Our Director, John O’Connell, has a column in today’s Daily Telegraph about Britain’s maddeningly complex tax system.
Complexity is expensive. That’s just as true of tax systems and economies as it is of manufacturing processes and prices. And few things are as maddeningly complex as the British tax system. As rising powers in Asia, South America and elsewhere develop increasingly competitive legal systems, workforces and infrastructure, our unwieldy and cumbersome tax code is becoming an obstacle to investment and growth that we can no longer afford to ignore.
The Government has indicated that it plans to rename National Insurance contributions as ‘Earnings Tax’ in a move to bring some honesty into the tax system. This is great news for which the TaxPayers’ Alliance has long campaigned. And Ben Gummer MP deserves much credit for his campaigning for the change, too.
Although it’s just a name, it’s important. National Insurance is not insurance, it’s a tax. When it was introduced it had many insurance features but these have long since disappeared, making the name ‘National Insurance’ both dishonest and misleading. It would be a lot simpler if we just called it what it is, as our video demonstrates:
Payments are not based on a risk profile, they’re based on earnings. There is scarcely any link remaining with benefits or pensions, which will become even weaker when single tier pensions are introduced. And contrary to what many people have been duped into believing, there is no ‘pot’ into which contributions are kept. Money received this year is spent this year. Most of us have paid National Insurance but there’s no money attached to our number. It’s all gone.
We first called for the change in 2011 in our Abolish National Insurance report. In May 2012 we published our major review of UK taxes, the Single Income Tax, which also called for National Insurance to be renamed. Once again in November that year, we published How to abolish National Insurance, which mapped out the practical steps the Government could take to align and merge it with Income Tax, and the first recommendation was:
National Insurance should immediately be renamed to accurately describe its genuine function
So we’re delighted that the Chancellor has shown interest in Ben Gummer’s 10 minute rule bill. The Government should now set out how, over the next Parliament, it will abolish National Insurance.
Reacting to reports that the Government is likely to back proposals to rename National Insurance to “Earnings Tax”, Jonathan Isaby, Chief Executive of the TaxPayers’ Alliance, said:
“Earnings Tax is a far more accurate description than National Insurance and Ben Gummer deserves huge credit for his campaigning. Renaming National Insurance will make it clear to taxpayers that it is a second Income Tax in all but name. In the long term it should be abolished entirely to make the tax system more transparent, remove a huge burden on employers and allow people to see how much the taxman really takes out of their pay packet each month.”
In November 2011, the we published a comprehensive research paper that showed exactly How to abolish National Insurance. You can read the report here
The paper set out how to do so without pensioners and the self-employed losing out. It contains a detailed guide showing that pensioners, the self-employed and other groups will all receive a tax cut under our plans.
The first recommendation of the paper was “National Insurance should immediately be renamed to accurately describe its genuine function”.
Cut National Insurance, raise and align its thresholds and prepare for it to be fully merged into Income Tax, says a new report from the CentreForum think tank:
National Insurance cuts (including employer side) should be prioritised over income tax cuts.
Tax simplification should also be considered when increasing allowances.
The number of separate tax thresholds should be reduced, with the National Insurance allowances in particular aligned with each other and with the Personal Allowance. They should also be annual rather than weekly, and per individual rather than per job.
The CentreForum report isn’t perfect. It says that cutting employers National Insurance “can sometimes increase the demand for labour” and seems to suggest raising the minimum wage to combat that, as if creating jobs for unemployed people jobs is bad thing.
It also recommends hiking National Insurance rates to “fund” the more generous allowances. This isn’t a good idea. With the Government wasting well over £100 billion a year and extending itself further than necessary anyway, its books should be balanced by cutting spending, not raising taxes in other ways.
But overall, the key message from the report of simplifying and cutting National Insurance should be welcomed.
