House of Commons Treasury Committee...Executive Summary 1. The broad rebalancing of taxation towards...

Published on 15 March 2011 by authority of the House of Commons London: The Stationery Office Limited

House of Commons

Treasury Committee

Principles of tax policy

Eighth Report of Session 2010–11

Volume II

Additional written evidence

Ordered by the House of Commons to be published 25 January 2011

The Treasury Committee

The Treasury Committee is appointed by the House of Commons to examine the expenditure, administration, and policy of HM Treasury, HM Revenue and Customs and associated public bodies.

Current membership

Mr Andrew Tyrie MP (Conservative, Chichester) (Chairman) John Cryer MP (Labour, Leyton and Wanstead) Michael Fallon MP (Conservative, Sevenoaks) Mark Garnier MP (Conservative, Wyre Forest) Stewart Hosie MP (Scottish National Party, Dundee East) Andrea Leadsom MP (Conservative, South Northamptonshire) Mr Andy Love MP (Labour, Edmonton) John Mann MP (Labour, Bassetlaw) Mr George Mudie MP (Labour, Leeds East) Jesse Norman MP (Conservative, Hereford and South Herefordshire) David Ruffley MP, (Conservative, Bury St Edmunds) John Thurso MP (Liberal Democrat, Caithness, Sutherland, and Easter Ross) Mr Chuka Umunna MP (Labour, Streatham)

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The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including press notices) are on the Internet at www.parliament.uk/treascom. The Reports of the Committee, the formal minutes relating to that report, oral evidence taken and some or all written evidence are available in a printed volume. Additional written evidence may be published on the internet only.

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All correspondence should be addressed to the Clerk of the Treasury Committee, House of Commons, 7 Millbank, London SW1P 3JA. The telephone number for general enquiries is 020 7219 5768; the Committee’s email address is [email protected]

Principles of tax policy 3

List of additional written evidence (published in Volume II on the Committee’s website www.parliament.uk/treascom)

1 Bryan Harris Ev w1

2 David Martin Ev w2

3 British Air Transport Association Ev w19

4 Shelter Ev w20

5 Coalition for Economic Justice Ev w21

6 UK Sustainable Biodiesel Alliance Ev w22

7 Scotch Whisky Association Ev w25

8 Forum of Private Business Ev w27

9 Imperial Tobacco Group plc Ev w31

10 Land Value Taxation Campaign Ev w33

11 NFU Ev w36

12 Joseph Rowntree Foundation Ev w37

13 ALTER Ev w40

14 School of Economic Science Ev w44

15 Labour Land Campaign Ev w47

16 Investment Management Association Ev w51

17 Publish What You Pay coalition Ev w55

18 David Chester Ev w57

19 Christian Aid Ev w57

20 ACCA Ev w59

21 TaxAid Ev w63

22 Low Incomes Tax Reform Group Ev w65

23 Transforming Communities Ev w69

24 Michael Learoyd Ev w72

25 TheCityUK Ev w73

26 The Henry George Foundation of Great Britain Ev w75

27 ActionAid Ev w79

28 Law Society of England and Wales Ev w80

29 Systematic Fiscal Reform Group Ev w83

30 Institute of Chartered Accountants of England and Wales Ev w87

31 Unquoted Companies Group Ev w92

32 HM Treasury Ev w95

33 Retailers Against VAT Abuse Schemes Ev w97

34 Child Poverty Action Group Ev w102

35 CBI Ev w105

36 TUC Ev w111

37 Catherine Fromant Ev w115

38 EEF Ev w116

39 British Bankers’ Association Ev w122

40 RSPB Ev w124

4 Principles of tax policy

41 Chartered Institute of Taxation Ev w129

42 Christopher J Wales Ev w132

43 City of London Corporation Ev w137

44 Richard Brooks Ev w137

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Treasury Committee: Evidence Ev w1

Written evidence

Written evidence submitted by Bryan Harris

I'm very pleased that some focus is being given to how we are taxed. It is long overdue, and I hope somelasting good will come out of it.

I am a mere taxpayer, not an accountant, so forgive me if I speak in broad terms, but hope you will considerthe points I make.

Statement of Intent

Firstly, I believe there should be a statement of intent that describes the approach to taxation by thegovernment and acts as an agreement that will remind politicians that the days of excess, as in milking thetaxpayers, are long gone.

It should also remind us all that governments should work within a budget, and keep borrowing for trueemergencies, not incompetencies.

My Vision

The tax industry is huge, and in my very humble opinion, totally unnecessary. Why do we have all of thesepeople employed working out how much we should be taxed. It borders on the insane.

Surely these people could be better employed in “Productive work”

Taxation may be a necessary evil, but its impact needs to be reduced and made to become more equitable.That is not to say that taxation is only for the very rich, it means the burden should not be placed in onequarter, while others exempt themselves because they live off the State.

There are far too many taxes, this volume badly need to be reduced and simplified, and the tax industry isripe for pruning.

Red tape of course pushes up costs, and while out of scope here, it needs to be kept in mind.

I have long maintained that government makes basic living too expensive, by their taxation policies andthe way they subsidise those on low income. The mere fact that we are all taxed so heavily makes it moredifficult for those impoverished to live without government support.

THIS HAS TO CHANGE.

Basic cost of living should be very cheap. What is the point in making it otherwise, apart from being counter-productive, it encourages the benefits bandwagon. Here we are talking about somewhere to live, food andclothes. In my opinion taxation should be removed on the latter two items and reduced significantly onaccommodation.

By the simple fact of making it easier and cheaper to get by, day to day, there would be less need to tax usall to fund the welfare state. So, people who administer the system would also be reduced, and the requirementwould then be for less taxation rather than more.

Specifics

My hope for a fundamental change in taxation rests with the following, and while an overnight change maynot be possible, we should be moving this way, dramatically:

— NATIONAL INSURANCE should be merged into INCOME TAX.

— INCOME TAX should in future be paid by the employer.

— PURCHASE TAX (or VAT if you prefer) should be the main form of tax revenue.

— CAR TAX should be merged into FUEL TAX.

— The TV LICENCE should be scrapped.

More Detail

NATIONAL INSURANCE should be merged into INCOME TAX

I support the views expressed in this article by Lorna Bourke, for this subject: http://www.citywire.co.uk/money/lorna-bourke-my-solution-to-fix-our-costly-and-unfair-tax-system/a452159?ref=citywire-money-featured-articles-list

The main benefit I see is in reducing the cost of collection and administration. If people have been employedfor more than 25 years they should be eligible for the State pension. Those that weren't will already be onbenefits, so lets continue to call it that, rather than give them a pension.

