Try the new FT.com

November 26, 2004 6:14 pm

Personal View: Stephen Herring

  • Share
  • Print
  • Clip
  • Gift Article
  • Comments

The run up to the final Pre-Budget Report and the Budget itself before a pending general election is normally the most depressing period for those who believe that a significant simplification and reform of our taxation system is long overdue.

Both the Government and the Opposition are keen to avoid any own goals. Becasue simplification typically means that a reduction of a tax rate or the increase of a relief somewhere leads to bad news somewhere else, the politicians calculate that their opponents will brush aside any good news and focus on where a business or an individual (i.e. an elector) will lose.

The once valuable concept of indexation that was essential in times of high inflation now merely increases complexity, and has become little more than a further political hurdle for chancellors. In the current tax year (2004/05), indexation increased the income tax personal allowance by £130 per annum, resulting in a saving of £2.38 per month for the basic rate taxpayer and £4.33 per month for the higher rate taxpayer; hardly life-changing but political ammunition to an opposition if the indexation is not applied.

If we were able to disregard these perceived political imperatives and focus on a broad reform of the taxation system and the rates applied so that the system became more transparent, easier to understand and simpler with which to comply, what reforms could be achieved?

By way of background, it should be remembered that income tax (£114 billion), national insurance (£72 billion) and VAT (£69 billion) are the big revenue earners for the Chancellor. Corporation tax only collects £29 billion and stamp duties only £8 billion. Much publicity is given to capital gains tax and inheritance tax but these only collect £2 billion and £3 billion respectively. Clearly it is more difficult to reform those taxes which the Chancellor can rely upon to pay for the bulk of his spending plans. Nevertheless, with the political will and a good dose of vision much could still be achieved if simplification and transparency were regarded as aims in themselves.

Looking first at income tax: there is currently a personal allowance of £4,745, a starting rate of 10 per cent on a band of £2,020, a 22 per cent basic rate on a band of £29,380 and a 40 per cent higher rate above this. Special rules apply to taxed investment income and most personal tax allowances are relieved at the highest marginal rate. These rates, rules and thresholds are not easily recalled and increase by small amounts each year as the amounts are indexed by retail price inflation.

An alternative would be to increase the personal allowance to £5,000, abolish the starting rate band, reduce the basic rate of income tax to 20 per cent and increase the basic rate band to £50,000 leaving the higher rate of 40 per cent above this amount.

The cost could be met partially by simplifying and increasing the national insurance lower earnings limit to £5,000 (the same as the proposed personal tax allowance), the upper earnings limit to £55,000 (the same amount at which the proposed higher rate tax band would apply) and applying a rate of 12 per cent for both employees (currently 11 per cent) and employers (currently 12.8 per cent) and partially by restricting the value of all personal allowances and reliefs to the basic rate of 20 per cent.

As personal pension contributions already receive basic rate relief “at source” this would itself simplify tax returns and calculations as it would no longer be necessary to compute the higher rate relief available. This would provide a far simpler and more transparent income tax system, particularly for the 3.3 million taxpayers who currently pay the higher rate of income tax.

Turning to capital taxation - and remembering the relatively small sums collected – the Chancellor could afford to increase the annual exemption for capital gains tax to £20,000 (currently £8,200) and the inheritance tax threshold to £500,000 (currently £263,000).

Capital gains tax could also be simplified by applying a 20 per cent rate to disposals within the first two years of ownership and a 10 per cent rate thereafter, broadly in line with the current rules for disposals of business assets.

For inheritance tax, further simplifications could include increasing the annual exemption to £10,000 (which, since 1981, has stood at £3,000) and, by way of an incentive to encourage additional funding for personal pensions, disregarding the first £100,000 of transfers made to relatives’ and dependents’ pension funds following the change of pensions regime planned for April 2006. Similarly, the stamp duty land tax threshold for residential property could be raised to £100,000 from £60,000.

In future years, the Chancellor could focus upon increasing the personal allowance by a larger (and more memorable) round sum amount until it became possible to increase the bands and/or reduce the tax rates themselves.

We estimate that there would be a cost to implement these changes which the Chancellor would need to meet assuming that his spending plans are fixed and he wishes to reduce the public sector deficit.

One area where many of our EU partners have a higher tax rate is VAT (e.g. the rates in France, Italy and Belgium are 19.6 per cent, 20 per cent and 21 per cent respectively). An increase of our current VAT standard rate from 17.5 per cent to, say, 18 per cent or 19 per cent might be a price worth paying for a substantial simplification of our personal tax system.

The real question is how much we would all welcome personal taxation reform and simplification and how this can be delivered by the political system. At some point we need a Chancellor to be willing to break out of the straight jacket caused by the perceived pre-election impact and the consequential restriction of his room to manoeuvre after an election brought about by campaign and manifesto promises. Our personal tax system was fundamentally reformed in the eighties but is there the will in any of the political parties to do this in the noughties?

Stephen Herring is a tax partner in BDO Stoy Hayward . The views expressed in this article are his own.

Copyright The Financial Times Limited 2017. You may share using our article tools.
Please don't cut articles from FT.com and redistribute by email or post to the web.

  • Share
  • Print
  • Clip
  • Gift Article
  • Comments


SHARE THIS QUOTE