondly, the Office will help identify areas of complexity in the present system that is easy to simplify. Finally, the Office will carry out studies into areas of tax system that are less amenable to simplification so that the government can think of reform alternatives. Beyond these three objectives, the Office will “publish individual reports on its inquiries that set out evidence it has collected, including on the views of interested parties, its analysis of potential options, and proposals for simplification. The Board members will meet the Chancellor or the Exchequer Secretary to the Treasury following publication of each report to discuss its findings. The Chancellor will lay the Office’s reports before Parliament, and Board members may be required to give evidence before the relevant Parliamentary committees on the contents of these reports”. (www.hm-treasury.gov.uk/ots.htm) But since the Office is hardly one month in existence, it is too early to say how effective it will be. In a year or two, analysts will be able to judge if the Office has stood up to its stated objectives and has achieved noticeable simplifications in the tax code. Moreover, in the documents released by the OTS so far, no concrete plan of action is mentioned, making it difficult to predict how successful this measure will prove to be. In the meanwhile, it is interesting to study more concrete proposals put forth by financial analysts and political commentators. In an article written for CPI Financial, its Chief Editor presents a few valid points. Firstly, there has to be a stable tax policy. The New Labour Party, despite being in power for thirteen years has failed to bring a semblance of stability to the taxation policy framework. With every passing Budget, more changes and complexities have been added during the New Labour regime. In order to arrive at a simpler set of tax laws, the government needs to be firm with its policy framework. The added advantage of such simplification is that it will attract foreign investments. Also, "if the Government is looking to rationalise the tax code, an obvious candidate for abolition is the fund-specific and very low tax-generating Stamp Duty Reserve Tax regime. If this tax was abolished, the UK could then capitalise on the growth opportunities created by the revised UCITS Directive and the Alternative Investment Fund Managers Directive. This would bring more business to the UK and therefore greater tax revenues." (Brummer, 2007) Similar constructive inputs to simplify the tax system have come from renowned economists of our time as well. For example, Ludovit Odor, the chief economist at Slovakia's ministry of finance has made important contributions to economic reforms in Europe. Meeting up with prominent members of the Conservative Party on the occasion of the Seventh Annual Julian Hodge Institute of Applied Macroeconomics lecture at the National Museum of Wales in Cardiff, the veteran economist made some valuable suggestions toward simplifying the tax system in the UK. Ludovit Odor told the attendees of the lecture that “if Wales followed the example of Slovakia, corporate tax rates would be cut in half. A radical simplification and reduction in corporate tax could stimulate economic growth dramatically”. (as told to David Williamson, Western Mail, May 10, 2006) He noted that dominant members of the EU, including the UK will ultimately have to modify their taxation rates to the standards set by newly joined members of the EU. He further added, “in our experience, and in that of other countries in Eastern and Central Europe, the flat tax is a success story. If a flat tax regime is currently too radical for the UK, then definitely a simplification and flattening of the tax system will be helpful for the British economy.” (as told to David Williamson, Western Mail, May 10, 2006) Inputs such as these could be very valuable for officials in the Office for Tax Simplification, for intellectuals such as Ludovit Odor have been involved in key economic development programs in Europe in the past. Another measure taken by the UK government in simplifying the tax system is the instituting of Tax Policy Committee (TPC). Taking cue from the successful role played by the Monetary Policy Committee (MPC) over the last ten years, the government saw merit in setting up a similar regulatory body. In the case of the MPC, the prime objective was to control inflation through careful adjustment of bank interest rates. Following a similar operating model as the MPC, the TPC is expected to issue tax policy decision that would be “more effective, open, accountable and free from short term political manipulation”. (The Daily Mail, 2007, July 16) “Like inflation, the effective management of the taxation system is an important factor in helping to encourage long-term stability and competitiveness in the economy. Tax simplification is no mean feat. It will take a valiant and determined group of people to tackle issues such