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Ev w2 Treasury Committee: Evidence

INCOME TAX should in future be paid by the employer

Just imagine how many administrators could be more gainfully employed if we didn't have PAYE!

The army of tax collectors could find more worthwhile employment, while those employed by companiescould move on to earning revenue for their company.

Rather than an employer giving the employee his wage, which then gets reduced by the PAYE scheme, whynot just have the company pay this tax directly, an average amount for each employee.

In other words, the employee gets the pay level he agrees with his employee, but the level is less taxation,which is fixed. The employee would no longer need to worry about how much tax he pays, as he would getthe same amount each week or month. The take home pay would be approximately what it is now.

The company would instead pay an employee tax, for the total number of employees. That tax level couldvary based on the average wage of people in the company, or it could just be a flat head count tax.

For overtime the company would pay an hourly rate to the employee reduced by a percentage for tax. Thecompany would then pay an additional tax based on how many extra overtime hours were worked throughoutthe year.

Most interest on savings is already taxed at source, this would be extended or removed totally to make thissystem work effectively and efficiently.

Pensioners, that is people over State retirement age, would no longer be taxed, save for their purchases onnon-zero rated items.

PURCHASE TAX (or VAT if you prefer) should be the main form of tax revenue

This tax should be radically reformed to be the main revenue for government. Luxury items can be taxedmore, but the more disposable income one has, and the more one spends, then the more one pays. Children’sclothes (plus shoes) and food would be zero rated, as would all books classified as “Education”.

CAR TAX should be merged into FUEL TAX

Another tax that costs a fortune to collect.

Just add a penny to fuel tax and then we pay for the road we use.

Rather than a tax disc being displayed in car windows, there would instead be an MOT disc.

The TV LICENCE would be scrapped

Yet another costly tax and so unnecessary. Funds should come from the general pool of taxation from VATand Company Peoples tax.

January 2011

Written evidence submitted by David Martin

Executive Summary

1. The broad rebalancing of taxation towards indirect tax recommended by both Mirrlees and the OECDreport Is strongly supported. The VAT base should be broadened. Many of the other proposals set out in theMirrlees Review are accepted, although neither an allowance for corporate equity nor a rate of return allowanceappear justified.

2. Direct tax should be levied in three distinct categories, business profits, earnings from employment, andprofits derived by individuals from non business activities. Business tax should be radically simplified, withtaxable business profits being calculated in a similar way for both incorporated and unincorporated businesses.Employment tax should be reformed through the merger of the tax and NIC systems. Other non-business profits(whether capital or income) should be aggregated and taxed together under a much simpler system. This systemshould however include relief for entrepreneurs, and also for savers under a new lifetime savings scheme.

3. Dividend tax credits should be abandoned, and a 25% withholding tax on dividends should be introduced.

4. Direct tax should be levied at 0% on income and gains up to £10,000, 25% from £10,000 to £35,000, andat 40% above £35,000. A simple payroll tax of 6% should be payable by employers. The shortfall for theTreasury arising from this proposed combination should be made good by a variety of measures, principallythe increase in VAT and also new local taxes.

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A. The Mirrlees Review

1. The Mirrlees Review shows a refreshing willingness to tackle fundamental issues. There is welcomeemphasis on the tax principle of neutrality and the point that If the tax base is complex and inconsistent thereis more opportunity for avoidance. There are many specific proposals which are well made:

(a) Personal allowance should not be phased out for high incomes.

(b) Income tax and NICs should be merged.

(c) Capital gains should be charged at the same rates as income.

(d) The VAT base should be broadened.

(e) There should be no transfer tax on shares.

(f) Traffic congestion charging should be expanded.

(g) The basis of inheritance tax should be reviewed.

The reasons for these proposals are not discussed in detail, although most appear in the package ofrecommended steps contained in this paper.

2. There are some other proposals which are not accepted. Reducing tax for older workers to encouragethem to take paid work would not appear fair to younger people. Older people who have a pressing financialneed to find work could find it more difficult because of increased competition from their contemporaries(many of whom currently work voluntarily for the community) who do not have the same need. An idea tocharge VAT on the amount of deposits appears frightening. This does not reflect the value of any supply, andthe amounts of VAT that would be involved (and hence liable to be misappropriated or incorrectly accountedfor) would be huge. These points are not however central to the structure of the tax system.

3. Of basic importance to the tax system is the way that investment income and gains are taxed. It is statedin Chapter 2 that double taxation results from taxing savings income, because any return on savings is derivedfrom income which has already been taxed. It is argued that this distorts the decision over when to consume.This reasoning seems misleading, however, and does not therefore justify the proposal for the rate of returnallowance (RRA) that follows. If, say, £100 of income is taxed at 40% and the balance of £60 is reinvested,the interest on that £60 is not taxed twice, only once. In the absence of inflation there is no reason to expendthe £60 sooner rather than later. But the RRA is not primarily designed to give tax relief for inflation (whichcould in any event be done through a simpler mechanism—see below). Further, several examples illustrate thatthere is no well defined boundary between savings and earned income. A 100% shareholder might choosewhether to take income as salary or dividends. It is impossible to say whether unincorporated business profitsare to be attributed to investment by an owner/manager or to his labour. The RRA would also be verycomplicated to apply. While the RRA for unincorporated businesses would be optional, (because the calculationwould be complicated), issues such as the treatment of depreciating assets or assets acquired by debt are notaddressed. Nor does the scheme provide entrepreneurs with any additional tax relief.

4. All income should, as a starting point, be taxed the same. However savings from earnings can be madetax efficiently through pension schemes. It is appropriate to have a wide ranging scheme to encourage savingsout of investment income. There may be a better way to achieve this than the RRA.

5. The question of how company profits and distributions to shareholders are taxed is also fundamental. Thereport advocates an allowance for corporate equity, which has been introduced in Belgium. This allowancewould certainly help to reduce current tax advantages of debt over equity. But the complications of such ascheme would also be considerable. Shareholders funds would differ for tax and accounting purposes. Belgiumonly allows the scheme for companies whose accounting period is the calendar year (presumably to preventavoidance by the onward subscription for shares in companies with different accounting periods). Differencesin tax bills for companies having the same profits may not be generally seen as fair. Indeed companies are notapparently asking for tax relief in this form. The best way of reducing the general tax burden on companies infuture is likely to be the reduction in corporate tax rates such as have already been announced.

6. The proposals for the RRA and the ACE also undermine what is stated to be a key requirement of a goodtax system—namely neutrality. Profits received directly by a businessman would not be taxed the same asprofits received by a company and paid out as dividends.

7. Further the report does not tackle sufficiently what is surely one of the most important problems with thetax system at present—namely its complexity. Of course, base broadening by abolishing some reliefs andexemptions will help here. But this would not solve the problem of complexity for taxing business profits, asexplained below.

