The Chancellor’s Autumn Statement included a series of proposals to obstruct, reverse or frustrate various schemes for tax avoidance. As the Statement noted, despite earlier initiatives, “a minority of taxpayers continue to seek out unacceptable ways to reduce the amount of tax that they pay.” The persistence of avoidance activity highlights one aspect of the issue that has received relatively less attention in recent debates – how tax avoidance has implications for tax design.
Consider the Rolling Stones’ Exile on Main Street, recorded in the south of France following the band’s decision to leave England in spring 1971. Arguably the first notes of the album were written by the then Chancellor Roy Jenkins in his 1969 Budget. Mr Jenkins noted concerns that the taxes he had introduced on the very highest incomes were having a significant impact on incentives, but reversing them could only be seen as a ‘high priority’ for a later Budget. A high priority, perhaps, but it was not soon enough for the Stones.
In this case study, we can see three aspects to tax design:
- Incentives for work or leisure – the extent to which direct taxes on wages, profits, or capital gains acts as an incentive for individuals to change the balance between the time they spend making this money, and the time they spend enjoying it.
- Investment in avoidance – the degree to which individuals will invest time and money to mitigate the impact of taxes by changing their behaviour, purchasing tax planning, even taking steps to frustrate the intention of tax legislation – often by responding to announcements of policy prior to it coming into effect.
- Questions of domicile, decisions on residence – the way in which national tax systems interlock, and the degree to which one’s liability to one country as opposed to another may reflect a person’s nationality, the place they make their permanent home, or, more simply, where they are living and working at any given time.
Overall, the story shows the importance of taxpayers’ behavioural responses. Responses to tax changes will often have an impact on revenues which, in turn, will feed back into the policy-making process, setting new priorities. This presents considerable difficulties to any reforming Chancellor who is seeking to bring stability to the tax system.
The Rolling Stones’ decision to quit this country for the Continent foreshadowed a fundamental shift in the UK system toward indirect taxation, as our entry into the Common Market necessitated the introduction of VAT – a broadly-based tax on consumption, which in some respects provided an answer to these problems of tax design.
This is because, whether the band spent more time in the living room and less time in rehearsal (incentives), or paid City lawyers to re-badge their gains as losses (investment), or told everyone they were no longer living in the UK (residence), they were still going down to the local shops for the necessities of life – necessities on which the Exchequer would take their cut. Of course one other thing the band had to do was live in a very, very large house…
In late 2009, when making the case for a ‘mansions tax’ – an annual levy on homes worth £1 million or more – Vince Cable observed that one of its advantages was the difficulties it posed to potential avoidance: as he said, “You can’t put a mansion in a suitcase and take it to Monaco.” However, the initial response to the proposal was almost unanimously negative. It remains very controversial and provides an illustration of another basic tenet to tax reform: the attraction to governments of taxes that individuals don’t notice – an annual levy on the market value of one’s home not being one of them.
Given these constraints, what are the prospects for further reform, beyond the immediate horizon of the Autumn Statement?
- Clearly the most important challenge to the tax system will be raising enough money to fund public expenditure, in the context of restoring the health of the public finances. In its analysis of the most recent Spending Review, the Institute for Fiscal Studies identified a £6bn shortfall in annual tax receipts for 2015: that is, if the Government maintained the ‘80/20’ split between spending cuts and tax increases in their respective contributions to cutting the deficit.
- The Office for Budget Responsibility has argued that in the longer term we can expect the yield of some taxes to fall significantly, due to forces quite outside the Treasury’s control – the profits from North Sea oil as oil fields are depleted, and the duties from road fuel as emission standards rise. This would suggest that alongside income tax and National Insurance (paid on incomes), VAT will continue to be very important.
- Arguably the fact that only just over half of consumer expenditure is charged VAT at the standard rate is both an anomaly, and an opportunity for major reform – but the difficulties of widening the tax base were illustrated in the ‘pasty gate’ controversy over the very minor changes to VAT in the 2012 Budget.
- The Financial Times writer Janan Ganesh has argued that over the next decade a shift from taxing income to taxing assets is highly likely. Will the millions of young people who find themselves priced out of home-ownership force a change in attitudes to the housing wealth accrued by their parents and grandparents? As there appears to be consensus on permanently freezing the rates of council tax, letting its yield slowly decline, might it be replaced by a new levy on homes or land values?
Author: Antony Seely