Reform the tax system and rein in government spending

The issue of tax avoidance cannot be divorced from the nature of the tax system, and that in turn cannot sensibly be discussed without thinking about what governments spend.

We have a hugely complicated system of corporate and personal taxation, and a tax code which is reputed to be one of the longest in the world at some 11,000 pages. The complications inherent in this system involve the creation of schemes to ensure that people and organisations who are not supposed to pay tax avoid doing so out of ignorance. Churches and other charities, which incidentally avoid about £4 billion of taxes every year as a result of their status, employ people to ensure that they gain all the exemption to which they are entitled. Every time we donate to a charity and it claims gift aid we are involved in tax avoidance.

Most attention focuses on corporations, of course. But here are strong arguments for saying that we should not have a system of corporate taxation at all – we didn’t until the 1950s. Corporations are legal fictions, not people. They are owned by shareholders. If there were no corporation tax, individual shareholders would pay income tax on increased dividends. Shares owned by pension funds and other financial intermediaries produce incomes for individuals who would then pay tax. Income which is not returned to shareholders goes to investments which generate incomes for individuals.

It is harder for individuals to avoid income tax than it is for corporations to avoid corporation tax. Scrapping corporation tax would largely be offset by increases in income tax, particularly since there is a net inflow of property income in this country: we own more corporate assets abroad than other countries’ residents own UK corporate assets.

Of course income tax itself needs reform. It is too complicated and there are too many exemptions. We should also merge it with national insurance, since there is no meaningful national insurance fund and the system misleads people into thinking that there is a distinction between employers and employees’ contributions. There is in reality no economic distinction between them: both fall on individuals, reducing their take-home pay (and also reducing employment). They also add substantially to the administrative costs of the system.

Income tax can in principle be progressive: in practice it is a crazy hotchpotch, with marginal tax rates rising and falling in bizarre ways as means-tested benefits and personal allowances are withdrawn. Something approaching a simple negative income tax would be much easier to administer and understand than the present system.

As for expenditure taxes (VAT and excise duties): we have increased our reliance on them in recent decades and they now raise three or four times as much as corporation tax and virtually the same amount as income tax. Yet they are regressive, with the heaviest burden falling on the poorest: ‘sin taxes’ on alcohol and tobacco are the most notorious examples.

So the tax system needs reform: but so too does government spending. Far too much of this spending simply involves recycling taxpayers’ money back into their own pockets – but with added administrative costs. I currently pay taxes but receive back ‘free’ travel with bus pass. I am entitled to ‘free’ winter fuel allowance and my daughter gets a ‘free’ 15 hours of nursery a week and will shortly be given ‘free’ school lunches. Why exactly? Much of our enormous (and expensive) tax and spend machine simply gives us our own money back in terms of services which we might have bought anyway – but would have preferred a choice.

The coalition government has made noises about attacking tax havens and preventing multinational firms from directing their profits to low-tax jurisdictions. I doubt it has the will to do this, and I’m sure it hasn’t the ability to do it in isolation. Can international action succeed? Again it seems doubtful. To a degree this is a zero-sum game: if the UK squeezes more tax out of Starbucks, less tax is paid in the USA or the Netherlands or wherever the coffee shop chain is currently hanging its corporate hat. Even ignoring this, the experience of international negotiations over carbon emissions surely shows the difficulties involved.

For the UK I am quite sure there is not a pot of gold which would relieve us of our need to rein in our spending. Corporation tax will bring in just under £40 billion this year. Suppose by some unspecified miracle we could increase that by 50% in one year with no adverse effects. Then suppose we could dramatically raise income tax on the 20,000 UK residents – the Jimmy Carrs and the Wayne Rooneys and so forth – with an income greater than £1 million a year. Let’s suppose, indeed, that we raised an extra half a million pounds a head from them on average (again a very optimistic assumption). Together the extra tax raised would be £30 billion. Not to be sneezed at, but less than a third of the projected deficit for this year. Or less than a seventh of our benefits bill.

The reality is that in a country with 60 million people a policy of squeezing money out of the rich and out of large corporations is not going to serve to cover all the things people want to spend public money on. The burden must inevitably fall on the average taxpayer in the long run, particularly if, as we see just across the channel, the rich resist expropriation and head somewhere more congenial. And the only way taxpayers can pay more, even if they are willing, is for productivity to increase – and this means encouraging, not discouraging business.

Editorial and Research Fellow

Len Shackleton is an Editorial and Research Fellow at the IEA and Professor of Economics at the University of Buckingham. He was previously Dean of the Royal Docks Business School at the University of East London and prior to that was Dean of the Westminster Business School. He has also taught at Queen Mary, University of London and worked as an economist in the Civil Service. His research interests are primarily in the economics of labour markets. He has worked with many think tanks, most closely with the Institute of Economic Affairs, where he is an Economics Fellow. He edits the journal Economic Affairs, which is co-published by the IEA and the University of Buckingham.

5 thoughts on “Reform the tax system and rein in government spending”

  1. Posted 02/12/2013 at 13:54 | Permalink

    As long as governments produce annual Finance Bills of more than six hundred pages (sic) I find it impossible to believe they are serious about ‘simplifying’ the UK tax system. To quote innumerable government spokesmen, some ‘difficult decisions’ need to be made. In particular, to enable total taxes to fall, government spending must be radically reduced. There’s never an ‘easy’ time to do this, but I’ve been waiting more than half a century and see precious little sign of progress. No wonder the British government (like so many others) is bankrupt — in the sense that it is unable to repay its debts in real terms. On the contrary, it is in the process of rapidly increasing its debts still further. It is easy to see why the government — easily the largest debtor in our economy — is keen on very low interest rates.

  2. Posted 02/12/2013 at 15:12 | Permalink

    Please flesh out your negative income tax idea, my tax reforms would be to double the inheritance tax threshold & halve the rate. To have a flat rate of 25% income tax, corporation tax & capital gains tax after a £12,500 threshold & have a negative income tax for UK citizens of £6000 a year paid at £2000 every 3 months once someone’s combined earnings & negative income tax/minumum income reached the £12,500 mark they would be taxed at 25% which would be taken from their negative income tax/minimum income money until they no longer needed the £6000 a year. Of course all tax credits, JSA, income support etc. would be abolished.

  3. Posted 02/12/2013 at 18:33 | Permalink

    The bare bones of the arguement are without question but, why might you think that the consumer pays VAT anymore than the consumer pays raw material costs or rents and rates or wages and salaries?

    Taxes fall upon the employers and the cost, as with all other costs fall upon the consumer. As Shakespear said, a rose by any other name….

    When taxes rise to beyond fifty percent as they have in the UK they are an absolute: an absolute in all respects and a relative disincentive.

    So, what to do? A tax on turnover. One page and a couple of Civil Servants to oversee it.

    Where’s the problem?

    Well, the problem lies with the level of taxation and the fact that a tax on turnover would strip away the obfuscation that goes with it.

  4. Posted 03/12/2013 at 11:04 | Permalink

    Nice leader by Alistair Heath in CityAM today emphasises the point that employers’ NI falls on the employee.

  5. Posted 26/07/2014 at 15:11 | Permalink

    What should be government priorities be when they have large debts? –

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