B. The OECD Report

1. The OECD Report does not address detailed points concerning the UK tax system. It argues that highcorporate taxation is the most likely to damage an economy, followed by personal income taxation, andconsumption taxes, with recurrent taxes on housing being the least damaging.

2. This broadly corresponds with the Mirrlees analysis concerning where taxes should fall, and is reflectedin the proposals which follow.



C. The Overall Tax Structure

1. The direct tax system should have three basic components: tax on business (and business profits shouldbe broadly the same, whether or not the business is incorporated), tax on employment and tax on personalincome and gains not derived from a business.

2. The residual elements of the imputation system for dividends should be abolished

3. More local taxation should be made possible. If local authorities are to have greater autonomy they willneed more money not handed to them by central government to avoid the maxim “He who pays the piper callsthe tune”.

4. Other proposed changes, while just as important, have less impact on the fundamental building blocks ofthe tax system—examples are broadening the VAT base, abolishing duty on share transfers etc.

D. Business Taxes

1. The existing code for taxing business is far too complicated. As a detailed examination of the lawdemonstrates, this is not primarily due to a proliferation of reliefs and exemptions, which are then exploitedby taxpayers, leading to countervailing action by HMRC. Rather the complication is due to the definition ofthe tax base itself. There are rules for calculating income, unnecessarily divided into different sources(particularly the division between trading and other income), a separate set of rules for calculating capitalgains, and a separate system for providing capital allowances for some assets. The rules for these systemsdo not marry together well. Much tax planning is required to try and ensure that profits and losses can bepooled together.

2. This is a waste of everyone’s time. Overseas jurisdictions do not approach the problem of taxing businessprofits in this way. The basic tax base should simply be the aggregate business profits, and those profits shouldbe determined according to GAAP. Tax adjustments will of course still be appropriate, but the degree ofsimplification and rationalization that becomes possible by applying this comprehensive tax base is surprising.Only a few adjustments would be required for small and uncomplicated businesses. Where for examplebusinesses are concerned with sophisticated financial instruments, or have overseas aspects, or they areconducted through a group of companies, or they indulge in avoidance, other tax law will be required. Buteven allowing for this the aggregate tax code could be hugely shorter and simpler than at present. (Apreliminary exercise has been done reviewing all the sections of the Taxation of Chargeable Gains Act 1992,the Capital Allowances Act 2001 and other tax law for assets which are not trading stock. The revised codewas one tenth of the 1,000 pages of law that it reckoned to replace.)

3. No distinction should be drawn between capital and revenue expenditure. Immediate relief should beavailable for capital expenditure which does not result in the acquisition of an asset that is recognized inthe accounts.

4. The capital allowances code should go—overseas jurisdictions (as far as the author knows) have nothinglike it. The code itself takes 400 pages of Tolleys, and this excludes further ramifications such as for leasingcompanies in other tax acts. Tax relief should be given for commercial depreciation, as is done overseas, whilstreserving the ability to provide enhanced tax depreciation for specified assets, should this be justified.

5. Business tax for incorporated and unincorporated businesses should be combined into one code.

E. Employment Taxes

1. A simple payroll tax of 6% should be applied to all pay and benefits provided by employers.

2. There would be no further charge to NICs, which would be merged into the rest of the tax system.

3. Some exemptions (eg the £30,000 exemption for termination payments to employees) should be abolished,to simplify tax and help keep headline rates of tax low.

F. Non Business Taxes for Individuals

1. All activities undertaken by a company should be deemed to be business activities unless undertaken ina representative or trustee capacity. Where the activities of an individual do not constitute a business nobusiness accounts would be required. Tax should then normally be assessed on the basis of cash realizationsrather than accruals, although there would be some exceptions to this. Property rents, for example, should betaxed on an accruals basis.

2. All profits from such sources (whether capital or income) should be added and taxed at the individual’smarginal rate.

3. A separate tax code for capital gains would not therefore be required, nor would the separate CGT annualallowance. (At the moment a taxpayer who has £10,000 income and £10,000 capital gains in the year is muchbetter off than a taxpayer who has £20,000 income or another taxpayer who has £20,000 capital gains—thereis no compelling reason for this)



4. Importantly however there should be three basic reliefs available—one for entrepreneurs on a sale of theirbusiness, one for employees (through employee share schemes, which are not addressed further in this paper)and one for savers.

5. A new lifetime savings account should be introduced in which all investments could be pooled. Incomeand gains would be rolled up tax free until withdrawn for personal expenditure. An annual tax free allowanceshould be available for withdrawals, which could be carried forward to subsequent years if not utilised. Thiswould solve the lock-in and the bunching problems of taxing capital gains. The annual allowance would alsogive tax relief for the effects of inflation, weighted in favour of smaller savers. The proposal is intended tohelp substantially to inculcate a new savings culture.

6. Great simplification would result from these proposals because for example special rules for deemingcapital to be income (eg the accrued income scheme, offshore funds rules and many others) could all beabolished.

7. Enterprise investment schemes and venture capital trusts should also be abolished. Individual investors(who under the tax rules are not allowed to be closely connected with the target companies) are not well placedto evaluate whether the extra tax relief justifies taking the risk of these investments.

G. Rates of Tax

1. It is proposed the rates of tax should be 0% for income and gains less than £10,000, 25% between £10,000and £35,000, and 40% for income and gains above £35,000.

2. Specifically targeted further taxes may be appropriate in the short term on excessive remuneration in somesectors, such as bank bonuses and some executive pay but It would appear that more effective competitionpolicy is needed, as a long term solution.

H. Dividends

1. The question of how to tax dividends so that the tax system works well for combining the effects ofcompany and individual taxation is not straightforward, and made more difficult by EU rules which mean thata full imputation system (such as is commonly applied outside the EU) is not practicable.

2. A simple but reasonable proposal would be to apply a 25% withholding tax on all dividends from UKcompanies paid to individuals. This would satisfy any tax liability on the dividends. However a taxpayer whosetotal income fell below £10,000 could elect to include the dividend in his tax return and claim a tax refund.(This is in fact the system that now applies in Germany). Where the small company tax rate of 20% applies,profits of 100 would after tax enable a dividend of 80 to be paid, on which 20 tax would be withheld. A higherrate taxpayer would have the same net income as if he had earned the company’s income directly. A basic rate(25%) taxpayer would be slightly worse off in this situation, but could choose to pay himself salary instead ofdividends. Lifetime savings accounts would be entitled to repayment of the dividend withholding tax.

