Taxation System of UK - Essay Example

Explore and explain the desirable characteristics of a good taxation system. Evaluate the extent to which the current UK income tax system fulfils these characteristics Introduction According to Adam Smith there are four main principles or maxims of taxation - equity, certainty, convenience and efficiency. Equity refers to equality in the distribution of taxes so that every tax payer has the capacity to pay what he has been asked to pay. Secondly the tax payer must be sure of what he is going to pay, for what reason, the amount and so on. Thirdly the payment of tax must be convenient to the tax payer. For example, quarterly payment of taxes must be arranged in a manner that the tax payer knows when it is due. Finally the system of collecting taxes must be efficient. For example if the government spends more in order to collect a given amount of tax money it is useless having a system of taxation. In the UK the current system of taxation has a number of shortcomings such as collective bias in favor of those who are able to pay and structural deficiencies at the deduction level. Analysis The British system of taxation is basically determined by a desire to act in conformance with the age old principles of taxation as enunciated by Adam Smith. In the first instance taxes must be fair or equitable; secondly they must be convenient; thirdly they must be neutral; fourthly they must be efficient; fifthly they must be simple; and sixthly they must be adequate (Jones & Catanach, 2008). Yet how far these principles have been adhered to in the current situation in Britain is to be decided by each individual because there is much more to be desired in the British tax system with reference to the equity principle and the government's efforts to redistribute income on a nation-wide basis. According to the first maxim of Adam Smith as noted above every person should pay in proportion to that which is based on their respective revenue earnings and to the extent to which they enjoy protection of the government. Simply it is the "ability to pay" principle. Further he shows that tax should be levied on economic rent because the rent and the revenue were considered as synonyms in Smith's days. However according to the tax system revenue includes only income from an investment and it excludes wages and salaries. Thus in the18th century Britain most of the income was earned from landed properties. In the 21st century Britain where services have come to occupy a very important place, the old approaches to taxation might not be feasible though the fundamental principles remain intact. Secondly, tax payers must be certain about the current and future periods of time. Moreover, it must be predictable and should not be arbitrary. Each person should be aware about the exact amount that he/she has to pay according to their earnings. They should know reasons, exceptions/biases, and abatements when they are paying taxes. Government revenue budgets are either one year in duration or less (Ricardo, 2006). This affects businesses because they have to plan for corporate taxation a number of months, if not years, in advance. According to the third maxim, tax payment should be convenient to the tax payer. In fact the government should be flexible in the application of the tax rules. For example in demanding due payments, collecting payments and so on, tax authorities ought to identify more convenient ways so that the taxpayer isn't inconvenienced by way of haphazard schedules and rules as in the case of VAT financial penalty on late payers in Britain. Finally, tax system should be efficient with reference to its determination cost and collection cost. Thus it ought to be as lower as possible. It is imperative that the cost of employing the tax officials should be less than the taxpayers' personal cost. However the British government has to spend a considerable amount of money on such things as maintaining records and form filling to collect taxes from people. Taxation system must be simple and comprehendible to the payer, tax collector and other parties who are involved in it. Adam Smith pointed out in his second maxim that "the 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" (Smith, 1776). Indeed there are some simple taxes in the UK. However, most of the taxes in Britain are complex. For instance some simple taxes in the UK tax system - duties on the retail sale of petrol or gasoline, community charge or poll tax and Cayman Islands departure tax, collected at the airport - all have one particular characteristic that economists would recommend to any country as more desirable, i.e. they are simply known in advance. Evaluation of the British Tax System The relative simplicity of a tax system is central to the successful operation of it because there is no guarantee that taxes could be collected with any ease if the system is overburdened with complex rules as in the case of the poll tax introduced in England in 1990. The government quickly realized how unpopular the tax was and promised to replace it no sooner than was introduced. Any simple taxation system ought to make both the assessment and the collection easier to the payer and the collector (James, 2009). The Births tax returns have been criticized for their complexity. In fact according to critics one needs financial experts to interpret them. According to estimates in 2002 roughly 90 million man hours were used to fill tax returns on income and capital gains. Subsequently the self-assessment method was introduced and yet again the complaint is that it has added to the woes of the individual by increasing the time spent on filling returns. How best to simplify the system depends on a number of factors like reducing the compliance cost of the individual taxpayer. For instance in 2004 more than 25,000 tax consultants were working in Britain giving advice to individuals and companies. Above all the whole exercise amounted to 12 billion in compliance costs to the British taxpayers in 2002. Compliance costs are becoming too much a burden for the individual taxpayer against the backdrop of an evolving system of techniques that promise to reduce compliance costs. The bane of the present tax system in Britain is that individual tax consultants claim to know how to obviate compliance costs by developing handy and articulate techniques in filing returns. Assuming that many individuals and companies that hire tax consultants to provide this service are ignorant of the procedures and above all hope to benefit from the existence of so called loopholes in the tax law, then indeed the situation is beyond the control of any particular authority or individual (Ault & Arnold, 2004). The most interesting feature of the whole exercise is the fact that both individuals and