Tax without design

Giving the annual CTA (Chartered Tax Adviser) Address today, Paul Johnson, IFS director, sets out some of the numerous ways in which tax policy in recent years has unnecessarily made the tax system more complicated, less efficient and less transparent.

The coalition government have pursued two tax policies with considerable consistency and at remarkable cost – the increase in the income tax personal allowance to £10,500 and the cut in the headline rate of corporation tax to 20%. Between them these are set to cost getting on for £20 billion a year – a remarkable cost in any parliament, let alone under current fiscal circumstances. But consistency in these two particular policies stands out among the complexity and uncertainty created elsewhere.

Responsibility for much, perhaps most, recent poor tax policy rests with both this government and its predecessor (and often earlier governments too). Gordon Brown, Alistair Darling and George Osborne all made some improvements to the tax system. But poor tax policies where this government and the last are both culpable include:

• There is a basic rate of income tax of 20%, a higher rate of 40% and a top rate now of 45%. What is less well known is that the last government introduced a rate of 60% on a band of income starting at £100,000. This government has maintained it and effectively increased its range considerably. There is now a 60% rate of income tax on income between £100,000 and £121,000 (where it drops back to 40%). It’s hard to make much sense of that.
• Several elements of the income tax system no longer adjust with inflation. The point at which the 45p rate becomes payable, and indeed the point at which the 60p rate becomes payable, is fixed in cash terms and has already fallen by more than 12% relative to the Consumer Prices Index since its introduction. More people will gradually be pulled into these higher rates. There is apparently no plan to stop this.
• This government has accelerated a trend overseen by recent governments which has fundamentally altered the nature of our system of income tax, namely a continued increase in the number of higher rate taxpayers. Numbers have risen from less than 2 million in 1990 to nearly 4 million in 2007 and well over 5 million by 2015. The problem is not necessarily so much the fact of the change – there is a case for, and a case against, such a system – but the fact that this fundamental change to our tax system, which appears to have the support of the three main political parties, has never been announced or properly debated.
• Governments of all stripes have continually cut income tax whilst increasing National Insurance Contributions (NICs) – a tax on earned income. The only reason for this is that income tax seems to be more salient and therefore increases to NIC rates are politically easier.
• This government has followed in the pusillanimous steps of its predecessors in failing to carry out any revaluation of properties for council tax in England. Council tax, our main property tax, is assessed on relative property values which will soon be a quarter of a century out of date. This situation is becoming increasingly absurd.
• The last government and this one raised rates of Stamp Duty Land Tax time and time again. This is one of the worst designed and most damaging of all taxes, yet revenues from it are due to hit £15 billion within just a few years. At the extreme a £1 increase in sale price can now trigger an additional £40,000 tax bill. The tax helps to gum up the entire property market.
• Having set out a clear direction for the taxation of pensions the last government set in train an absurd complication of the regime. This government has moved in a slightly better direction but has dramatically reduced the generosity of income tax allowances for pension contributions. It has not made any long term direction clear. Once again it, like its predecessor, has ignored the role of NICs. The Labour Party appears set on further complicating the system for those with incomes above £150,000 while the Liberal Democrats want to do this for all higher-rate taxpayers too. Long term stability in pension taxation is crucial. What we have is costly short term meddling and complication.
• Both this government and the last have continually planned for increases in fuel duties and then decided to delay, and then abandon them. The continued failure even to raise duties in line with inflation adds to a long term loss of revenue and reduced tax on the external costs created by motorists.

But the current government hasn’t just carried on with mistakes made by its predecessor. Among problems of its own creation are:

• The failure to increase the threshold for paying National Insurance Contributions at the same time as increasing the income tax personal allowance. It is hard to think of a rationale, and none has been offered, for continuing to increase the latter while not increasing the former. More than one million low paid workers now pay NICs but not income tax;
• The way in which the transferable allowance for married couples and civil partners is being introduced effectively creates an infinite marginal tax rate. Since the full value of the allowance is withdrawn as soon as one partner becomes a higher rate tax payer, it is possible to become more than £200 a year worse off as a result of a £1 pay rise;
• Huge policy uncertainty has been introduced through continual (at least annual) changes to elements of business rates, corporation tax allowances and carbon taxes.

And of course the last government could fill its own hall of shame with damaging tax policy including:

• The introduction and then abolition of a 10p starting rate of income tax. The chaos around the abolition is what is remembered. The introduction was the mistake. A new 10p band of income tax achieves nothing that could not be better and more simply achieved by an increase in the personal allowance. Yet despite the lessons one would hope they had learned, the Labour Party now promises the reintroduction of this starting rate.
• The introduction and then abolition of low rates of Capital Gains Tax (CGT). Again it is the furore around the abolition which is perhaps better remembered but it was the introduction of a 10p rate of CGT which allowed hedge fund managers to claim they were paying lower rates of tax than their cleaners. There is still some way to go to sort out CGT.
• The introduction and subsequent abolition of a 0% rate of corporation tax for the lowest profit companies. It seemed to surprise the government that this led to a wholly predictable upturn in the number of self employed people deciding to incorporate and hence a loss of revenue to no good purpose.

Sadly the list of examples of poor policy could be greatly extended. And if one were to include the failure to sort out existing problems then, despite some improvements made by both the current government and its predecessor, it could be extended over many pages.

And this all matters. Complexity, uncertainty and inefficiency in a tax system which takes £4 in every £10 generated in the economy costs a huge amount in lower welfare, less economic output and straightforward inequity. Even if we can’t have perfection something close to coherence and consistency would be nice. In the words of former US Treasury Secretary William Simon we should have a tax system which looks “like someone designed it on purpose”. That feels like a low benchmark, but it is one we are a long way from meeting.