Resolution Foundation calls for targeted tax reform and simplification

August 01, 2012 1:26 PM

The Resolution Foundation has called for significant reforms to the tax and benefits system. ‘Fairer by design: efficient tax reform for those on low to middle incomes’, written by the Institute for Fiscal Studies’ Paul Johnson, looks at revenue neutral ways how the tax and benefits system could be reformed to make it simpler and less economically destructive while simultaneously maintaining or increasing redistribution from higher to lower earners.

The report contains five key proposals.

1. Benefits for mothers could be adjusted in favour of younger children and away from older children, because mothers of older children are more responsive to incentives. Therefore the increase in employment would rise among mothers of older children thanks to reduced benefits by more than employment among younger mothers would fall because of increased benefits.
2. Second earners’ incomes could be disregarded for calculating withdrawal of Universal Credit to improve incentives.
3. Older people (over 55) demonstrate greater responsiveness to incentives so lowering their marginal tax rates could improve employment rates, perhaps by raising the personal allowance for over 55s or by reducing the age when National Insurance is no longer payable.
4. Exemptions and reduced rates of VAT are a poor mechanism for redistribution so standardising VAT rates on items such as food and children’s clothing could fund more effective redistribution elsewhere in the system.
5. Pensions tax treatment is irrational and could be simplified by equalising the rules for employee’s and employer’s contributions and by reducing the amount of pension eligible to be paid as a tax free lump sum on retirement.

While many of these proposals have merit when considered individually, the UK tax system would benefit from deeper reform that goes to the root of the problem with British taxes: overreach and complexity. Special exemptions and disregards for selected groups such as the over 55s and second earners mean additional complexity and, for everyone else, higher marginal rates to make up the difference. In addition, benefits should serve a specific purpose of satisfying a need. Just because providing mothers of older children with benefits at their current level of generosity does not represent value for money for taxpayers, it does not follow that the saving ought to be spent on more generous benefits for mothers of younger children. Interestingly, the proposal to reallocate benefits away from mothers of older children appears to support the Government’s decision to the generosity of the EMA.

The report’s review of VAT addresses the problem of complexity and high rates more directly, however. It shows that while standardising rates of VAT would have unfortunate distributional effects when households are measured by income, the effect is less marked when measured by expenditure. This is in part because groups like students have expenditures greater than their incomes. Rightly, they anticipate higher incomes in future and therefore borrow to fund the difference, meaning they are not as poor as their income suggests. But while the table below highlights the absurd complexity in current VAT rules, the political difficulty of imposing the tax on such basic items as food and rent while the rate is remains so high is unlikely to be worth the benefit of simplicity and a lower overall rate, at least for ministers.

[caption id="attachment_47056" align="alignnone" width="493"] Source: Resolution Foundation, 'Fairer by design', p.21[/caption]

In contrast, the Single Income Tax proposal of the TaxPayers’ Alliance and Institute of Directors 2020 Tax Commission goes right to the heart of the complexity problem by addressing the fact that, to a large extent, the complexity is an inevitable result of trying to raise too much revenue. Trimming back taxes from around 39 per cent of national income now to around 33 per cent would not only provide a significant boost to economic incentives but would also allow for much more radical simplification than can ever be realistic as long as the system attempts to capture as much of the national income for the Government as it does now.

Without accepting this fundamental point of tax reform, meaningful and substantial change is simply not realistic. While the Resolution Foundation report has much to recommend it, we need to rethink what we should expect from our tax system and the steps that can be taken to tackle the Byzantine complexity that, layer by layer, has grown up over the years and is now quietly stifling British enterprise, jobs and prosperity.The Resolution Foundation has called for significant reforms to the tax and benefits system. ‘Fairer by design: efficient tax reform for those on low to middle incomes’, written by the Institute for Fiscal Studies’ Paul Johnson, looks at revenue neutral ways how the tax and benefits system could be reformed to make it simpler and less economically destructive while simultaneously maintaining or increasing redistribution from higher to lower earners.

The report contains five key proposals.

1. Benefits for mothers could be adjusted in favour of younger children and away from older children, because mothers of older children are more responsive to incentives. Therefore the increase in employment would rise among mothers of older children thanks to reduced benefits by more than employment among younger mothers would fall because of increased benefits.
2. Second earners’ incomes could be disregarded for calculating withdrawal of Universal Credit to improve incentives.
3. Older people (over 55) demonstrate greater responsiveness to incentives so lowering their marginal tax rates could improve employment rates, perhaps by raising the personal allowance for over 55s or by reducing the age when National Insurance is no longer payable.
4. Exemptions and reduced rates of VAT are a poor mechanism for redistribution so standardising VAT rates on items such as food and children’s clothing could fund more effective redistribution elsewhere in the system.
5. Pensions tax treatment is irrational and could be simplified by equalising the rules for employee’s and employer’s contributions and by reducing the amount of pension eligible to be paid as a tax free lump sum on retirement.

While many of these proposals have merit when considered individually, the UK tax system would benefit from deeper reform that goes to the root of the problem with British taxes: overreach and complexity. Special exemptions and disregards for selected groups such as the over 55s and second earners mean additional complexity and, for everyone else, higher marginal rates to make up the difference. In addition, benefits should serve a specific purpose of satisfying a need. Just because providing mothers of older children with benefits at their current level of generosity does not represent value for money for taxpayers, it does not follow that the saving ought to be spent on more generous benefits for mothers of younger children. Interestingly, the proposal to reallocate benefits away from mothers of older children appears to support the Government’s decision to the generosity of the EMA.

The report’s review of VAT addresses the problem of complexity and high rates more directly, however. It shows that while standardising rates of VAT would have unfortunate distributional effects when households are measured by income, the effect is less marked when measured by expenditure. This is in part because groups like students have expenditures greater than their incomes. Rightly, they anticipate higher incomes in future and therefore borrow to fund the difference, meaning they are not as poor as their income suggests. But while the table below highlights the absurd complexity in current VAT rules, the political difficulty of imposing the tax on such basic items as food and rent while the rate is remains so high is unlikely to be worth the benefit of simplicity and a lower overall rate, at least for ministers.

[caption id="attachment_47056" align="alignnone" width="493"] Source: Resolution Foundation, 'Fairer by design', p.21[/caption]

In contrast, the Single Income Tax proposal of the TaxPayers’ Alliance and Institute of Directors 2020 Tax Commission goes right to the heart of the complexity problem by addressing the fact that, to a large extent, the complexity is an inevitable result of trying to raise too much revenue. Trimming back taxes from around 39 per cent of national income now to around 33 per cent would not only provide a significant boost to economic incentives but would also allow for much more radical simplification than can ever be realistic as long as the system attempts to capture as much of the national income for the Government as it does now.

Without accepting this fundamental point of tax reform, meaningful and substantial change is simply not realistic. While the Resolution Foundation report has much to recommend it, we need to rethink what we should expect from our tax system and the steps that can be taken to tackle the Byzantine complexity that, layer by layer, has grown up over the years and is now quietly stifling British enterprise, jobs and prosperity.

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