companies rely on tax consultants to provide not so much the service of becoming transparent but the opposite. In other words transparency has become a casualty in the present system. Transparency along with accountability is considered to be very essential for a successful system of taxation. On the other hand transparency isn't one way traffic. As much as the individual taxpayer or the company has an obligation to be transparent in his declaration of income and assets, the government has an obligation to be transparent in its revenue and expenditure budgeting exercise. In fact the term transparency has been used more in the latter sense to refer to government's obligations. If voters were told in advance in clearer terms how the tax revenue would be spent by the government-to-be before the elections there would be sufficient transparency. The average voter would know for whom to cast his/her vote. The fact that governments aren't as transparent as they claim to be is clear enough though in Britain government's revenue and expenditure budgets are becoming not smaller but bigger due to the fact that successive governments have been increasingly committed to pay unemployment benefits and subsidies. Accountability is the next aspect of the government's revenue budgeting act. Successive governments in the UK through the 1970's to the present have adopted the same accountability approach in government revenue and expenditure budgeting. For instance except some local council taxation, the central government has often adopted a policy of doing the maximum for the maximum number of people. However critics point out that such claims are without substance (Ross, 1990). In the first instance social security payments and unemployment benefits have been criticized due to their particularly disturbing growth pattern. While many young employees have been experiencing reduced real income only some job categories with specialized skills have enjoyed benefits associated with the national minimum wage. In other words subsequent to every upward revision of the national minimum wage there is a round of unemployment among inexperienced youth. Thus the government increases both direct and indirect taxation to pay unemployment benefits. Corporate taxation in the UK has entailed higher collection cost. For instance simplification of tax rules has led to further cumbersome details in tax returns. Companies which pay corporate taxes on their profits before dividends are made have come to realize that the simplification procedures associated with tax collection has led to higher costs. For example in 1990 the British Government spent 8 billion on tax collection. Right now it must be more than that. The cumulative impact of this exercise is reflected on the ever increasing tax burden on corporate profits. During times of an economic recession like the current one profit margins shrink but nevertheless the government has to find the money for its programs of expenditure somehow or the other. The net result is higher costs incurred by the government in collecting taxes that are less likely to be collected at other times. Lower tax collection costs are recommended on the ground that benefits associates with less costs will accrue to the people who are required to pay taxes. Government expenditure patterns have shifted from one priority to the other due to changing obligations. The British Government has been involved in collecting taxes to meet its many expenditure programs including social security payments (Bernardi, 2003). As for development related activity the government collects taxes from a variety of sources that are likely to benefit from the infrastructure and security. Due to the increasing complexity of the tax system collecting costs have also increased. For instance with the Channel Tunnel coming in to being the system of tax collection at the Tunnel has become more complex along with a substantial rise in the costs. In order for any tax collection system to be effective there must be a legislative process of scrutiny. For example tax systems can be designed to achieve long term national goals such as development and equal distribution of income. However in the process of execution there must be legislative control over the operational aspects of the system. In the UK the current legislative scrutiny mechanism has some big shortcomings. The British Government has relied on HM taxation office to put in to effect such widely known practices as national and local level supervision of collecting procedures, though there has been very little effort at codifying the existing rules to achieve a broader level of convergence between local authorities and the central government (www.hmtreasury.gov.uk). In fact local authorities are much less amenable to central government scrutiny. In Britain local government authorities have adopted their own tax procedures that often tend to be peculiar in nature. Above all such procedures have to be subject to national legislative scrutiny though local authorities might resist such attempts by the central government. This is essential in the light of what has been happening in Britain recently. For example local authorities have their own system of rates on services provided by them. These rates are subject to revision at regular intervals though a corresponding examination of the quality of service is not undertaken. It is here that parliamentary scrutiny of local authorities' tax practices is essential. Expenditure taxes have become one of the most controversial issues in the recent times. Expenditure taxes are charged on goods and services. For example when a consumer buys a certain good or a service he or she ends up paying a tax to the government. The government has a habit of taxing demerit goods such as tobacco products, private transport and alcohol. The government's argument is that such goods are more likely to cause harm one way or the other to the society and the individual (Hirshleifer & Teoh, 2009). While the argument is acceptable, the way such expenditure taxes are collected in Britain is open to question. For example in the absence of clearly defined rules some of the demerits goods will be sold and bought in higher quantities without the knowledge of the authorities. With many countries from Eastern Europe joining the EU the possibility for low quality goods entering Western European Markets cannot be ruled out. These goods include demerit goods such as high tar and nicotine cigarettes which can be less expensive to the consumer. The system of expenditure related taxation in the UK has invariably helped the growth of secondary industries that seek to avoid the negative impact of heavy expenditure taxes. For instance electrical and electronic goods that fail to satisfy EU wide standards might