Yesterday taxpayers commiserated the 215th anniversary Income Tax. It was first introduced in 1799 to pay for the war against Napoleon at a starting rate of 2d per pound on earnings over £60 and 2s per pound on earnings over £200. In today’s terminology and earnings, that’s equivalent to 0.8 per cent (there were 240 old pennies per pound) on earnings over £65,000 and 10 per cent rate on earnings over £217,000.
Only a year after Waterloo, the hated tax was abolished ‘with a thundering peal of applause’ and Parliament ordered all records connected with it should be “collected, cut into pieces and pulped”.
But in 1842 Sir Robert Peel reintroduced it and it has since become the biggest contributor to government revenues. In 1874 it contributed just 8 per cent to Treasury coffers but today that number stands at around 44 per cent including National Insurance which is these days little more than just another type of income tax.
Technically it remains a temporary tax and is renewed by Parliament every year. So the next time you hear politicians telling you they want to introduce a small new tax which will be paid by the rich, remember that’s an incomplete sentence. What they actually mean is that it will be at low rates and paid by the rich at first, but then extended to everyone else at higher rates before long.
Mark Field, MP for the Cities of London and Westminster, has written a very good article for the Telegraph explaining why Britain needs major reform of our corporate tax system:
“The move towards lower taxes and the crackdown on so-called aggressive avoidance need not be mutually exclusive. In fact, they can easily be made complementary. Corporation tax is an imperfect levy that adds significant complexity to the system since it triggers endless disputes over what counts as profit. Armies of lawyers and accountants seek to bend definitions to lower tax liabilities. Loopholes are found and exploited. Governments end up introducing innumerable reliefs to aid particular sectors. And so the tax manual expands.”
“simplicity and stability were ranked as more important than a low effective tax rate”
“in today’s globalised economy corporation tax is no longer fit for purpose.”
Speakers from the TaxPayers’ Alliance, the Institute of Directors and the Institute for Fiscal Studies discussed tax reform at an event hosted by the Institute of Directors yesterday. Graeme Leach, Matthew Sinclair and Stuart Adam spoke about the need for comprehensive tax reform and Britain’s two major recent reviews of the British tax system. Matthew and Graeme spoke about the 2020 Tax Commission’s Single Income Tax approach to that challenge. Stuart Adam spoke about the different approach found in the Mirrlees Review’s Taxation by Design.
Videos of the three talks can be found below, with brief excerpts copied underneath.
Graeme Leach, Chief Economist and Director of Policy, Institute of Directors
Just as the temperature can plummet from 30 to 10 degrees coming back home [from Dubai] so too can the economic performance of a country plummet if you get tax policy wrong
Traditionally, in the post war period, whenever taxes changed it was by a relatively marginal amount, you know, 1p off income tax plucked out of the hat at the end of the budget. It’s not going to fundamentally change economic performance. But where you have examples of significant changes in marginal rates then you do have a much stronger evidence base there.
But on top of that, over recent years, there has been a rapid increase in the number of studies showing at the macroeconomic level of a robust relationship, unfortunately a robust negative relationship, saying that high taxation does lead to a reduced economic performance.
There was a study in recent years, which summarised all the literature in addition to the Single Income Tax study, and that came to the conclusion, roughly as the TPA report, which is that if you’ve got a roughly ten percentage point [change] of GDP in the burden of taxation, let’s say 35 to 45 per cent, then that probably on average leads to a reduction of 0.5 percentage points off the growth rate, ie, from 2.5 to 2 [per cent].
It’s not just the burden of taxation in terms of the overall level and marginal rates, it’s the complexity of the system which is also a problem in the UK. The complexity compounds the existing rate problem and overall burden. So it’s not just a case of looking at a number and saying “that’s the end of the story”. Far from it. The nature of the tax system itself will undermine and impact on economic performance. If you look at how these effects compound each other, look at the increase in complexity of the tax system in the UK in recent years, it’s quite absurd, really.