as capital gains tax taper relief, inheritance tax in relation to trusts, national insurance and income tax benefit rules, VAT partial exemption; the list is endless. AND because tax touches all aspects of our personal and business lives, there would undoubtedly be a lot to review and discuss. An independent, apolitical group to tackle tax issues would be the more modern way of doing things”. (Graetz & Warren, 2006) But the TPC alone will not be able to achieve the intended simplification. The Budgetary process also needs an overhaul. There is a compelling case to be made for any newly appointed Chancellor to set long term Budgets at the beginning of a Parliament and make small adjustments to it each year. The TPC will also bring in an element of certainty to the tax system. It would also be instrumental in creating “independent, transparent and robust consultative mechanisms about key tax changes” (The Daily Mail, 2007, July 16). In collaboration with HMRC and the Treasury, the TPC can greatly help simplify the present tax system. Admittedly, no government can please all sections of the electorate through its taxation policies. Despite remaining in power for more than a decade, the recent New Labour regime has not done enough to simplify tax system. A good indication of this came in 2004 when all main political parties assembled in Bournemouth and exchanged proposals on important personal finance issues such as pensions, the housing market and taxes. To identify which areas of the tax system needed simplification, it is instructive to look into the proposals made by different political parties during the conference. With respect to taxes on pensions and savings, the measures by New Labour government have only added complexity. For example, “All the means-tested benefits available at retirement mean that it pays most people not to save for fear of losing handouts. And Labour relentlessly attacks pensions and tax-friendly Isas. In 2006, pensions will be radically overhauled under the guise of simplification. Instead of payments being linked to earnings, a cap will be applied on pension savings. Any surplus in an individual fund above [pounds sterling]1.5 million will be taxed at up to 55 per cent. Thousands of savers are likely to be caught, though Labour argues it is aimed at high earners.” (Financial Mail, 2004) The drawbacks inherent in the prevailing pension system were just one area of discussion in the Bournemouth conference. The conference acknowledged similar complexities in inheritance taxes, stamp duty on house purchase, capital gains tax and income tax. Further, “certain tax allowances, such as the married couple’s allowance, have been converted into non-refundable tax credits, and changes to mortgage interest tax relief mean that its effect is similar to a refundable tax credit. At the same time, the basic tax system retains an allowance and rate/band structure. The combined effect of these elements means that the way in which the tax system is described does not readily correspond to the structure of marginal rates faced by taxpayers”. (Fougere & Ruggeri, 1998) In this scenario, what is required is a radical new way of presenting taxes. According to researcher Julian McCrae, both the New Labour government of recent years and the Tory government that preceded it have given in to the habit of dressing up flawed taxation policies in a politically attractive way. Faring well in public opinion polls has always been important to both the parties and as a result they have resorted to euphemistic terminology and apparently appealing taxing policies. But ‘playing to the gallery’ in this manner has made “certain potentially desirable policies difficult to implement without changing other elements of the tax system. In addition, it allows certain plausible-sounding, but in reality spurious, justifications to be made for policy changes”. Julian McCrae suggests that such problems confronting the tax system can be reduced by using a different terminology. In other words, it involves “describing the tax system in terms of the actual marginal rate schedule faced by taxpayers instead of the current use of allowances and credits”. (J McCrae, 1997) Further, the current formal structure employed in framing tax policies also needs to be changed. The present formal structure is “at best unhelpful and at worst misleading to those with limited understanding of its operation. It introduces differences between the formal and effective limits and widths of bands, and also means that the effective band limits are dependent on the amount of the allowances”. (J McCrae, 1997) A simpler way of expressing the tax system would be to state it clearly in terms of the effective marginal rate structure faced by taxpayers. Such a change would be simpler and easy to understand for both accountants and lay people. A special area of tax law that needs immediate simplification is that pertaining to small businesses. The IR35 legislation is