George Bull

Written by: George Bull

George Bull

Senior Tax Partner

Supporting the welfare state - do more people need to pay more taxes but at lower rates?

We’ve previously expressed concerns that the reduction in the number of UK taxpayers represents a reduction in the size of the UK tax base. To put it another way, if we carry on like this then the Exchequer simply won’t have the annual funding necessary for critical expenditure such as the welfare state.

Two recent documents throw a fresh spotlight on this thorny issue.

First, the Institute for Public Policy Research has published its report Tapering over the tax – reforming taxation of income in the UK. Looking in detail at the way the current tax system applies to individuals, the IPPR concludes that the taxation of individual incomes combines two different tax regimes, for income tax and employees’ national insurance contributions (NICs). This produces a complicated landscape of different tax rates, bands, thresholds, allowances and reliefs. However you look at it, the UK’s current tax system performs poorly in terms of efficiency, progressivity and coherence.

While the IPPR avoids bandying around too many numbers, the report notes that on average the poorest 20 per cent of households pay 35 per cent of their gross income in tax, far more than the average for all other households. It is also well recognised that the top 1 per cent of income taxpayers already pay around 27 per cent of all income tax. Such lumpiness in the tax system creates suspicion and disharmony, producing disunity instead of contributing to social cohesion.

The IPPR goes on to make two key recommendations. First, income tax and employee NICs should be amalgamated into a single rate and applied to all incomes on an individual, annual basis. This will apply to all types of income whether earned or unearned. Next, the present system of marginal tax bands should be replaced with a formula-based system. The effect would be that the marginal rate of income tax paid by an individual would rise slowly between a new tax-free allowance and a new threshold for the top marginal rate. Every person’s effective rate of income tax would depend on their own precise level of income.

Second, the Institute for Fiscal Studies (IFS) has published a document on Tax reliefs: look for the tax design behind the big numbers. This addresses the emotive topic of the cost of the various annual tax reliefs available within the UK tax system. It’s estimated that these amount to around £400bn. When compared with total government spending of around £800bn, it’s tempting for people to call for these reliefs to be curtailed. After all, that would be easy money, wouldn’t it?

Interestingly, the three most valuable – or expensive, depending which way you look at it - tax reliefs aren’t those focused on wealthy individuals or large corporations. They are the income tax personal allowance (a little over £100bn), VAT zero rating and exemptions (a little less than £100bn) and the primary and secondary NICs thresholds (more than £50bn). Cutting these would increase the disproportionate tax burden already borne by low-income households as identified in the IPPR report.

Reading the two documents together, highlights the absence of easy solutions to this conundrum. However, the IFS notes that a good tax system has a broad base and low rates. That makes a lot of sense: as taxes influence individual behaviours, spreading taxes means that distortions are not skewed towards one part of the tax base. It also means that there are fewer incentives and opportunities for tax avoidance.

While nobody pretends that there is a magic-bullet solution, I find it very encouraging that the IPPR and the IFS have signposted simple approaches which, if adopted by parliamentarians, would offer the real prospect of positive reform.

Will this happen? 

I had hoped to end on a positive note but I cannot. There is a powerful argument that many of the problems with the gig economy, problems which among other things led to Matthew Taylor’s report Good Work, arose precisely because income from self-employment is subject to income tax and NICs in a way different from earnings from employment. You would think from this that a key component of the government’s response to the Taylor report would be to pave the way for integrating income tax and NIC. Far from it; Chancellor of the Exchequer Philip Hammond’s first attempt to make small changes to the NIC regime for the self-employed were quickly reversed by the Prime Minister’s office. 

Now a consultation on employment status has been instituted jointly by the three government powerhouses of HM Treasury - responsible for the Modern Industrial Strategy with its productivity improvement agenda, thereby emphasising the central role that employment status plays in productivity issues -  by HMRC and by BEIS. In terms of tax status, this government consultation seeks views on whether employment rights identifiers remain the correct categorisation for employment tax treatment or whether there should, as Taylor proposed, be a closer alignment of tax to the working activity rather than the employment rights nomenclature. At the same time, the consultation rejects the proposal to reduce the difference between the NICs of employees and the self-employed and specifically states there are no plans to revisit this issue. So time will tell whether the Taylor concept of aligning tax to working activity is the government’s route to tax alignment whilst on the face of ruling that out!

In the short term the whole issue has now been kicked into the long grass. That is not acceptable. UK taxpayers deserve better than this.

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