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This particular paper aims to contribute the discussion for simplification and rationalisation of taxes and also to review new approaches to tax policy making. The report is based on three significant sections. Section I provides the insights to identify key issues which have resulted in the need to rationalise the current tax system. In section II, the attempt has been made to identify areas which focus on the reform of income taxation and its impact on the incentive to work by evaluating the issues. Finally, section III consists of a set of recommendations to policy makers and points for further consideration to ensure the success of any further changes by the Government.
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UK TAX SYSTEM
Identification of the key issues which have resulted in the need to rationalise
the current tax system of United Kingdom
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TABLE OF CONTENTS
1. INTRODUCTION -------------------------------------------------------------------------------------------- 2
2. KEY ISSUES IN CURRENT TAX SYSTEM --------------------------------------------------------------- 2
3. REFORM SCENARIO --------------------------------------------------------------------------------------- 4
3.1 AREAS OF CONCERN ---------------------------------------------------------------------------- 4
3.2 EVALUATION OF ISSUES ------------------------------------------------------------------------ 5
3.3 IMPACTS ON INCENTIVE TO WORK ----------------------------------------------------------- 6
4. RECOMMENDATIONS & CONCLUSION -------------------------------------------------------------- 7
REFERENCES --------------------------------------------------------------------------------------------------- 9
APPENDIX I:
TABLE1: DISTRIBUTION OF VAT AMONG VARIOUS PRODUCTS ------------------------------ 11
TABLE2: MEAN PTR FOR DIFFERENT DEMOGRAPHIC GROUPS (1997 – 2010) -------------- 12
TABLE3: MEAN EMTR FOR DIFFERENT DEMOGRAPHIC GROUPS (1997 – 2010) ----------- 12
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1- INTRODUCTION
The tax system of every country is based on its national income. The tax rate also vary
from country to country; for example, some countries charge 30% taxes and some impose
nearly 50% overall taxes. Basically, it depends on how the tax system of a particular
country has been designed. It is very rare that policy makers consider redesigning the
whole tax system, but improvements and tax reforms are regular actions performed by
every government. At present, UK government wish to reduce inequality in the tax
system and for that purpose the Government has established an Office of Tax
Simplification to provide government an independent advice on simplifying current
taxation system in UK.
This particular paper aims to contribute the discussion for simplification and
rationalisation of taxes and also to review new approaches to tax policy making. The
report is based on three significant sections. Section I provides the insights to identify key
issues which have resulted in the need to rationalise the current tax system. In section II,
the attempt has been made to identify areas which focus on the reform of income taxation
and its impact on the incentive to work by evaluating the issues. Finally, section III
consists of a set of recommendations to policy makers and points for further consideration
to ensure the success of any further changes by the Government.
2- KEY ISSUES IN CURRENT TAX SYSTEM
The current tax system of UK is designed for the improvement and welfare of Britain’s
people and economy but according to Mirrlees review, the present tax systems is costly
and inequitable because it dejects saving and investment (Mirrlees et al., 2010). The
major issues which have resulted in the need to rationalise the current tax system can be
classified into 6 types of taxes: income taxes, indirect taxes, housing taxes, environmental
taxes, saving taxes, and business taxes.
The current income tax system in UK is confusing and gratuitously multifaceted that
divides earning tax into two separate taxes: Income Tax and National Insurance
Contribution; and both taxes are intensifying year-by-year. According to recent changes
in income tax rates and taxable bands for 2010-11, the marginal rate has increased on
incomes between £37,401 and £150,000, and it will go up again during 2012-13 (HMRC,
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2010). National Insurance Contribution (NIC) is another form of Income Tax which
entitles individuals to contribute social security benefits (Jin et al., 2010). According to
the survey studies, from 1979 to 2011, National Insurance contribution increased from
6.5% to 12.8% (Adam and Browne, 2011).
Many changes can be seen in Value Added Tax (VAT) from past three decades. In the
context of implications of VAT as an indirect tax, two common issues are incentives and
redistribution. Adam and Browne (2011) state that rationalizing income tax will not take
effect until the prices of commodities and services will go down due to cut in
consumption tax because if the prices will remain same or increase with equal
percentages, the tax burden will transfer from one end to another end.
The redistribution of VAT is another issue which was raised in Mirrlees launch in 2010.
As compare to other developed countries, UK applies zero rates to few items such as
foods, books, and children clothing in order to give relief to people with low incomes, but
according to Mirrlees review (Mirrlees et al., 2010) it is an inefficient and expensive
approach of tax distribution because VAT cannot detached from the entire tax system.
Similarly, the VAT rate of domestic fuel and power has also diminished from 8% to 5%
recently to cover multiple women and children related products. This redistribution of
VAT among zero-rated, reduce-rated, and exempted products brought many
inconsistencies in entire tax system. Table 1 is showing the estimated costs of VAT
distribution from 2010 to 2011.