I. VAT

1. The VAT base should be considerably broadened.

2. This would remove unjustified distortions and enable direct taxes to be reduced, thus increasing incentivesto earn, and increasing individual choice over spending and saving.

J. Local Taxes

1. New local taxes should be introduced. These might be congestion charges, extra duties on alcohol sales,levies charged to large supermarkets, charges to use council facilities, special property rates to cover specificcapital schemes (such as the Victorians used to great effect for projects such as sewerage schemes or new townhalls), road tolls, and so on. (EU law forbids any turnover taxes apart from VAT, but this not prevent fixedcharges on specified supplies eg per bottle of beer or wine). This would be a major change, but it should benoted that the proposed aggregate charge of £25 billion proposed under “costings” below would still be lessthan 5% of total taxes. Local taxes (including council tax, which would increased as suggested below) wouldstill be at a lower proportion than in most overseas jurisdictions.

2. Council tax should be raised, and a new band created for the most valuable properties. This would besimpler to achieve than the new tax proposed by Mirrlees, which might in practice give rise to many disputesconcerning the exact value of expensive properties.

K. Transaction Taxes

1. Transaction taxes are criticized by Mirrlees, but the real problem occurs where such a tax is not borne bythe ultimate consumer.

2. Stamp duties on houses should therefore be kept. However the problem of the quantum leap in duty asthe purchase price reaches different thresholds should be dealt with. For example sales could be charged at



2.5% on any value over £150,000, at 4% on value over £250,000, and at 5% on any value over £1 million.This would broadly reflect the current burden of duty, but would also remove a serious anomaly.

3. Stamp duty on shares should be abolished.

L. Costs

Exchequer gain (loss)£ billion

Revised tax rates 96% payroll tax instead of NICs (59)Extra tax by having lower payroll tax than employer NICs 3Abolish of some reliefs (eg the £30,000, exemption for termination payments to 2employees)Abolish duty on share transfers (3)Reduction in benefits 3VAT broadening (net of extra benefits which would need to be paid) 12Increase in CGT rates and abolition of CGT threshold. 4Lifetime savings scheme (5)Council tax increase—especially a higher charge on the most valuable properties. 5New local taxes 25Government admin savings from simpler tax system 2Net change (2)

(The calculations for this table are given in Annex A to this paper)

M. Supporting Material

1. While it is a privilege to have the opportunity to make a submission such as this, it must necessarily berestricted in length. It is not therefore possible to set out a fully reasoned basis for proposals made in thispaper. A summary such as this would stand little chance of persuading someone already inclined to a contraryview to accept for example the taxation of capital gains at the same rates as income, or the abolition ofcapital allowances

2. Annex B to this paper addresses in more detail the linked issues of taxing capital gains and the lifetimesavings account. If requested the author would be able to suggest further material which addresses other issuesin more detail.

Annex A

TREASURY COSTINGS (BASED ON 2009–10 FIGURES)

More work could be done to refine the estimates shown below. However this would require identifyingexactly what VAT supplies would cease to zero rated, what the annual exemption on the lifetime savingsaccount should be, together with expected take-up for such a scheme, how the new local taxes would apply,and so on. It would appear that such extra quantification and precision would not be appropriate at this stage.The objective is only to provide reasonable estimates, and to demonstrate that a programme such as is proposedin the paper could be introduced on a broadly neutral basis for the Treasury.

1. Tax Rates

There is set out below a direct calculation for the cost effect of the proposed revised rates of income tax.

This may be more accurate than simply using the HMRC ready reckoner, because, for example, if one usesthe reckoner to calculate the effect of an increase in the personal allowance it is not clear that a second use ofthe reckoner to show the effect of a change in the basic rate of tax would give the correct result. The readyreckoner itself advises that it should be used with caution.

Unfortunately there is a significant difference in the results from using the direct calculation and using theready reckoner. The direct calculation indicates that the extra income tax (disregarding the loss of NICs) wouldbe approx £12 billion. The ready reckoner indicates that the extra tax would only be approx £5.7 billion. Theremay be some simple error in the calculations, but it is not possible to attempt a reconciliation of the two figuresin the absence of information as to how the ready reckoner has been worked out.

The costings shown in the paper have taken an average of these two figures of £9 billion. One can perhapstake some comfort that this figure is unlikely to be more than £3 billion out, and because of knock on effects( if the gain to the exchequer is less than £12 billion then the extra income in the hands of taxpayers will meanmore VAT collected, less benefits paid out etc) the overall margin for error should be reduced below this £3billion figure.



Direct Calculation (using figures from Table 2.6)

Income range No of taxpayers Actual tax liability Total income Proposed tax liability(thousands)

(£m) (£m) (£m)

£0–10,000 3,614 1,107 30,080 0£10–15,000 6,470 6,230 80,500 3,141 (1)£15–20,000 5,260 10,300 91,600 9,092 (2)£20–30,000 6,830 22,900 167,000 23,821 (3)£30–50,000 5,430 31,500 204,000 39,513 (4)£50–100,000 1,910 28,000 125,000 35,197 (5)£100–150,000 319 11,000 38,400 12,847 (6)£150–200,000 124 6,580 21,200 7,503 (7)£200–500,000 143 13,600 41,100 15,313 (8)£500–£1 million 27 6,340 18,400 7,147 (9)Over £1 million 13 10,900 30,400 12,057 (10)Total 149,000 165,631

Assumptions in the direct calculation—the new personal allowance is £10,000. The new personal allowancefor pensioners is £12,000, which is not abated for high incomes (as pensioners would not benefit from theabolition of NICs). Pensioners are one quarter of total taxpayers, so that weighted average personal allowanceis £10,500. The 40% band starts at £35,000 for all taxpayers, however, including pensioners.

1. Taxable income = 80,500−(6,470 x 10.5) = 12,565Tax @25% = 3,141

2. Taxable income = 91,600−(5,260 x 10.5) = 36,370Tax @25% = 9,092

3. Taxable income = 167,000−(6,830 x 10.5 ) = 95,285Tax @25% = 23,821

4. Assume 1,500 taxpayers £30–£35 average income £32, with total income = 48,000(Group A), and 3,930 taxpayers 35–50 with total income 204,000−48,000 = 156,000(Group B) =Group A taxable income = 48,000−(1,500 x 10.5) = 32,250Tax for Group A @25% = 8,062Group B taxable income @25% = 3,930 x 24.5 = 96,285Tax @ 25% for Group B = 24.071Group B taxable income @ 40% =156,000−96,285−(3,930 x 10.5) = 18,450Tax @ 40% for Group B = 7,380Total tax for both groups = 7,380 + 24,071 + 8,062 = 39.513