particularly relevant in this context. It is comforting to know that “the Government has already indicated that reviewing IR35 legislation is a priority and that it will seek to replace it with simpler measures that prevent tax avoidance but do not place undue administrative burdens or uncertainty on the self-employed, or restrict labour market flexibility” (H ardiman, 2000). As part of its first report to the Chancellor, the Office of Tax Simplification has promised to “identify and provide evidence of the complexity and uncertainty created by IR35; consider alternative legislative approaches that would be simpler and create certainty while ensuring that, where intermediaries are used to disguise employment, any income that is effectively employment income is taxed fairly; and consider the scope for tax avoidance and the extent to which alternatives to IR35 would affect it.” (www.hm-treasury.gov.uk/small_business_tax_review_terms.htm) This is certainly a progressive step and should help alleviate the number of cases of incorrect tax filings that small business owners tend to do. Hence, in conclusion, the government, businesses, accountants and lay people, all recognize the need to simplify the tax system. The conception and inauguration of the Office of Tax Simplification, which falls under the purview of Her Majesty’s Treasury is a positive step forward. So also is the idea of setting up Tax Policy Committee. These offices can make use of valuable suggestions from such economic thinkers as Ludovit Odor and Julain McCrae in devising a comprehensive simplification effort. One should also keep in mind that the labyrinthine complexities that are inherent in the present system will not be easy to reduce in a short span of time. Hence the officers in-charge of this effort need to show patience and perseverance, while professionals, businesses and common people should extend their cooperation and support. References AGENDA: So, What Is Labour Really Doing about Your Tax? Eric Williams, Head of Entrepreneur and Private Client at the Birmingham Office of Grant Thornton, Warns the Government That Tax Policies Made in Haste May Come Back to Haunt Them Politically. (2007, October 12). The Birmingham Post (England), p. 10. Brown Talks of Simplification, but Delivers Hundreds of Minor Tax Measures. (2006, May 24). Western Mail (Cardiff, Wales), p. 17. Brummer, A. (2007, October 15). The Fat and the Lean: The Pre-Budget Report Presages an Era of Financial Uncertainty, Borrowing and Squeeze. New Statesman, 136, 16. Office of Tax Simplification, Her Majesty's Treasury, retrieved from (http://www.hm-treasury.gov.uk/ots.htm) on 30th July, 2010. Julain McCrae, 1997, Simplifying the Formal Structure of UK Income Tax, retrieved from www.ifs.org.uk/fs/articles/fsmccrae.pdf on 30th July, 2010 Council Tax System Leaves City Residents 'In the Dark', Accountants' Body Reveals. (2009, June 24). The Birmingham Post (England), p. 33. Cut in Corporation Tax Vital for UK, Says Institute. (2006, March 13). The Birmingham Post (England), p. 32. Fougere, M., & Ruggeri, G. C. (1998). Flat Taxes and Distributional Justice. Review of Social Economy, 56(3), 277+. Graetz, M. J., & Warren, A. C. (2006). Income Tax Discrimination and the Political and Economic Integration of Europe. Yale Law Journal, 115(6), 1186+. Hardiman, N. (2000). Taxing the Poor: The Politics of Income Taxation in Ireland. Policy Studies Journal, 28(4), 815. Hodge Lecturer Calls for Flat Tax Revolution in UK. (2006, May 10). Western Mail (Cardiff, Wales), p. 8. Messere, K. (Ed.). (1998). The Tax System in Industrialized Countries. Oxford: Oxford University Press. Mo, P. L. (2003). Tax Avoidance and Anti-Avoidance Measures in Major Developing Economies. Westport, CT: Praeger. No Better Time for a Company Tax Review; CITY COMMENT. (2007, March 6). The Evening Standard (London, England), p. 27. Only Experts Should Decide Our Tax Policy. (2007, July 16). The Daily Mail (London, England), p. 57. Positive Action Needed Now for Brighter Future; Barry Smith, Head of Tax at Professional Service Firm PricewaterhouseCoopers in the Midlands Hopes Alistair Darling Uses the Budget to Address the Nation's Growing Deficit and to Modernise the Tax System. (2009, April 21). The Birmingham Post (England), p. 9. Tax System Needs Simplifying for Needs of All; AGENDA. (2008, July 8). The Birmingham Post (England), p. 9. Tax.Who Asked You? as All Three Main Political Parties Unveil Ambitious Financial Reforms, One Important Group Has Yet to Be Consulted - the Taxpayer. So for the Households Already Paying [pounds Sterling]1,000 a Year More under Labour, Financial Mail Launches: THE GREAT TAX DEBATE. (2004). 15. Unrest in Labour as Axing of 10p Tax Rate Hits Lowest-Paid; 'Low-Paid Workers without Families Would Be Hit Hardest by Changes'. (2008, April 7). Western Mail (Cardiff, Wales), p. 9. Vaux, G. (1994, July). The Underpayment of Social Security Benefits. Consumer Policy Review, 4, 144+. Read More