[TABLE 1]
The taxation system for housing market is also designed badly with no clear economic
rationale for stamp duty, and the threshold system is subject to create inefficiencies in
housing market (Mirrlees et al., 2011). The band system of stamp duty identifies the
liability of buyers to pay higher rates of duty on the total value of their properties once the
thresholds of rates are increased (Crawshaw, 2009). This causes a quick rise in duty
amount payable at each threshold. Similarly, many people with low and high incomes pay
council tax on regular basis. The council rate is determined on the basis of 20 years old
system when housing market was entirely different (Crawshaw, 2009; IFS, 2010).
In UK, 90% environmental taxes are concerned with motoring including high fuel tax and
vehicle excise duty and after 1994, three additional environmental taxes have been
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imposed on landfill, industrial energy use, and extraction of aggregates (Adam and
Browne, 2011). The major problem with environmental taxes is to determine the rate at
which the tax is charged especially in case of carbon emissions because of its complexity
and uncertainty (The Treasury Committee, 2008).
According to Mirrlees et al. (2010), the taxation on saving and wealth is also inequitable
and inefficient because of absence of any reliable tax base. In addition, different forms of
savings such as dividends, shares, foreign savings, and bank & building society accounts,
are taxed at different rates.
Another issue in the current tax system of UK belongs to corporate tax which favours
debt financing and discourages the investment by equity (Mirrlees et al., 2011). One of
the major problems in corporate taxes is that the rate at which the profits are taxed is not
uniform and also not properly allied with personal tax system (Mirrlees et al., 2011). This
inconsistency in corporate tax system is creating more complexities and avoidance
opportunities in the whole tax system.
3- REFORM SCENARIO
3.1 AREAS OF CONCERN
Since 1997, few changes to income tax have occurred. For example, the lower rate of
20% was replaced with 10% starting rate in April 1999 and then was abolished in April
2008 (Browne and Phillips, 2010). Another change occurred recently when new
additional rate of 50% has introduced by the Government applicable on income over
£150,000 (HMRC, 2010). On the other hand, in past two decades, two momentous taxes,
mortgage interest and married couple’s allowance were abolished (Browne and Phillips,
2010).
In 1997, there was no NIC on earnings of less than £62 per week but later on 2% NIC was
imposed on employees and 3% on employers. One of the first major changes in National
Insurance Contribution was the abolition of ‘entry rate’ for both employers and
employees in 1999. In 2003, NIC was announced as second tax on earnings that made tax
system more opaque, difficult, and expensive (Browne and Phillips, 2010). According to
Adam and Browne (2011), since 1997, NIC increased from 10% to 12.8%.
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From 1997 to 2002, the corporation tax reduced from 33% to 30% for big enterprises and
for small firms/business it fell from 24% to 19% (HM Treasury, 2003). In the budget of
2007, the main corporate tax rate was again condensed to 28% with a decrease in the rate
of capital and machinery from 25% to 20% (Browne and Phillips, 2010). Not just in UK
but other OECD countries are also practicing corporate tax reforms from past three
decades. Such reforms include the establishment of allowances for corporate equity in
Italy and Austria and elimination of split rate in Japan and Germany (Griffith and Klemm,
2004).
3.2 EVALUATION OF ISSUES
It is clearly evident, that income tax and NIC are two important elements of taxation on
earnings, but both have different sources and objectives. In 2010/2011, the total receipts
from income tax were £153.5 billion whereas total receipts of National Insurance
Contribution were £96.5 billion (Office of National Statistics, 2011). In order to simplify
and rationalise the current tax system, the Government wants to identify the proposals
that will: reduce burdens on employers, remove distortions in the economy, improve
transparency, deliver fairer outcomes, and reduce administrative cost of government (HM
Treasury, 2011).
By following the simplification and rationalization policy of Government, Mirrlees
review recommends to merge NIC with income tax in order to avoid confusion and
complexity (Mirrlees et al., 2011). According to Mirrlees et al. (2010), there is a need to
introduce single integrated benefit in order to replace most of the current and previous
multiplicity benefits by rationalising the way in which total support varies with income
and other characteristics. Merging these two taxes is a major issue that will bring many
challenges for the government and will also carry various impacts on incentive to work.
In order to reduce the burdens for employers, the government is working on to introduce
Real Time Information to make PAYE simpler and efficient. In addition, call for evidence
also emphasized on the issue of different assessment periods for income tax and NIC
(HM Treasury, 2011). In this context, the government is already taken few steps to
facilitate employers. For example, now P11 form is covering earning taxes, income tax
and National Insurance Contribution.
