Simplicity would be the ultimate tax freedom

Wednesday May 28 was “tax freedom day”. That’s the point in the year, according to the Adam Smith Institute, where the average Briton stops effectively working for the government.

It’s a date extrapolated largely for public relations purposes by an organisation that espouses lower taxes and a smaller state. I think the immediate problem with tax is not its quantum (though less would of course be nice) but its complexity, so I’ve contrived my own rival date: May 14.

That’s because starting on New Year’s Day, assuming an average reading speed of 260 words per minute, and a reading day of 12 hours, it would take until mid-May to read the whole of Tolley’s Tax Guide — assuming that the reader didn’t die of boredom some time during February.

Tolley’s is the definitive reference work on UK tax. When Labour came to power in 1997, it was just under 5,000 pages long. By the time Gordon Brown was ejected from Downing Street in 2010, it had swelled to almost 12,000 pages. The coalition came to power promising to simplify the tax system, and even set up a promisingly-named Office of Tax Simplification. But the guide carried on growing and is now around 18,000 pages.

In fairness, a lot of that wordage is examples, explanations and footnotes rather than actual legislation. But few dispute that the UK tax code is among the most complex in the world, and that’s bad. It creates perverse incentives and ample opportunity for evasion and avoidance.

What could be done to simplify it? Top of my list of reforms would be to merge income tax and national insurance, something rejected as “too complex” in the past.

National insurance is an anachronism, based on weekly earnings and devised in 1911, when it was intended as insurance in the true sense of that word. Yet it now accounts for almost a fifth of government tax revenue and should be recognised for what it is — income tax.

Many lower earners lifted out of income tax by a higher personal allowance still pay national insurance “contributions” as they are levied on earnings over £7,956 per year.

Combining NICs and income tax would shine unwelcome light on the true level of deductions from an employee’s pay packet, which may be one reason that it hasn’t happened. Reform would also offer an opportunity to halt the “fiscal drag” of recent years, and end distortions such as the tapering of the personal allowance, where those earning between £100,000 and £121,000 pay a marginal income tax rate of 60 per cent.

Then there’s property. Currently, the government raises £12.7bn a year via stamp duty land tax, a crude levy on purchasers that creates distortions in the property market. Local authorities collect council tax under a system rushed into operation by Michael Heseltine in 1992 to replace the politically disastrous poll tax, and based on property valuations that are over 20 years old.

Many tax experts think some kind of land value tax — based on a property’s location rather than its size — is the best way to tax property. But even the alternatives such as mansion taxes and extra council tax bands would be an improvement on the current shambolic system.

Recent fiddling with capital gains tax (CGT) has been counterproductive. The highest rate at which this is levied — 28 per cent — is below the highest rates of income tax. That’s resulted in all sorts of financial engineering designed to convert income into capital gains. More harmonised rates would make more sense and, if combined with some form of indexation (abolished in 2008), could encourage more long-term investing.

More logical treatment of property and capital gains would allow inheritance tax (IHT) to be sorted out. I cannot find much fault with the idea, espoused in FT Money lately, that inheritances should be taxed at the marginal rate of the recipient rather than the deceased.

What chance of any of the above happening? Very slim indeed. Reform of IHT, CGT and land value taxes are Liberal Democrat policy aspirations. The Conservatives have hinted at raising the IHT threshold. Labour would reintroduce the 10p and 50p rates and tax high-value homes. As for Ukip, its tax policy was written by Godfrey Bloom (of “sluts” fame) and has been discarded. It is committed to abolishing IHT.

When I asked a Treasury minister recently about fiscal reform, he responded that simplifying tax always creates winners and losers. The losers tend to be vocal and the weak state of public finances means it’s hard to compensate them in another way. An answer that was both refreshingly candid, and depressingly familiar.

Financial Times