Matthew Sinclair, Chief Executive, TaxPayers’ Alliance
There is a lot of agreement on the objectives: a simpler, fairer and more competitive tax system, and how important the simpler part of that has become, however you want to measure that. Whether it’s the Tolley’s tax handbooks being over 17,000 pages long, whether it’s the sheer amount of work companies are having to put into managing their tax affairs, whether it’s how opaque the system has become and how poorly the public understands tax which I think is what’s driving a lot of the scandals we’ve seen recently, real and imagined.
I think that that need for simplification has become very clear but at the same time a need to address public concerns about fairness, whether those are problems of perception or problems of reality, the need to create a tax system which is, and is seen to be, fair. And finally competitiveness, there is a constantly moving set of goalposts.
If you look at the Corporation Tax rate for example, if you look at the numbers and what’s been going on, the excellent work the Government has been doing cutting Corporation Tax rates, is just restoring Britain’s position relative to the European normal to where it was before Gordon Brown went relatively slow in cutting Corporation Tax.
That is a constantly moving set of goalposts as countries compete for investment, for jobs, for economic growth. Now, the question I think we were trying to address when we started the Tax Commission is how we can get away from constantly worrying about what set of policies can give us a good next quarter of economic growth. I think it’s a debate that’s very sterile and can lead to some very poor decisions to prioritise what will work for the next quarter.
Instead, think about how can we get a tax system that’s fit for the next quarter century, how can we get a tax system which will be a positive boon to Britain rather than simply trying to keep up with the pack, how can we get a better, lasting reform to the tax system.
The need to address the disparity between how debt and equity is treated within corporate taxes. We do that in different ways. I think that’s where the interesting difference between the two reports starts to come through. The Mirrlees Review recommends the Allowance for Corporate Equity, which I’m sure Stuart will want to talk about later.
The 2020 Tax Commission’s is funnily enough in some ways inspired by the Meade Review, which was the Mirrlees Review’s predecessor from the Seventies, which is to tax distributions instead, to tax when money leaves (net) the UK corporate sector. Now, we think that has a number of advantages over the status quo.
Firstly it means you completely abolish the unfairness between debt and equity and the unfairness that creates. Secondly, it means you’re not taxing retained earnings. Some people see that as a bug in the system we’re proposing. We very much see it as a feature, indeed it is a feature in some of the most competitive tax systems around the world. Firstly it removes the need for a whole host of allowances in the system at the moment. It removes the need for so many of these fiddly little reliefs which create so many of the problems with the tax system today.
Secondly it creates a very powerful incentive to invest and to try and strengthen the corporate sector for the long run. It allows you to remove a lot of the existing iniquities in the system. It allows you to remove the advantage for share buybacks, for examples. It allows you to ensure that there’s no advantage to incumbency through the simple credits system recommended to ensure that it’s net distributions that you tax. And it allows, crucially, for the same tax rate, without impeding competitiveness, on labour and capital income. You can tax them in a way that is very similar, and looks very similar.
Stuart Adam, Senior Research Economist, Institute for Fiscal Studies
The importance of neutrality. That is, taxing similar activities similarly as at least a benchmark, a starting point for tax design. Broadly speaking, taxes that treat similar activities similarly, will tend to be simpler, fairer, more efficient and less prone to avoidance. Now, that won’t always be the case and there are times when you’d want to depart from neutrality. There are cases for taxing environmentally damaging activities more heavily. Perhaps, cigarettes and alcohol.
Conversely, you may want to give more generous tax treatment to thinks like pension savings and R&D. But the hurdle for those kinds of exceptions should be high, given the harm that can be done from departing from neutrality. And in fact, the ones I’ve just mentioned may be an almost comprehensive list of where you’d want to depart. And where you do want to depart from neutrality, you have to be particularly careful about how you design that.
On corporate tax itself, the major suggestion, as Matt mentioned, is the introduction of an Allowance for Corporate Equity.