still be available at a lesser price. Expenditure taxes are also related to discontent among many consumers. Consumers who buy luxuries and semi-luxuries like vehicles, LCD TV sets and laptops argue that the government has failed to take in to account the degree of necessity associated with the good. As a result the average consumer is compelled to pay an additional sum of money even if the good is a necessity according to the consumer. The British system of taxation depends on too much of corporate taxes and expenditure taxes. And as a result there is a considerable amount of discouragement among producers and consumers. In fact the classical theory of taxation based on laissez-faire principles has done some harm to the entrepreneurial spirit irrespective of the government's intentions. Further successive tiers of taxation on individual incomes have discouraged employees from working harder. The impact of such taxes on the provision of labor skills can only be understood when mass scale withdrawals of labor supply occur during and after national budgets are passed in the parliament. As a corollary of the above the government's efforts to reduce the number of errors that occur at every level of assessment and collection have not been so successful. For example according to statistics approximately 3.8 million British citizens paying taxes through the PAYE system do not pay as much as they are required to pay by law (www.hmrc.gov.uk). The net result is the loss of revenue to the government and inadequate funds for the development of infrastructure. Similarly the problem of tax credit overpayment is a chronic shortcoming in the system. According to estimates in 2004/05 revenue year almost 2.2 billion were overpaid in tax credits. The government's position is illustrated by the fact that the total number of taxpayers in the country has been rising at a rate that is highly questionable for its lower pace. The tax net has failed to bring in many British taxpayers in to the national coverage mainly due to the fact that tax authorities have not initiated a proper and reliable tax data collection system at national and local levels. According to independent researchers about two out of every ten taxpayers escape the net due to inadequate availability of national data on the expanding tax base. Tax avoidance is a persistent problem both in developed and developing economies while in many countries such tax avoidance is taken for granted. In Britain tax avoidance has become a problem though the extent is not known due to the unavailability of data. An increasing number of tax evasion cases occurs in respect of false income declarations. For example despite real income rising almost equally with money income many Britons declare their income and assets at a dwindling rate in order to benefit from more money for further investment or expenditure. The government's efforts to reduce income inequalities by taxing the rich and redistributing the income among the poor by way of projects intended to benefit them have added to the existing problems. Actually the upper decile of the population has greater wealth than the five lower deciles all put together. In other words income disparities have been widening over the years in the UK. Theoretical explanations apart these disparities have caused innumerable problems both to the government and the society. Progressive income and wealth taxes have not helped to solve the problem because many taxpayers do not make the right declaration. Progressive taxation has been advocated as a potential solution to the problem of income inequality. However in Britain income inequalities have been persistent throughout the years even with some government intervention to reduce such inequalities through progressive taxation. Skills shortages in the recent times have forced many private enterprises to recruit foreigners. The ever rising influx of Eastern European nationals in to Western Europe shows the extent of the problem. Many tech cities in the UK have become the target of foreign workers who prefer to work abroad. Finally distortions have to be reduced in the British tax system in order to achieve comparable standards with countries like Japan and South Korea. In fact disincentives in the British economy have been cited as the main reason for the slackening entrepreneurial spirit and the short supply of those skills that are particularly in high demand. The British system of education has failed simply because the government's tax policy in rewarding entrepreneurs and skilled labor has failed. There is some truth in this argument. For example many universities are geared to provide high quality programs of study in critical fields of interests though only a few British students enroll on such courses. Conclusion The British tax system is basically determined by the equity principle or ability to pay principle. Its current level of approximately 600 billion shows that the government is growing in size despite the claims to the contrary. British tax system has come a long way from its rudimentary system of haphazard collections and poor planning. The British tax system is becoming ever more complicated with the government involvement in providing social welfare and unemployment benefits to the lower income and unemployed people. The UK tax system has been criticized by many for being inequitable because it has some loopholes that favor the rich. Finally as for the future trends, the British tax system would not shrink as long as the government has to provide social security and unemployment benefits to the people. REFERENCES 1. Ault, HJ & Arnold, BJ 2004, Comparative Income Taxation: A Structural Analysis, 2nd edn, Kluwer Law International, Bedfordshire. 2. Bernardi, L 2003, Tax Systems and Tax Reforms in Europe (Routledge Studies in the Modern World Economy, 42 ), Routledge, London. 3. Hirshleifer, D & Teoh, SH 2009, 'Systemic risk, coordination failures, and preparedness externalities: Applications to tax and accounting policy', Journal of Financial Economic Policy, vol. 1, no. 2, pp. 128 - 142. 4. HM Revenue Customs, Retrieved from www.hmrc.gov.uk on December 17, 2009. 5. HM Treasury, pre-budget report, 2008, Retrieved from www.hmtreasury.gov.uk on December 17, 2009. 6. James, M 2009, UK Tax System: An Introduction, 2nd edn, Spiramus Press, Biggleswade. 7. Jones, S & Catanach, SR 2008, Principles of Taxation for Business and Investment Planning, 2009 Edition, 12th edition, McGraw-Hill/Irwin, New York. 8. Ricardo, D 2006, Principles of Political Economy and Taxation, Cosimo Classics, New York. 9. Ross, D. A 1990, The UK Taxation of Modern Financial Instruments & Transactions Cassel, London. 10. Smith, A & Krueger, AB 2003, The Wealth of Nations (Bantam Classics), Bantam Classics, New York. Read More