5. Taxable income @25% = 1,910 x 24.5 = 46,795Tax @ 25% = 11,698Taxable income @40% = 125,000−(1,910x 35) = 58,150Tax @ 40% = 23,260Total tax = 11,937 + 23,260 = 35,197

6. Taxable income @25% = 319 x 24.5 = 7,815Tax @ 25% = 1,953Taxable income @40% = 38,400−(319 x 35) = 27,235Tax @ 40% = 10,894Total tax = 1,953 + 10,894 = 12,847

7. Taxable income @25% = 124 x 24.5 = 3,038Tax @ 25% = 759Taxable income @40% = 21,200−(124 x 35) = 16,860Tax @ 40% = 6,744Total tax = 759 + 6,744 = 7,503

8. Taxable income @25% = 143 x 24.5 = 3,503Tax @ 25% = 875Taxable income @40% = 41,100−(143 x 35) = 36,095Tax @ 40% = 14,438Total tax = 875 + 14,438 = 15,313

9. Taxable income @25% = 27 x 24.5 = 661Tax @ 25% = 165Taxable income @40% = 18,400−(27 x 35) = 17,455Tax @ 40% = 6,982Total tax = 165 + 6,982 = 7,147

10. Taxable income @25% = 13 x 24.5 = 318Tax @ 25% = 79Taxable income @40% = 30,400−(13 x 35) = 29,945



Tax @ 40% = 11,978Total tax = 79 + 11,978 = 12,057

One further adjustment needs to be made. The calculation has been made without regard to the fact thatdividends are included in the aggregate income figure, but are taxed at a lower rate. Aggregate dividends paidto individuals are about £46 billion (Table 3.7). The 25% proposed withholding is less than the blended rateof, say, 35% implicit in the above table. So the aggregate figure above need to be reduced by about 10% of£46 billion, ie £4.6 billion. The total tax in the final column is therefore reduced from £165.631 billion to£161.031 billion. This differs from the figure for actual tax paid in the year of £149.000 billion by £12.031billion. (The actual figure will reflect lower tax on dividends). Income tax paid will be reduced by other reliefs,in particular relief for pension contributions, but such reliefs are assumed to be equivalent for the actual andthe proposed situations)

Read Reckoner calculation

1. Personal allowance increase from £6,475 to £10,000Increase of £3,525 costs £680 million per £100, ie 35.25 x 680 = (£23.9 billion)

2. Increase in basic rate from 20% to 25%Increase of 5p brings in 5 x £4,150 = £20.7 billion

3. Reduction in basic rate band. Previously higher rate payable forincomes over 6,475 + 37,400 = £43,875. Proposed to reduce this to£35,000. The difference of £8,875 is 20% of the basic rate band.Decrease by 10% brings in £3.2 billion. Decrease by 20% = £6.4 billionNet extra tax £3.2 billionDividend adjustment—at present higher rate taxpayers pay tax at 25%on net dividend, as is proposed, but above direct calculation assumesbasic rate taxpayers also pay tax at 25% on net dividend. If basic ratetaxpayers receive say £10 billion net dividends, the extra tax raisedwould be £2.5 billion £2.5 billion

£5.7 billion

2. Loss of NICs and Gain of Payroll Tax

Employment income for 2007–08 (table 3.6) = 611 billion. Assume 640 billion in 2009–10 6% of 640billion = £38.4 billion.

Before After Difference

NIC/Payroll tax 97,000 38,400 (58,600)

3. Extra Tax Collected as a Consequence of Abolishing Employer’s NICs and SubstitutingPayroll Tax

As a result of this either salaries will stay the same and employer taxable profits will rise, or salaries areincreased and employee tax will rise (or a blend of the two).

Assume employer tax is paid at the rate of 28% (the full rate of CT for 2009/10), and guess that employeetax is at an average rate of 28% (a weighted average of the basic and higher rates).

Employer NICs = £50 billion(this figure derived from overall NICs figurewith apportionment)Payroll tax = £38 billionDifference = £12 billionExtra tax paid @28% = £3 billion

4. Reduction in Benefits by Reason of Reduced Tax and NICs

The table in para 1 above shows that all taxpayers at present having an income of less than £10,000 wouldsave £1 billion income tax from the tax proposals and taxpayers having an income of between £10,000 and£15,000 would save £3 billion from the proposals. These two groups would also save a similar amount onNICs. (See table 16A of Household incomes). Assuming that at least half of these taxpayer are on benefits andthat it would be appropriate to reduce their benefits by some, but not all of their tax and NIC reductions, afigure of £3 billion is estimated for benefit reduction.

5. Abolition of Some Reliefs

The saving to the Treasury of abolishing the exemption for the first £30,000 of a termination payment isabout £1.2 billion. The OTS are of course reviewing exemptions and reliefs—it is assumed that the total savingto the Treasury could be increased to £2 billion as a consequence



6. Abolition of Duty on Share Transfers

The cost to the Treasury of abolishing this duty would be about £3 billion pa. (see Table 15.1)

7. Extra CGT From Abolishing Annual Allowance and Increasing Rates

A figure of £2.6 billion is given in the 2007 ready reckoner for the abolition of the annual CGT allowance(no corresponding figure being given in the current ready reckoner) This must be difficult to estimate sincethere is no obligation to report small disposals to HMRC. The current ready reckoner suggests that the proposalto raise the CGT rate may yield in the region of £1.5 billion. Thus an aggregate increased yield of £4 billionis made in the costings table. Any such estimate must be treated with caution, since the yield from CGT hasfluctuated very much in the last few years.

8. Extra VAT

This figure is simply an estimate of what might be done without setting out any detailed proposals for whatsupplies should become standard rated and what supplies should remain zero rated or with a reduced rate ofVAT. It should be noted that the total cost to the Treasury of zero rating is considerably more than £12 billion.It is assumed however that more than £12 billion extra VAT is collected, but that the net effect after increasingbenefits appropriately to compensate (especially for non taxpayers) would be £12 billion. (The calculation ofthe reduction in benefits in para 4 above is made on the assumption that VAT remains the same)

9. Lifetime Savings Scheme

The essence of this proposal is for tax deferral rather than tax reduction as the tax would be payable whenmoney is withdrawn from the lifetime savings account. It is assumed however that if the proposal weresuccessful there would be substantial take-up and substantial utilization of the annual tax free allowance.Neither of these two factors is quantified in the paper, and so a “guesstimate” only of £5 billion is made forthe purposes of the costings

10. Local Taxes and Council Tax

Similarly the figure of £25 billion and £5 billion respectively for new local taxes and an increase in counciltax are not estimates of the consequences of tax changes, but targets for such tax changes. The calculations fornew local taxes would also need to take into account the requirement to protect poorer boroughs by Governmentcross subsidy.