The broad gist of it is… that you provide an allowance equal to a normal rate of return on the shareholder funds invested in the company. That avoids taxation making investments unviable. It also largely eliminates the tax bias of in favour of debt over equity. And has various other nice properties, including getting rid of sensitivities to inflation, problems around capital allowances not matching true depreciation rates and in fact, all the things that Matt mentioned, which is not coincidental because the ace turns out, although it’s not obvious, to be very closely related to the kind of cash flow corporation tax which the Meade report recommended and a slight variant of which is in the 2020 tax commission.
PS – Sadly a technical error resulted in the recording cutting short moments before the end of Stuart Adam’s talk, preventing us from being able to show the Question & Answers session.
The Director General of the Institute of Directors, Simon Walker, has spoken out against complicated and high tax rates, citing the 73 per cent marginal combined income tax and child benefit withdrawal rate faced by a taxpayer with four children earning between £50,000 and £60,000.
This is a huge disincentive: some people can be paying 70 per cent, 75 per cent.I am all for a flat simple tax system – it has been shown to raise a lot more money.
The top one per cent of taxpayers pay a very large share of all the tax in this country. Flat, simple taxes are the way to do it.
He’s right. We need to sweep away as much of the complexity as possible. The Single Income Tax which the TaxPayers’ Alliance published jointly last year with the Institute of Directors, sets out a plan to do just that. A single rate of tax, on all income, however it’s received, should apply so that above a minimum level, those who earn twice as much should pay twice as much. Everyone should pay their fare share: no more and no less.
Tax is in the news again thanks to Deputy Prime Minister Nick Clegg’s comments on the Andrew Marr Show about raising the personal allowance to match the minimum wage. And others at the Liberal Democrats’ party conference have made less welcome suggestions, too, on a so-called ‘mansion tax’ and raising income tax rates back up to 50p while the party’s leaked lines-to-take document revealed that the party wants to empty more money (known as “a further contribution” in politician speak) from the pockets of taxpayers earning £50,ooo a year.
But Nick Clegg’s comments on raising the tax-free personal allowance are the most significant:
We are committed as a party – and I am committed to this – to raising the allowance further such that… everybody on the minimum wage pays no income tax.
Good. Politicians shouldn’t dip their fingers into the pockets of those who do not earn enough to cover the barest essentials. Raising those on the minimum wage out of tax will do two things.
First, it will secure the promise in the Liberal Democrat manifesto to raise the personal allowance to £10,000 in April 2011. It should never be forgotten that £10,000 this year, next year or any other year is not the same as in 2011-12, because inflation has reduced its value since then. If that £10,000 figure in April 2011 were increased to take account of inflation so that it would have the same value, it would be equivalent £11,204 by April 2014. So while the rise in the personal allowance to £10,000 next year is welcome, their manifesto commitment can only be said to have been met if it assumed that it would be frozen until now so that inflation would eat away £1,204 of it.
Secondly, it would have much of the effect on the after tax income of people earning the minimum wage as it would if their wages were to increase to match the so-called ‘living wage’. But while raising the minimum wage to a more generous level has the unfortunate side effect of increasing unemployment, cutting tax on low earners would have the opposite effect. It would encourage more people in to work and cut unemployment. The rhetoric of raising the minimum wage sounds benign. After all, who could object to the idea of anyone (and especially low earners) enjoying a higher income? But minimum wages simply prohibit employment below a set price. For workers who cannot convince an employer that their labour is worth more than the minimum wage, the reality of the policy is that it condemns them to unemployment, which will only compound their difficulty in finding well-paid employment later on. On the other hand, cutting tax on low earners won’t just leave them better off by letting them keep more or even all of the money they have earned. That extra money will strengthen the incentive for people to be employed putting downward pressure on unemployment rates.