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In removing distortion in the economy and to improve transparency, the reformation of
NIC and income tax may play an imperative role. The integration of earning taxes may
stop employers to pay employees in certain ways and it could be easier for employers and
employees to understand the way how to calculate income tax liabilities (Mirrlees et al.,
2011). Similarly, individuals will also have clear understanding about benefits
entitlements. Mirrlees et al. (2010) highlight the fact that current tax system is not fair for
employees who work for multiple employers. Working on this issue is a great challenge
for the government because it can create tension between the principles. According to
stakeholders and Mirrlees et al. (2010), the impacts of operation on NIC and income tax
may have adverse effects on employees and employers if not designed carefully.
3.3 IMPACTS ON INCENTIVE TO WORK
The changes in NIC to match income tax structure on annual, semi-annual, and collective
basis will end up with different liabilities to different individuals. According to the survey
of Office of National Statistics (2011), nearly 9 million people work less than a whole
year and roughly 3 million people work for more than one employer at the same time. In
addition, the earnings of over 7 million individuals are not uniform. Therefore, some of
these people will pay less and others will pay more NIC tax if one threshold of National
Insurance Contribution will be applicable.
The impacts of changes in NIC and income tax can be determined in two ways:
Participation Tax Rate (PTR) where the proportion of total incomes taken in tax and
withdrawn benefits, and Effective Marginal Tax Rate (EMTR) where proportion of a
small increase in incomes taken in the tax and withdrawn benefits (Mirrlees et al., 2010).
In calculating both formulas, higher figures indicate weaker incentives. For example, the
higher figures of PTR means ‘unemployment trap’ and similarly higher EMTR represents
low income families (‘poverty trap’). To see the impact of reforms on work to incentives,
Browne and Phillips (2010) calculated PTR for each demographic group from 1997 to
2010. Table2 is representing the means of PTR.
[TABLE 2]
In table 2, it is shown that PTRs for individuals without kids have not been affected from
tax and benefit reforms. The work to incentive of Lone parent (whose partner does not
work) is strengthening and the means PTR of couples with children (whose partner does
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work) are rising as a result of tax reforms. From the calculation of PTR it is clear that tax
reforms are affecting the demographic groups.
Table 3 is demonstrating the means of EMTR of each group from 1997 to 2010. As a
whole, tax and benefit reforms cause to weaken the incentive to work for all demographic
groups with small variations. One important variation in the EMTR average can be seen
for parents without kids when EMTR increased little as a result of tax reforms in 2005,
but this average reduced with the reform in April 2008 when there was a cut in basic rate
of income tax.
[TABLE 3]
In summarizing the whole fact, it can be said that tax reforms in the past have slightly
weaken the incentive to work for people with low incomes, and on the other hand, small
reliefs in income tax caused a slight increase in earnings of the workers. Specifically, the
incentives to work for both partners (working couples) has been weaken, and in contrast,
big rise in the number of workers with high EMTR as a result of extension of in-work
benefits and tax credits in 1997 (Adam et al., 2010). Conclusively, the impact of tax
reforms is different on each demographic group. For example, the incentive to work for
those who had weakest incentive to work, such as lone parents, has strengthened.
Alternatively, single adults with no kids faced strongest incentives.
4- RECOMMENDATIONS AND CONCLUSION
In the previous sections, some major issues and improvements in tax system have been
discussed to critically evaluate the steps the coalition government is taking. In addition, in
this research the attempt has been made to identify areas which focus on reform of
income taxation and its impacts on the incentive to work. In this section, the attempt will
be made to formulate a set of recommendations by considering contemporary and
proposed developments in taxation.
A number of proposals have been given to the Government to reform the tax system but
the proposal of Mirrlees et al. (2010) in November has great significance. In this review,
numbers of recommendations were made to the policy makers for the simplification of
tax system. The following set of key recommendations is based on Mirrlees review of
2010:
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1. Integration of income tax and National Insurance Contribution to avoid confusion
and complexity
2. VAT should be applicable on all products and services including financial services
3. The policy makers may consider to abolish stamp duty and reform council tax
based on present value of the property
4. The tax on standard bank and building society should be abolished
5. The attempt should be made to associate corporate tax with personal taxes
6. The introduction of allowance for corporate equity may result to increase 1.4%
(approximately £20 billion) in the national income
7. The treatment of three types of tax systems should bring into line; employment,
self-employment, and corporate-source income
Mirrlees et al. (2010)
The above proposal looks ambitious that may cause to eradicate many tax confusions. In
fact, the Government is currently undertaking careful consideration for merging NIC with
income tax. In order to proceed with any further reform, the Government needs to ensure
the effects of reforms on stakeholders. In addition, the Government should need to work
with stakeholders in assessing the costs and benefits of any further reforms in the taxation
system, to ensure the affordability.
