James Mirrlees, the chair of the IFS review on taxation, is reporting as criticising the Scottish Government’s proposal for a property transaction tax. His review in 2010 described property transactions taxes as ‘highly inefficient’ and argued that there should be an annual tax on housing services, based on up to date valuation of property. That’s all very well, but no such valuations exist; the current information is more than twenty years out of date. The problem faced by the current Scottish Government, then, is that there is no mechanism in place to do what Mirrlees recommends, and it will take years to create it.
The Scottish Government is inheriting a complex, rather obscure system. For example, there are some twenty-five different reliefs; three or four do all the heavy lifting, and about 15 are hardly claimed at all by anyone, but by the same token those reliefs don’t actually cost anything, and the Government can be sure that if they abolish them, there will eventually be protests. The system makes little sense, but it more or less works (largely because all property transfers are registered and solicitors enforce it). That’s an argument for incremental change at best.
The purpose of tax reliefs on charitable donations is intended, in part, to limit abusive tax avoidance, but there are points of principle to consider. Whenever tax relief is given, the state is foregoing the tax revenue it could otherwise claim; effectively, the charity is receiving money that would otherwise have gone to the government. Charities are already exempt from a range of taxes, particularly council tax and water rates. Charities which raise money by asking people to declare that they are are taxpayers are effectively seeking – and receving – government subsidy. The idea that this is “free” money is illusory.
The support of “philanthropy” by tax relief effectively means that people are able to give money to charities in lieu of giving it to government – a situation which puts individual preference in place of collective decision making. What a phalanx of very rich “philanthropists” are demanding is that they, not the government, should be able to determine how their tax liabilities are spent. The US Government accepts that demand, unreasonable as it is, and the US functions consistently with the federal government in deficit as a result. Most European governments would not tolerate it, and they should not.
In conventional economic theory, the costs of any tax on business will be transferred to the customers of that business. That implies that business taxes can only be used with caution, that they tend to distort markets, and that it makes more sense to raise money in other ways. Business taxation does, however, have another function, and that is to ensure equity between different taxpayers. Current concerns about Amazon are based in issues of fairness, not about the economic effects.
More generally, there is another side to business taxation. People who run businesses often have the option of treating revenue as either part of the income of the business, or as personal income. If business is lower than income tax, the incentive is to run costs through the business. If income tax was lower, the reverse would be true. The only equitable position would be if business taxes were set at the same rate as personal taxes. That would not quite be neutral, because business expenses can be offset against income in a way that personal expenses cannot be, but it would be fairer.
Following other work on tax, I have just been listening to a student paper about the flat tax in Kazakhstan. Most earned income is subject to a flat tax of 10%, one of the lowest rates in the world, but the incomes of some groups are exempt. They include soldiers, police, veterans of the second world war, fire services, some disabled people and their families, the victims of a nuclear accident and lawyers.
Because I’ve been looking at the tax system in the course of the last week, I’ve been considering some of the arguments for “simplification” and the possibility of a flat tax. Some of the allowances and approaches being used are bizarre, and several complications seem unnecessary – for example, the calculation of NIC on a weekly basis when everything else is monthly or annual, the arcane mechanisms for clawback, and the lack of integration with tax credits.
However, I’ve argued in the past that attempts to simplify social security systems are illusory. Benefits have too many aims, they deal with too many people in complex and changing circumstances. The same arguments seem to me to apply with as much force to taxation. Taxation is supposed to do many things at once. Richard Murphy begins with five: raising revenue, repricing, redistribution, fiscal policy and solidarity (though Richard found a way to begin the last two with an “R”). To that I can add at least two others – changing behaviour (incentives, disincentives and subsidies) and conveying a moral position (e.g. in support for families). Add to that the complexity of people’s lives, the things that are being taxed, and the constant changes in circumstances, and I am sceptical that taxation can ever be anything other than complicated.
That doesn’t mean, that nothing could be simplified, or that the system could not be made more comprehensible – for example, by unifying allowances with credits, or by harmonising rates between employment, self-employment and taxation of companies. One thing is unavoidable; in any reform, there will be gainers and losers. If the system costs the same, then some people will be worse off; if no-one is to be worse off, the system must cost more. There is no way round that.
