The case for UK tax reform

With Brexit on the horizon, now is the time to revise our taxation system, argues Staffordshire University law student Naz Khan

Death and taxes are every British citizen’s inevitable fate. A stable tax system that raises revenues in an efficient manner while taxing similar individuals fairly is necessary. However, there are long-standing problems with the UK tax system.

For example, an increasing number of people are now self-employed and so can receive their income through dividends. Profits and dividends are more lightly taxed than employment income. Furthermore, upward pressure on public spending and social care is growing in line with an ageing population.

Future governments will be able to avoid the question of reform due to these ongoing economic trends, which are undermining the revenue-raising capacity and transparency of the tax system.

Whether tax reform is necessary to make the national system simpler and fairer is a given. The bigger question is how far — and how quickly — the antiquated and inherently unbalanced tax system can be reformed into a truly workable and equitable taxation structure.

In 2012, the exhaustive Mirrlees Review established beyond any sensible doubt what British taxpayers appreciate every year they file their returns — the system is broken beyond salvation. Three areas identified by the Mirrlees Review will be discussed below: (1) VAT (value-added tax); (2) income disparity; and (3) tax havens.

VAT

In theory, VAT has many virtues and few flaws in terms of its inherent tax fairness implications. Unlike estate taxes that perniciously prey on the deceased who lack foresight or capital gains tax that punishes the fortunate, the VAT has beauty in its simplicity — the more individual taxpayers consume, the more tax they pay. In this sense, VAT is resolutely fair.

However, theory and practical effects are not always aligned within the VAT sphere. VAT is charged on an unusually small share of goods sold in the UK, compared to other countries. This creates incentives for businesses to expend time and effort trying to prove that their goods should not pay VAT. The 1991 McVities ‘Jaffa Cakes’ tax ruling exemplifies VAT absurdity. If these confections were classified as cake, no VAT was charged, but if they were defined as a biscuit, VAT applied.

These consumption taxes are more proportionately impactful on low-income persons than those who are wealthy. Various schemes have been proposed whereby VAT could be offset by credits, or other means that would reduce its impact on lower income people. None have been implemented to any meaningful effect, and the VAT system remains inconsistent in its application. Economist James Mirrlees put forward a reasonable case for broadening the current VAT base, but his recommendations have not been implemented out of apparent fears of political backlash. Indeed, former Chancellor George Osborne attempted to widen the VAT base in 2012, applying the tax to pasties and static caravans but both proposals were quickly reversed. This is typical of the inertia that has characterised all UK tax reform initiatives.

Income disparity

How to reduce the gap that has been identified globally for decades as existing between the top 1% income bracket and regular wage earners is arguably far more challenging than solving VAT inequities. There is no avoiding our economic system reality — some people earn far more money than others. We live in (and have largely profited from) a capitalist society where hard work, initiative, and innovation are rewarded. Any other system will naturally collapse over time.

But UK income disparity realities cannot be brushed aside so easily. The flipside of wealth that was perhaps initially generated by hard work and personal initiative is income tax avoidance (and the tax havens discussed below). Human nature is simple in this respect. People who have strived to succeed financially are equally resistant to the notion that they should pay maximum personal tax rates. It is here the current tax system unfairness strikes its cruellest blow. A family with two wage earners, two children, and the assorted obligations of childcare, mortgage payments, vehicles, and simply ‘making ends meet’ cannot sensibly set up accountant-approved trust funds and other legitimate tax avoidance options. This is the 2019 British middle class, one that is now increasingly assuming another burden — unpaid, and profoundly unrecognised caregiver services provided to their aging parents.

A typical scenario readily illustrates this point. Family X has their widowed mother Y living alone, but she requires care beyond what the local authority can reasonably provide. X members can adjust their respective work schedules but they are paying a financial and personal cost that is not effectively captured by UK tax system rebates. The wealthy can pay for professional caregivers, and deduct such expenses from their annual tax burden. Inequity abounds.

Tax havens

In many respects, the ongoing publicity that offshore tax havens attracted in the now-infamous Panama Papers scandal has reinforced the very sound tax reform suggestions Mirrlees made in 2012. From a tax fairness perspective, it is bad enough that mega-corporations can generate billions in profits, but then organise their subsidiaries in ways that leave them paying little to no UK tax. Amazon won £26 million in public contracts from the UK tax authority, HM Revenue & Customs (HMRC), despite only paying £1.7 million in corporation tax. It is worse when the wealthy can create family trusts and other devices that allow for assets to be hidden from HMRC. However, the core problem is an unwillingness to mandate tax system transparency — and the UK is not alone in this respect.

So long as the international community remains resistant to adopting common tax reporting methods, two outcomes that damage our economy will persist: (1) our national tax base will continue to erode, with fewer government services provided for people in need; (2) profit shifting and tax avoidance will frustrate the general public, increasing doubts that the government has any true commitment to tax system change.

However, the fact that other countries have the same problems as the UK does not mean that reforms cannot proceed. Some matters are entirely within UK government control, while others require working with the Organisation for Economic Cooperation and Development (OECD), and other international institutions to promote greater global tax policy coordination.

The seven years that have elapsed since the Mirrlees proposed reforms were published indicate the struggles to overcome the barriers to reform. Mirrlees not only identified the problems — they mapped out solutions in 2012 that remain valid, and entirely workable in 2019.

The much-mooted political gridlock that has gripped our democracy since (arguably) the June 2016 Brexit referendum outcome should have no particular bearing on solving long-term, systemic tax fairness problems. Before and after Brexit became a UK reality, successive governments have promised reforms, but ultimately failed to deliver on them because they sensed that reform would prove politically unpopular.

Both Jeremy Hunt and Boris Johnson have proposed reforms, promising to cut the rate of corporation tax by 6.5% in an attempt to boost economic growth and GDP, but there is little mention of a desire to address long-standing structural inefficiencies of the tax system.

There may be no better time than the present to take the reform steps set out above. If our relationship with the EU is being reformed, revising the tax system at the same time is well aligned with the new start the UK is poised to make as a nation.

Naz Khan is a final year undergraduate law student at Staffordshire University and an LLM candidate at Durham University. Upon completion of his masters, he aspires to work as a barrister.