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REFERENCES
Adam, S. and Browne, J., (2011). A survey of UK tax system, IFS briefing note 9, [online],
available from: http://www.ifs.org.uk/bns/bn09.pdf [Accessed: 04 Feb 2012]
Adam, S., Brewer, M. and Shephard, A., (2006). The poverty trade-off: work incentives and
income distribution in Britain, Institute of Fiscal Studies, [online], available from:
http://www.jrf.org.uk/sites/files/jrf/1590-poverty-benefits-taxation.pdf [Accessed: 08 Feb
2012]
Adam, S., Brewer, M. and Shephard, A., (2010). Financial work incentives in Britain –
comparisons overtime and between family types, Institute of Fiscal Studies, [online],
available from: http://www.jrf.org.uk/sites/files/jrf/1590-poverty-benefits-taxation.pdf
[Accessed: 08 Feb 2012]
Blundell, R., (2000). Work incentives and ‘in-work’ benefit reforms: a review, Oxford
University Press, 16(1), pp. 27-44
Browne, J. and Phillips, D., (2010). Tax and benefits reforms under labour, IFS briefing note
88, [online], available from: http://www.ifs.org.uk/bns/bn88.pdf [Accessed: 07 Feb 2012]
Crawshaw, T., (2009). Rethinking housing taxation: options for reform, Shelter policy
discussion paper, [online], available from:
http://england.shelter.org.uk/__data/assets/pdf_file/0003/224472/Rethinking_Housing_Taxa
tion.pdf [Accessed: 04 Feb 2012]
Griffith, R. and Klemm, A., (2004). What has been the tax competition experience of the last
20 years? Institute of Fiscal Studies, [online], available from:
http://eprints.ucl.ac.uk/2900/1/2900.pdf [Accessed: 09 Feb 2012]
HM Revenue and Customs, (2010). Income tax rates and taxable bands, [online], available
from: http://www.hmrc.gov.uk/rates/it.htm#2 [Accessed: 04 Feb 2012]
HM Treasury, (2003). Corporation tax reform: a consultation document, HM Revenue and
Customs [online], available from: http://www.hmrc.gov.uk/consult_new/corp-tax-reform.pdf
[Accessed: 07 Feb 2012]
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HM Treasury, (2010). Tax policy making: a new approach, HM Revenue and Customs,
[online], available from: http://www.hm-
treasury.gov.uk/d/junebudget_tax_policy_making.pdf [Accessed: 07 Feb 2012]
HM Treasury, (2011). Integrating the operation of Income Tax and National Insurance
contributions, HM Revenue and Customs, [online], available from: http://www.hm-
treasury.gov.uk/d/condoc_integration_it_nics_contributions.pdf [Accessed: 07 Feb 2012]
Jin, W., Levell, P. and Phillips, D., (2010). A survey of UK benefit system, IFS briefing note
13, [online], available from: http://www.ifs.org.uk/bns/bn13.pdf [Accessed: 05 Feb 2012]
Mirrlees, J. Adam, S., Besley, T., Blundell, R., Bond, S., Chote, R., Gammie, M., Johnson,
P., Myles, G., and Poterba, J., (2010). Tax by Design - The Mirrlees Review, Institute of
Fiscal Studies, [online], available from:
http://www.ifs.org.uk/mirrleesreview/design/taxbydesign.pdf [Accessed: 03 Feb 2012]
Mirrlees, J. Adam, S., Besley, T., Blundell, R., Bond, S., Chote, R., Gammie, M., Johnson,
P., Myles, G., and Poterba, J., (2011). Mirrlees review of tax system, Institute of Fiscal
Studies, [online], available from: http://www.ifs.org.uk/pr/mirrlees_sept11.pdf [Accessed:
03 Feb 2012]
Office of National Statistics (ONS), (2011). Labour marketing statistics – December 2011,
Statistical Bulletin, [online], available from:
http://www.ons.gov.uk/ons/dcp171778_247485.pdf [Accessed: 08 Feb 2012]
Office of National Statistics (ONS), (2011). Public sector finances – November 2011,
Statistical Bulletin, [online], available from:
http://www.ons.gov.uk/ons/dcp171778_247485.pdf [Accessed: 08 Feb 2012]
The Treasury Committee, (2008). Treasury – Fourth Report, House of Commons, [online],
available from:
http://www.publications.parliament.uk/pa/cm200708/cmselect/cmtreasy/231/23102.htm
[Accessed: 06 Feb 2012]
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APPENDIX I
TABLE 1: Distribution of VAT among various products
Source: Adam and Browne (2011, p. 16)
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TABLE 2: Mean PTR for different demographic groups (1997 – 2010)
Source: Browne and Phillips (2010)
TABLE 3: Mean EMTR for different demographic groups (1997 – 2010)
Source: Browne and Phillips (2010)
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