The government’s plan to reduce the tax allowances of pensioners was clumsily presented. The issue is not, as the IPPR suggested, that pensioners must be expected to bear a greater burden in deficit reduction – that argument seems feeble when the purpose of economies is to support handouts in corporation tax and to reduce the demands made of very high earners. It is, rather, that the distributive implications for pensioners need to be seen in the round. “The net changes made by this government … mean that pensioners are better off.” That is the answer George Osborne has given to criticism, and it is a strong argument.
Pensioners are gaining in some ways, primarily through proposals to increase the level of state pension and in the ratcheting effect of the “triple lock” which means that pensions will rise faster than inflation. They are likely to lose in other ways – through this tax increase, the loss of the state second pension, increases in the pension age, and reductions in housing benefit. (The poorest pensioners, recipients of Pension Credit, will not gain in the short term – but they will nto lose out because of the tax increase, either.) The Chancellor may well be right, but it would be helpful to see the figures laid out more clearly.
There are three main problems tied in with raising tax thresholds. They are all well-known about, but I don’t see them being reported or discussed in the press.
First, it costs a great deal to raise tax thresholds, because it delays the point where rich and poor alike start to pay tax.
Second, the people on the lowest incomes benefit least, because people who pay tax on only a part of their income will not get the full benefit of the increased threshold.
Third, the tax threshold interacts with higher tax rates. Increasing the tax threshold directs more money to rich people than to poor ones, because it delays the points at which rich people become subject to higher tax brackets. It is possible to compensate partly for this effect by lowering the bands for higher tax brackets early. That is what the government has been doing. The threshold for the 40% rate has been applied to progressively lower bands:
|| Tax threshold
|| 40% band
||Income level at which
40% tax is paid
There is a simpler way around the problems. If people are paid the equivalent of a tax relief in cash, and then all income above that is subject to tax, the second and third problems disappear, and it’s possible to pay for the cost of the first by raising the tax. We did this once when we converted child tax reliefs into a cash payment. The allowance is called “Child Benefit”.
Attacking HMRC on a range of issues, a Times editorial comments: “Tax Credits have repeatedly been overpaid because changes in individual circumstances occur too frequently for the bureaucracy to keep up.” That’s quite true. But the Universal Credit scheme, contained in the Welfare Reform Bill currently passing through Parliament, relies centrally on the principle that it will be possible to respond to changes in people’s needs as they happen, “in real time”. It is not possible now, and it is not going to happen like that.
The government has sidled away from the promise of a computer system that will cope with everything – no system could be expected to record changes in household circumstances as they happen. What they are currently relying on is the development of a faster PAYE system, which generally depends on income coming from employment. Changes to overpayment rules mean that claimants who are overpaid will have to repay money regardless of whether they could reasonably have known they had been told the wrong thing or were being paid the wrong amount – a situation which the Ombudsman has previously criticised for the instability it creates for low-income households.
Recent political debate in the UK has been seized by an abstruse discussion of the merits of inheritance tax. Politicians have been wrong-footed; no-one, it seems, can remember what the tax is for, which makes it rather difficult to justify.
There are four main arguments for taxing people on legacies.
- Inheritance tax is highly progressive. It is solely related to ability to pay.
- The capital gains on a person’s principal residence property are untaxed while someone lives there, and finally realised only when when they do not; death and probate are the best time to tax. Other property which is held would have been subject to capital gains tax.
- Both the capital gain on property, and the legacy made after it, are unearned windfalls. The taxation of legacies is unrelated to economic incentives.
- The persistence of inherited wealth across several generations is one of the major sources of inequality in the UK.Inheritance tax breaks the link.
The case against inheritance tax is that
- People’s holdings have been taxed once already. This is largely untrue. The principal source of wealth in the UK is not holdings derived directly from income, but real property; the main reason why large numbers of estates have been brought into the tax bracket is the increase in house prices.
- People have an aspiration to pass their goods to their children. They may have, but that is possible only if they have children. There are no criteria to distinguish family legacies from others.
- Inheritance tax is inequitable. The taxation of residences leads to inequities when people who share the residence are required to pay tax from capital they cannot realise directly.
Only the final criticism has major substance – but none of the current proposals attempts to deal with it.