KPMG: Britain’s tax system is having an identity crisis
Every so often a debate about UK tax policy cuts through into the media and public imagination, as we’ve seen in this last couple of weeks. The Health and Social Care levy has thrown a light on some big questions about how, and from whom, we raise money to fund the country’s public spending needs. For a tax professional like me these moments are refreshing, but it’s usually not long before they disappear from the front pages and into obscurity.
This is a shame. Over decades as successive governments have introduced, tweaked and repealed parts of our tax system it has evolved into a complex series of levies and reliefs that may have made political sense to introduce at the time, but once in place have proved difficult to reform.
Now that there is a degree of political consensus that taxes need to rise to fund post-pandemic spending, we have an opportunity to conduct a broader conversation about the “what” and the “how” of taxation.
The debate in recent days has focused on National Insurance. There are well-known distortions that arise from the way we charge it separately from income tax or taxes on investment income. It’s a tax with a confused identity: it’s not insurance, nor is it just like all other taxes: it is partly but not fully hypothecated. It starts at a lower level of income than income tax but contributions for individuals drop off significantly once income is over £50,000. It also looks very different depending on whether you’re employed or self-employed.
NI is not the only part of the tax system that has distortive effects. Often these distortions occur as a result of distinct steps or cliff-edges within the tax. For example, if an individual starts paying tax but at the same time has in-work benefits cut this can effectively cause “double taxation”. Similarly, when a worker earns over £100,000 the personal allowance tapers off leading to a marginal rate of tax of 62% (which will rise to 63.25% from April 2022). The VAT registration limit of £85,000 is a cliff-edge after which a business must charge 20% VAT which can significantly affect its price competitiveness if customers are not VAT registered. At the margins these kinds of anomalies affect economic decisions and can act as disincentives to growth.
This is not just another plea for tax simplification, or an argument in favour of one form of taxation over another. All taxes have aspects of unfairness. Sometimes the simplest can be the most distortive, and it is sensible for government to take a portfolio approach to revenue collection: not to put its eggs in too few baskets. The issue is that nobody can really explain why our tax system looks the way it does, or articulate how our mix of individual taxes is the right mix. It is an inheritance rather than a strategy.
Events like the economic crisis created by the pandemic, and the growing awareness of other critical issues such as climate change, intergenerational inequality and “levelling up” can be a catalyst for reform. A broader conversation about tax would provide an opportunity to challenge traditional thinking and ensure that the UK tax system is one that provides adequate services, promotes fairness and encourages innovation and growth. It could also be a chance to future-proof the tax system as we look towards increasing digitalisation and AI.
Tax needs to be viewed at the societal level. We should look again at the balance between the taxation of income and wealth, individuals and employers, employment and self-employment, local and national. We should consider whether we tax other areas such as property in the most efficient way and whether there is a case for further devolution of some aspects of tax and spending.
Tax policy can tend to divide rather than unite, but the pandemic has heightened the need for a grown up reassessment. It is a nettle worth grasping.