Nick Clegg should ignore the calls for a mansion tax, which are unfair, arbitrary and will end up hitting ever more of us. And he should dismiss talk of tightening the tax grip on the squeezed middle. It’s great that Lib Dem activists voted against tightening the tax grip by hiking the 45p tax rate back up to 50p, which instead should be abolished. But Clegg should press ahead with his policy of taking more of the poorest out of not just Income Tax but National Insurance too. At £11,400, this level is roughly the same as that proposed by the TaxPayers’ Alliance last year when our Single Income Tax plan for a 30 per cent rate above £10,000 (in 2010-11 prices). And as the Centre for Policy Studies’ Ryan Bourne writes in this morning’s City AM, the other parties would do well to learn a lesson from Clegg on tax for low earners, too.
And raising the personal allowance to the level proposed by the Single Income Tax isn’t the only thing that’s on the cards, either. As Andrew Marr said in his question to Nick Clegg yesterday
If David Cameron says we’re going to cut the rate of Income Tax to 30p, again, we understand that, we know it’s a particularly plausible outcome
I wrote for the BBC News website about why we should introduce a proportionate Single Income Tax:
Britain’s tax code is one of the longest in the world. Tolley’s yellow and orange tax handbooks now extend to over 17,000 pages, three times longer than in 1997.
We have a basic rate, a higher rate and an additional rate of income tax, with a different set of rates for dividends and yet another for savings.
And then there’s National Insurance
Google, Apple and Starbucks have all recently been enjoying the attention of the House of Commons Public Accounts Committee or equivalent bodies in the US Senate. Committee Chair Margaret Hodge even said that it is ‘evil’ of Google to fail to arrange its affairs in a way that would result in it paying more tax than it is required to. But however silly some of the claims in Parliament might be there is genuine and justified anger about a tax system that very few of us really understand.
At a conference on corporate tax avoidance and reputations, Public Accounts Committee chair Margaret Hodge MP backed the TaxPayers’ Alliance position that tax complexity is the root cause of much of the opportunity for tax avoidance in the UK. She told the Oxford Centre for Business Taxation’s conference that:
Simplification is at the heart of tackling tax avoidance and I blame my party just as much as the current government.
It’s great that the TaxPayers’ Alliance message is now established as the most credible critique of the problems relating to tax avoidance and the legitimacy of the system. Complexity leads to misunderstanding, which leads to mistrust. And that encourages people to avoid their own tax because they think others might be getting away with something. So it’s encouraging that this, and the point that complexity so often provides the means for tax avoidance, are being acknowledged.
Exchequer Secretary to the Treasury David Gauke MP also gave a resounding defence of the lower 10 per cent rate of Corporation Tax available for activity connected with the ‘patent box’, claiming the lower rate encourages investment, jobs and growth in Britain. He said the rate had encouraged GlaxoSmithKline to invest £500 million in a new factory, creating thousands of jobs.
Mr Gauke also said that raising the rate “would cost the UK jobs and investment”. He’s right. And that’s why the Government should be cutting Corporation Tax faster than it is. Recent economic data seems to suggest that the recovery is underway but only at an extremely turgid pace. So cutting the rate to 10 per cent would both boost incentives and make the patent box redundant, simplifying the system.
Corporation Tax isn’t a free lunch. As Janine Juggins of Rio Tinto put it, it’s “not a victimless crime”. The money comes from corporate profits. That doesn’t mean incorporation certificates or gleaming corporate office buildings suffer. It means reducing dividends, which in turn means lower pension payments as most shares owned in the UK are held by pension companies. And it means higher prices in the shops. But more than anything, it means lower wages for workers. So it was great that Ms Juggins, Bill Dodwell of Deloitte and John Gapper of the Financial Times all made this point. It can’t be stressed often enough.
The final word was given to Michael Devereux, Director of the Centre for Business Taxation, who stressed that tinkering at the edges will not provide the system we need:
Simplicity has to involve fundamental reform of the tax system.
It’s clear what we do need: a much simpler system with fewer reliefs and exemptions but, crucially, lower rates. And the 2020 Tax Commission proposed just that in The Single Income Tax.