The continuing furore over the Budget – ranging from charitable giving to pasties – reflects the enormous complexity of the world’s most obtuse tax system. It’s time for the chancellor to start rationalising the tax code
Generally speaking, budgets are short-lived affairs. As far as the public is concerned, the course of events is pretty predictable – the chancellor discusses the economy, increases taxes on the usual suspects, announces various initiatives, raises most allowances in line with inflation, commends his measures to the House, and braves the formal censure of the leader of the opposition. There is intense, detailed coverage in the following day’s newspapers, and a deafening silence after that.
George Osborne’s latest budget, delivered on 23 March, certainly breaks with this tradition. At first, the controversies centred on the taxation of ‘the rich’. Osborne reduced the top rate of income tax to 45% from 50%, arguing – perfectly reasonably – that there is not a lot of point in having one of the western world’s highest marginal tax rates if the deterrent effect to enterprise and investment far exceeds the very modest sums which it raises.
Equally reasonably, the chancellor sought to introduce various measures to reduce the extent to which the country’s highest earners can remove some of their earnings from the tax-man’s avaricious eye.
This was duly debated and reported, and the predictable near-silence reigned – until a more detailed perusal of the details triggered anger from pressure groups including charities, pasty-eaters and the owners of listed buildings.
Whilst one cannot but sympathise with hard-pressed charities, the basic principle is that the wealthy should not enjoy the privilege of hypothecating where their taxes go. Their laudable philanthropy should come from their after-tax incomes, and should not divert tax funds whose disposition should be a matter for Parliament alone.
The key point is the ludicrous complication of having the world’s most verbose tax code. When Gordon Brown took office in 1997, the tax rules covered 5,000 pages. By 2007 – and despite the publishers’ use of a smaller typeface to prevent four volumes from becoming five – the code had swelled to over 11,500 pages, and it has continued to grow ever since.
The longer a tax code is, the greater are the opportunities for tax avoidance (which, unlike tax evasion, is perfectly legal, incidentally). A tax code as verbose as the current British one is a happy hunting ground for tax specialists but a nightmare for almost everyone else, including taxpayers, HMRC (many of whose mistakes surely result from the sheer complexity of the system) and even chancellors.
Can anyone actually read – let alone fully comprehend – a set of tax rules covering almost 12,000 pages of closely-spaced type?
Also during March, the government issued new planning guidance, achieving in 50 pages something that took 1,300 pages under the previous system. It is high time that taxes were simplified in the same way.
Logically speaking, there are three tests of a tax system’s fitness for purpose.Does it raise sufficient funds for the government to provide the social services deemed desirable by Parliament?
- Does it raise sufficient funds for the government to provide the social services deemed desirable by Parliament?
- Is it cheap to administer?
- Does it have a minimal adverse distorting impact on the economy?
The present British system, by these measures, is not fit for purpose. It doesn’t meet the test of funding government outlays. The system most certainly isn’t cheap to administer and neither, for that matter, is it wholly equitable or effective. And the system is certainly an abject failure in terms of the third (distortion) test.
If you were setting out to write a new tax code today, the very last place you would start is with the current British version.
There are two reasons for the excessive length and complexity of the British tax system. The first of these is the British disease of bureaucracy, something that plagues public services, and the regulation of businesses, just as much as it complicates taxation. Bureaucrats and the tax-avoidance industry are symbiotic, in that both revel in the extent and complexity of the fiscal rules.
The second root cause of complication is the historic accumulation of well-intentioned initiatives, such that ‘the road to obscurantism is paved with good interventions’. In the past, chancellors have wished to discourage some forms of behaviour whilst encouraging others. Hence, extra taxes are imposed on smokers, drinkers and motorists, whilst incentives are given for charitable fund-raising, various forms of saving and sundry types of investment.
What, in idealised form, would constitute a ‘fit for purpose’ fiscal system? For a start, the rules would be simple. The same tax rates would apply to all types of expenditure, and common rates would be levied on all types of income. There would be the very minimum of allowances (as a result of which, overall tax rates would be lower).
In the United States, Fair Tax campaigners are calling (probably in vain, because their proposals are far too rational) for an extremely simple system in which all other taxes would be replaced by a tax on final sales. Levied at 23% and affecting about 90% of GDP, this would raise more than all of the current tax income of the US government, and would eliminate the deficit.
Those on low incomes would be protected because everyone would receive a monthly ‘prebate’ (a rebate, but paid in advance) equivalent to the cost of the tax to a person on a low income. In the highly implausible event of Fair Tax becoming law, all of the current tax systems could be swept away (and so too, for that matter, could the IRS).
Whilst few would advocate such a system for the United Kingdom – in any case, the sales tax would need to be well over 50% in high-spending Britain, rather than the 23% proposed for the US – the basic principles of simplified taxation are appealing.
Short of this, George Osborne is surely going in the right direction with his aim of simplifying the system and reducing the allowances that the well-off (in particular) can use to reduce their tax bills. Anything that reduces the sheer complexity of the current system would be an improvement.
There is also the issue of who chooses how tax revenues are spent – the wealthy taxpayer, or the government? Under the present system, a high-earning taxpayer can make a very big donation to a charity in the knowledge that the real cost to him or her is far smaller, since the remainder received by the chosen charity is foregone by the exchequer.
It is at least arguable that this person is obliging the government to surrender to the charity a substantial sum which otherwise might have been spent on schools, hospitals and defence. Less affluent taxpayers, and the users of public services, are entitled to wonder whether it should be the wealthy individual or the elected government that decides how this money is spent.
In the real world, Osborne is almost certainly going to have to back down, at least in part, but he should stick to his intentions where simplification is concerned. Indeed, efficiency surely requires that he go further still. If VAT were charged on all goods and services without exemption, the rate charged could be significantly lower than the current 20%. The same would be true for income taxes if the chancellor could cut a swathe through allowances.
As America’s Fair Tax campaigners are likely to discover, counsels of perfection are seldom welcome in an imperfect world. But taxpayers should applaud anything that Osborne can do to give Britain a tax system which is simpler, cheaper to collect, less distorting of the economy and generally fitter-for-purpose.
Dr Tim Morgan is global head of research at Tullett Prebon. This is an edited version of a Tullett Prebon Strategy Note
