Low rates and flat taxes – why are we avoiding tax reform?
Lord Fink was recently ridiculed for arguing that everybody undertakes tax avoidance. However, to a large degree, that is true. Avoidance simply involves re-arranging your affairs or changing your behaviour with the purpose of paying less tax. The Church of England – a strong critic of tax avoidance – receives huge benefits from its status as a charity which go well beyond the gift aid scheme. People use the pension system, self-employed status, the rules relating to the importation of cigarettes from the EU and a wide range of other schemes to reduce tax bills. Labour and Conservative donors and prominent politicians alike have used yet more complex ways of reducing the tax they owe by exploiting trusts or capital gains tax wheezes.
It is clear that the public are not happy about this state of affairs. This is partly because politicians and the media – either wilfully or through incompetence – often mix up tax avoidance with tax evasion, the latter being a form of theft. However, people are also aggrieved at what they see as “aggressive” tax avoidance. Unfortunately, there is no hard and fast line one can draw between vanilla tax avoidance, vanilla with chocolate sauce tax avoidance and aggressive tax avoidance. Some people may believe they know aggressive avoidance when they see it but, in reality, the number of cases that fall into that category is small.
In fact, the use of tax avoidance strategies has benefits. It allows companies to circumnavigate very high rates of tax which discourage economic activity or avoid tax systems – of which there are many – which unintentionally tax some types of income twice. Nevertheless, the current position is neither desirable nor stable.
Tax loopholes distort the economy and their exploitation wastes talented people who should be doing something better with their time. If we want to reduce tax avoidance, there is an easy solution. We should simplify the tax system and hugely reduce the rates of the most punitive taxes such as inheritance tax. We could keep exemptions for charitable giving and limited pensions saving but we should stop there.
Furthermore, the whole system of corporate taxation needs to return to an economically rational basis. Instead of a labyrinthine system whereby accountants try to work out in which of several dozen jurisdictions a company has earned its profits, we should simply tax investors in a company on the returns they earn in the tax jurisdiction in which investors live. That is how corporations used to be taxed and how interest on corporate borrowing is taxed. At a stroke this would remove several of the most hotly disputed problems in the corporate tax system.
This article was first published in House Magazine.