It is recognized that only a small proportion of houses are in the existing top rate band, and that an evensmaller proportion would therefore fall into the proposed new top band. It would appear that lower bands ofcouncil tax would also need to be significantly increased to achieve the £5 billion figure.

11. Administrative Savings

Total costs of administering the tax system by HMRC are some £5 billion p.a. The proposed changes wouldalso reduce the costs to DWP of paying benefits, however. There would also be administration savings tobusiness through substantial simplification, which would increase taxable profits, and hence the tax paid bybusiness.

An estimated saving to Government of £2 billion appears reasonable.

(The IEA publication earlier in 2010, “Taxation and Red Tape: The Cost to British Business of Complyingwith the UK Tax System” suggests that tax admin costs are usually underestimated)

Annex B

TAXATION OF CAPITAL GAINS A LIFETIME SAVINGS ACCOUNT DISCUSSION PAPER

(This paper is based on a budget submission made by the author to the Treasury in June 2010)

A. Introduction

1. This paper considers the taxation of capital gains. It proposes that a lifetime savings account offerssolutions to the problems of taxing capital gains, and would also dramatically encourage saving.

2. It argues that income and capital gains are best seen as two components of a single tax base of profit.Creating a single tax base for non-business income and gains realised by individuals would enable substantialrationalisation and simplification of the tax code. However, generous tax relief is appropriate for gains accruingto entrepreneurs on the sale of a business which they control. Relief (but less generous) is also appropriate forshares owned in their company by employees who do not have an entrepreneur’s controlling influence. It isalso essential to make appropriate provision for savers. This could be done by giving investors the ability toroll over gains on sales and repurchases on investments until such time as profits are withdrawn for personalexpenditure, as described below.



3. Such measures would be simple compared with current legislation, would not give rise to large taxdifferences which depended on fragile and uncertain tax distinctions, and (it is hoped) would be groundedin principle.

4. Under the lifetime savings scheme a saver would have a special bank account on which interest earnedcould be credited gross, and which would be used to purchase new investments and into which the proceedsof sale of investments would be paid. A very wide range of investments would be eligible for this regime. Taxwould only be due when funds were withdrawn from this special account for personal expenditure. A savercould use a third party financial services company to operate the account on his behalf, and to make thenecessary tax calculations for him. The saver would then need only one line in his tax return to show thetaxable amount in respect of all of investments held through the account, namely the taxable amount withdrawnfor personal expenditure, as certified by the services company. Such an account, which might be named alifetime savings account, would be a logical way of addressing the many problems associated with taxation ofsavings income and gains discussed below, and could inculcate a radical change in moving towards a savingsculture in this country.

5. Unfortunately this is a long paper. A sustainable medium to long term solution to the problem of taxingcapital gains can only be achieved, however, if there is widespread agreement not only on the steps to be taken,but also on the reasons for taking those steps. There are many issues that need to be considered and it is hopedthat what follows may contribute to the debate.

B. History of Capital Gains Tax For Individuals

1. Capital gains of individuals were first brought within the charge to tax in 1965. Gains that exceeded anannual allowance were charged at the rate of 30%. As a result basic rate income tax payers were paying agreater rate of tax on their capital gains, and higher rate income tax payers paying a smaller rate on theircapital gains. This position seemed particularly anomalous and in 1988 Nigel Lawson subsumed capital gainsand income into one system. After deduction of the annual capital gains allowance capital gains were pooledwith income and taxed at the individual’s marginal rate.

2. From 1988 to 1998 the principal tax advantages for capital gains over income, apart from the separateannual capital gains allowance, were the indexation allowance and a few specific reliefs, such as retirementrelief on the sale of a business, and relief for the sale of inexpensive small chattels such as items of furniture.

3. In 1998 the taper relief system was introduced and the indexation allowance ceased to accrue from thatthat time. Taper relief was later modified, and as the rules stood before the introduction of the fixed 18% rate,only one quarter of the gain on a business asset was brought into the charge to tax, provided the asset has beenheld for at least two years. For non–business assets the gain was reduced on a sliding scale by up to 40% ifthe asset has been owned at least ten years. This meant that the rates of tax paid by higher rate taxpayers onbusiness assets and non-business assets could be as low as 10% and 24% respectively.

4. With effect from April 2008 capital gains became taxed at 18%, regardless of the length of ownership ofthe asset. Taper relief, and any indexation allowance for assets held before 1998, were abolished. As a resultof vociferous complaint, a new relief for entrepreneurs was also introduced, so that lifetime gains of up to£1 million would be taxed at the earlier rate of 10% (although it was not explained how this allowance,subsequently increased to £2 million, and then in June 2010 to £5 million, would be effectively monitored overa long period of time).

5. In June 2010 the rate of CGT was increased to 28% for higher rate taxpayers.

6. There have been other less fundamental changes to CGT in the above period.

C. Relevant Principles

1. A principle which needs to be taken seriously in relation to tax is the principle of neutrality. Neutralityimplies that, as a starting point, all elements of the tax base are taxed in the same way, and that taxpayers whoarrive by different steps at the same economic results should be taxed in the same way. The basic argumentfor neutrality is considered further in para 7 below.

2. An argument which is often deployed that capital gains should be taxed lightly, if at all, can be illustratedas follows. A man who picks apples provides only for the needs of today, and is producing no wealth for thefuture. A man who plants an orchard, however, is creating a store of wealth which will supply apples for yearsto come. This kind of activity is to be encouraged, in particular by providing tax relief when the orchard is sold.

3. While this may be a powerful argument in relation to entrepreneurs it will be noted that the argument ismuch less straightforward to apply in many other situations in which capital gains may be realised, such as onthe sale of second homes or even of portfolio shareholdings. Everyone would accept that tax incentives areappropriate in some circumstances. But one has to be careful when providing incentives. They can lead tocomplexity, and also have the unintended result of giving provide scope for avoidance. While limited reliefscan be relatively easy to define and to police, a more general relief for all capital gains leads, (as explainedbelow) to tax advantages which may not be justified, to avoidance, and complex anti-avoidance rules. As



mentioned above this paper will seek to make the case that incentives should be conferred for entrepreneurs,shares owned by other employees, and for savings.

But to tackle these issues and see where the problems arise it is necessary to go back to first principles.

4. If there is to be a general rule that all capital gains are to be taxed differently to income it is (a) necessaryto establish what capital gains are and then (b) to analyse what justifies the different tax treatment.

