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.