19 Jan 2012

Cracking the tax code

Tinkering with the tax system is a reflex action for a new government, but is any benefit gained from minor changes? Do politicians meddle too much, is an overhaul of the system possible, and is simplification is too complicated?

Every industry has its own jargon, but tax surely runs neck and neck with IT for the prize of sheer impenetrability to outsiders. To be able to talk tax is akin to having a second language.

Although the basic principles are straightforward, the tax system itself has become hugely complex.

“In the last 10 to 15 years we’ve seen unprecedented growth in tax legislation,” says Frank Haskew, head of the tax faculty at ICAEW. “We have probably the longest tax code in the world, which for a nation of  60 million people doesn’t seem right. And it’s difficult to support growth and encourage investment if the UK is seen to be a hard place to do business in terms of tax.”

Politicians tend to agree, in theory, if not always in practice. The 2010 Coalition Agreement promised a “wholesale review” of small business taxation to create “simpler measures”, and reform of corporate tax “by simplifying reliefs and allowances”.

In July 2010 the Government created the Office of Tax Simplification (OTS) to advise the chancellor on delivering a simpler tax system. In November 2011 the government published a discussion paper setting out its vision for a more open and understandable personal tax system.


Lifting income tax threshold

Following consultation over the summer of 2011, working groups have been established to plot the next steps for consultation on the operational merging of income tax and National Insurance, as announced by George Osborne in the March 2011 budget. The Coalition Agreement also commits the government to a flagship Liberal Democrat policy: lifting the income tax threshold to £10,000, although the principle aim here would be direct stimulation of demand rather than simplification.

The OTS has recommended the abolition of more than 100 reliefs (the government has agreed to abolish more than 40 of these) and reforming small business tax, and has launched reviews on the taxation of pensioners and employee share schemes. But whatever ideas the OTS or the Treasury put forward, politics will always get in the way.

“Any tax simplification is almost certain to create winners and losers,” says Tony Dolphin, senior economist at the left-leaning Institute for Public Policy Research (IPPR).

“The way governments have got around this in the past is to make sure that the losers are unpopular, like bankers or big oil companies.”


Timing the change

Dolphin also points out that the best time to embark on major changes to the tax system is when revenues are buoyant and there is a surplus to spend, which isn’t quite where we find ourselves today. Other observers have yet to be greatly impressed by the OTS. “The surprising thing is that it’s got a part-time chairman and a part-time tax director and there are a few members of staff who I think are only there for a few days a week,” says David Martin, research fellow at the right-leaning Centre for Policy Studies (CPS) and a member of the Tax Law Review Committee at the Institute for Fiscal Studies – here expressing his own views.

“Clearly the object of the exercise is to keep costs down and make sure the office doesn’t overreach itself.”

Nevertheless he welcomes, with reservations, the work the OTS has done on small business taxation. It has put forward a series of options including, for the smallest unincorporated businesses: flat rates for expenses; a tax based on turnover or on other indicators, such as number of employees; or a tax based on standard lump sum payments in lieu of income tax and Class 4 National Insurance. A turnover tax could make life simpler, but would certainly be criticised. As David Martin points out, turnover might represent five per cent of profits for one business and 90 per cent for another, yet both would pay the same tax.

“The basic problem with UK tax law is that we have a fragmented tax base,” he says. “We tax capital gains, we have capital allowances, [tax on] income is split into investment income and trading income and none of these rules fit together. The best thing for business is to put it all together, just tax profit. You don’t need hundreds of allowances.” He believes implementing this proposal would remove 75 to 80 per cent of tax law applicable to businesses. On personal tax he would amalgamate income tax, National Insurance and Capital Gains tax. “If you find you need exemptions, create some. So, for example, I would be in favour of relief for entrepreneurs selling a business. If you’ve got a coherent tax base you can have a number of tax reliefs without overcomplicating it.” He also believes this change would help to reduce tax avoidance by increasing transparency.

But, in every case the practical difficulties created by the shape of the current system remain. Frank Haskew cites Geoffrey Howe’s quote which likened reforming the British tax system to painting Brighton’s Palace Pier while someone else was extending it to France.

“The trouble is, politicians are always looking for new ideas and initiatives for stimulating growth, so you end up with conflicting objectives,” says Haskew. “To make meaningful simplification you need to be quite radical. But that is very hard to do when you’re up against a big deficit and difficult to sell without a tax-cutting agenda. Clearly we’re not in the best part of the economic cycle to do that. So we’re seeing a lot of tinkering around the edges.”

“If we’re doing some useful tinkering at least we’re being useful,” says John Whiting, tax director at the OTS. “I hope we’re going to promote some radical thinking, but simplification isn’t easy. We are trying to simplify the legislation and the running of the system. It isn’t necessarily going to scythe through the legislation but it is hopefully going to have practical benefits.”

He also accepts the doubts some have expressed about the size of the OTS, noting that his small team depends on individuals seconded from the Treasury, HMRC or the private sector.

“It would be nice to have more resources, but what it’s forced us to do is to talk to people and gather the evidence, rather than sitting in a big think tank thinking we can do it all,” he says.

Finding a balance

And Whiting stresses the dangers of trying to change too much too fast. “Small businesses tell us the biggest source of complexity for them is change in the system,” he says. “If you simplify you have to change, so you have to get a balance.”

But IPPR’s Dolphin would like to see a radical overhaul of the system. “I want to halve the size of the tax code, so you have simple structures and lower rates,” he says. “It could be done, but it is political dynamite.” And he says: “We’re a decade away from being in a fiscal system where any government could contemplate a radical overhaul of the system.”

But there are also some reasons to be thankful for complexity, says Bill Dodwell, head of the tax policy group at Deloitte. He cites international financial reporting standards, which can compel companies to report profits that haven’t yet been realised. “The tax system has a number of ways to express understanding of that situation – we don’t think it’s realistic to tax unrealised profits,” says Dodwell. “Usually those things are options – companies don’t have to do them. That’s an example of complexity we don’t need to worry about.”

Tony Dolphin also thinks it’s difficult to be certain a complicated tax system harms competitiveness. “An efficient, simpler tax system probably is a good thing. Businesses will say they spend too much time worrying about tax law, but I haven’t seen any evidence of a negative correlation between the complexity of the tax system and the growth rate,” he says.

But change is coming, slowly. Necessarily so, says John Whiting: “I’m not sure anyone would want radical change tomorrow. You need to plan properly.”

Bill Dodwell stresses the importance of giving companies, advisors and technology providers time to adapt: “My focus would be on systems and things that benefit the public and less on simplifying the law.”

Frank Haskew says: “Simplification is a worthy aim, but making it meaningful will take a long time and will mean taking big decisions. Without that it’s just tinkering around the edges. That’s not to say it’s not resulting in important administrative simplification there’s nothing wrong with that, but that’s all it will be.”


David Adams