5. Capital gains arise can only arise on the disposal of capital assets. The distinction which UK tax lawseeks to apply is that an asset bought with intention of reselling at a profit is owned as trading stock. If,however, an asset is held with the intention of holding it as continuing source of income (such as, for example,holding land to earn rent, or holding shares to earn dividends), the asset is a capital asset. However, as explainedfurther in Appendix One, it is often hard even for tax professionals to tell whether a profit on a sale is capitalor revenue based on this rule. Arbitrary rules of thumb may be deployed to resolve the issue, which may lacka basis in principle.

For many tax professionals the traditional tax distinction made in the UK between income and capital andassets, which is based on the taxpayer’s intention at the time of acquisition, is not robust or satisfactory. Theprofit on realisation does not appear any different no matter what the taxpayer’s intention on acquisition. Onemight also remark in passing that it seems theoretically inconsistent to argue that reduced tax on the sale of acapital asset serves as an incentive to invest in the purchase of that asset. This is because the very test for acapital asset is that it is not acquired with a view to sell at a profit.

6. Under current law, having decided that an asset is capital in nature, it is still necessary to identify whetherlumps sums derived from the asset are income or capital. At first blush one would expect that the answer tothis question is that receipts derived from the sale or realisation of the asset are capital. However the proceedsof realisation may represent accrued income, or be deemed to be income for tax purposes under a large numberof (often complex) anti-avoidance rules. This aspect is addressed further in Appendix Two.

7. Having briefly discussed the difficulties of identifying what are capital assets and what is capital derivedfrom such assets we return to the argument that capital and income profits should best be seen as componentsof a single tax base.

This tax base would be defined as taxpayer’s total profit for a period, broadly defined as that which can bewithdrawn or consumed at the end of the period without being any worse off than at the beginning of the period.

This seems a natural concept and to be a satisfactory starting point, not least because it provides a measurethat is clearly related to taxable capacity.1 This basic definition of the tax base would of course includecapital gains.

Apart from the practical and theoretical problems of distinguishing between income and capital there areother reasons for including “capital gains” in one tax base, (even though we may subsequently want to conferreliefs on eg entrepreneurs who plant apple orchards, and on savings):

(a) capital gains can be utilized in the same way as income—eg where some shares are sold every yearto pay for living expenses;

(b) business accounts do not normally distinguish between capital and income profits;

(c) to the extent that reduced tax is payable on capital gains the tax avoidance industry becomes focussedon schemes for turning income into capital, as it was before the rates of capital gains tax and incometax were conformed under Lawson in the mid 1980’s;

(d) regressive taxation may result form low CGT rates, because the rich are more likely than the poor torealise capital gains; and

(e) further, it is a commonplace of economic theory that a single tax base with a broad scope is less likelyto distort economic activity than different taxes with many exceptions and special rules. A broadlybased tax on profit satisfies this requirement.

As Nigel Lawson said in his budget speech in 1988 “In principle, there is little economic difference betweenincome and capital gains, and many people have the option of choosing to a significant extent which to receive.And, in so far as there is a difference, it is by no means clear why one should be taxed more heavily than theother. Taxing them at different rates distorts investment decisions and inevitably creates a major taxavoidance industry2”.

There are strong reasons for revisiting the Lawson approach. The basic distinction is hard to make, andmuch tax law is currently needed for calculating income and gains separately, and to combat avoidance byswitching from one to the other.1 It is not, of course, the only possible tax base that achieves this—a wealth tax on the value of the taxpayer’s assets is another

possibility.2 There is a tradition of financial engineering/avoidance in the UK (and in the US) that should be borne in mind in making

comparisons between how different jurisdictions treat capital gains. There are probably many thousands in the City of London(and beyond) who make their living from tax planning and exploiting differentials of tax treatment.



8. Nevertheless there are some real problems concerning the taxation of capital gains which cannot beignored. Analysis of these problems shows where reliefs would be appropriate.

D. Problems With Taxing Capital Gains

1. Tax on the appreciation of capital value may discourage the growth of capital value, to the disadvantageof everyone. In particular entrepreneurs should not be discouraged from starting and building up businesses,because this is to the advantage of us all.

2. The next problem is the lock-in effect, which discourages the sale of an asset pregnant with a capital gainand the purchase of a replacement asset.3

3. Another problem is the bunching effect, whereby a gain which may have accrued over many years istaxed at a higher rate for a basic rate taxpayer, simply because the gain is all realised in one year, whichappears unfair.

4. It is noted that the lock-in effect and the bunching effect are likely to be exacerbated the longer an assetis held, since the accrued gain might be expected to be higher.

5. A further problem is that capital gains tax may apply to inflationary as well as real gains.

It should be noted, however, that income is also eroded by inflation. If for example one has £100 in the bankand it earns £4 interest, the £4 is not all surplus for the period if the value of the £100 deposit has been erodedby inflation. No tax relief is available for this effect.

6. The above problems may be more severe for individuals than for companies, which are of course taxedat the same rate on capital gains as on income, subject only to the indexation allowance being available forcapital gains. The lock in effect would be worse for an individual who is taxed at 40 or 50% compared with acompany which has a maximum rate of 28%. The bunching effect is more likely to be relevant to an individualthan to a company.4

There may be further reasons for distinguishing between the tax treatment of an individual and of a company,by giving tax relief to an individual. A company is normally entitled to tax relief for its financing costs, whereasno such relief may be available for an individual who borrows to invest. An individual has the choice of eitherinvesting or spending for personal pleasure. The option of spending for personal pleasure is not available to acompany, which is immune to such temptations. This means that it may be sensible to have some differentrules for companies and for individuals.

7. Double tax issues may arise, for example in relation to the sale of shares in a company. A company is aseparate taxpayer, but can be viewed as paying tax on behalf of shareholders. Is it therefore wrong to tax theprofit on a sale of shares as well as to tax the profits of a company? These issues are addressed in AppendixThree to this paper. In short, Appendix Three concludes that double tax does arise to an extent, but there is noready solution to this without opening the door to widespread avoidance. The best solution to the problem,even though it is only a partial solution, is to reduce the rate of corporation tax.

(Less valid as an objection to CGT is a more general argument that to tax capital gains involves doubletaxation. The argument is that the increase in value of a capital asset, viewed as a source of income, reflectsthe increase in future income expected to be derived from the asset. This future income will be taxed in duecourse, and double taxation occurs. This argument appears to beg the question, however. If it is decided onlyto tax income, on the assumption that a satisfactory distinction can be made between income and capital, thenone can argue that the income is double taxed. If it is decided to tax profit, however, the problem seems todisappear. A person who buys a source of income, receives income, and sells for a profit is only taxed onceon his profit. The same is true for the next person who acquires the source of income. If the next person infact resells for a loss, his loss should of course be deductible in deciding his overall profit for the year.)

E. Should the Tax System Incentivise Taking Risk?

1. It is sometimes argued that profits realised by an investor should be more lightly taxed where he hasassumed greater investment risk. While both work to grow the economy the investor, unlike an employee, maylose his money.

2. This fact would not however appear in itself to justify the giving of tax relief. Investors earn a higherreturn by assuming more risk. But the degree of risk is in practice impossible to assess with any accuracy fortax purposes. The former system of taper relief, for example, conferred substantial capital gains tax benefitsfor AIM shareholdings, even though it has been said that many of these companies are only cash shells withno real underlying business. Even where risk can be quantified the assumption of risk is an unsatisfactory3 Eg if an asset is worth £1,000, and a gain of £900 would be realised on sale, tax at (say) 40% would be £360, and only £640

would then be available to buy a new asset. This may discourage an investor from switching from a poor investment to a betterinvestment. It could also discourage, for example, a manufacturer from selling a fixed asset used for production to reinvest in amore modern asset for use in the business.

4 While the bunching effect can apply to a company, since the small companies rate applies to the first £300,000 of profit, itwould not often be relevant. It is likely that the value of assets sold by a company would have to be greater than the value ofassets sold by a basic rate taxpayer, before the bunching effect became material.



criterion on its own for conferring tax benefits. Betting on the horses is risky, but the tax system should notencourage it! Buying a second home, or short term speculation on the Stock Market may also be risky5, butit is not clear that society benefits from these activities to the extent that tax on gains accruing should bereduced below the tax paid by an employee for his work. What the tax system should encourage is thatcombination of initiative, hard work and risk taking that creates new capital value in the form of new business—this concept can be satisfactorily captured in tax law. The concept of risk should not be taken as a sole criterionto justify tax distinctions.

3. Some further problems connected with using the criterion of risk to justify tax advantages are set out inAppendix Four.

F. Incentives

1. A tax incentive is a measure which results in a taxpayer paying less tax on profits which he receives froma specified source than taxpayers generally pay on their profits. What principles should apply to decide whetherto confer an incentive? It can readily be argued that an incentive can be provided to a taxpayer where it isconsidered that those taxpayers who do not qualify for the incentive are also better off, by reason of the indirectbenefits of an enhanced economy that flow back to them. Without such a criterion there needs to be some othergood reason for asking some taxpayers to subsidise others. When considering a tax incentive, the governmentmust be careful to avoid trying to spot winners that the market has not identified. The various schemes forbusiness expansion relief, venture capital relief, etc, which lay down detailed rules for which businesses qualifyall suffer to some extent from this defect. The usual consequences in terms of distortion, avoidance, andstimulating tax driven investment arise when it would have been preferable to leave investments to be madesimply on a market evaluation, not for tax reasons.

2. It is however considered that the sale of a business by entrepreneurs satisfies the above criterion for taxrelief. Although clear-cut research results are not easy to obtain6 it is easy to appreciate that reduced tax onthe sale of a business is likely to encourage the combination of initiative, risk taking and sustained hard workrequired by entrepreneurs to build a successful business. It also seems appropriate that the proportion of thegain qualifying for relief should increase the longer the business is owned (up to a maximum period), toencourage a medium to long-term approach by entrepreneurs.7 The effect of such a relief, along the lines ofthe old retirement relief that subsisted until the introduction of taper relief is likely to be to stimulate an“enterprise economy”. The relief need not be restricted to the first £5 million of gains.

3. It is also considered that the sale of employee shareholdings satisfies the criterion for some form of taxrelief. Where the employee’s interests are aligned with shareholders in this way the employee will be motivatedto contribute to the profitability of his company. This relief should be less generous than that afforded to trueentrepreneurs who own and control their business. It would seem appropriate, however, that the relief shouldalso become more generous the longer the shares are held.

4. It will be noted however that the fragile distinctions discussed above between income and capital, andbetween accrued income and capital gains on the sale of assets would not matter in relation to the incentivessuggested for entrepreneurs and employee shareholders. It would simply be assumed that an entrepreneur, oremployee shareholder, would be entitled to the relief if the asset is owned for a qualifying period, irrespectiveof his motives on acquiring the asset.

5. This paper does not address in detail the issue of private equity managers who take ordinary shares of aspecial class in their company. One can argue, however, that where a special class of shares confers anadvantage where the company earns profits in the short term, the interests of shareholders of that class are nottruly aligned with other ordinary shareholders. (Some further points concerning private equity are set out inAppendix Five).

6. It is of course possible for there to be too much investment and too little spending in an economy (whichmay have been the case until recently in Japan). It is undoubtedly true, however, that we are all better off ifpeople have been sufficiently encouraged to save that they will not become dependent on the state for financialsupport. A tax incentive seems appropriate for savers

It is suggested that this relief should become more valuable the longer that savings remain invested (and arenot used for personal expenditure). In other words an incentive should simply be based on the length of timethat wealth remains invested, and not on the existing rather subjective test of whether an asset is purchasedwith the intention of reselling at a profit. However if an investor wishes to switch from one investment toanother for financial reasons on the basis of economic analysis the tax system should not discourage him fromdoing so by conferring relief the longer that a particular investment is held. This is an important point—a5 And it should be borne in mind that simply giving tax relief for losses means that taxpayers in general share that risk6 The 1995 policy analysis by the Cato institute (The ABCs of capital gains tax) recognises the different results but says that the

historical evidence favours the overall economic benefits of cgt cuts. Other US papers, such as by Huppi (www.huppi .com./kangaroo ) and by Summers come to an opposite conclusion. Further, it is not so hard to measure the impact of cgt changes onrealisations following changes in tax rates—what is more difficult to measure is their impact on new investment, which is themain concern..

7 Retirement relief pre-1998 is an example of such a relief, although perhaps not very generous. The limits changed over time,but at the time of abolition the first £50,000 gains on the sale of a business were tax free, and one half of the next £150,000gains were also exempt. These reliefs were only available in full if the business had been owned for at least 10 years.



substantial problem with taper relief was that it was distortionary—it encouraged a taxpayer to hold an assetfor tax reasons even though it would be more efficient to sell and reinvest in another asset. There seems noreason why the tax system should encourage this.

The way in which it is suggested that more appropriate tax relief for savers could be granted in practice isdiscussed in Section J below.

G. Current Tax Incentives For Investments

1. Tax law applicable to investors is very complicated. There are different rules for investing in shares incompanies, bonds, investment trusts, authorised unit trusts invested in shares, authorised unit trusts invested inbonds, insurance products, offshore investments etc. There is also voluminous additional tax material, such asthe accrued income scheme and rules for deep discounted securities etc.

2. There are many complex rules for different tax-exempt savings vehicles (in addition to those for pensions):

(a) ISAs. These are the government’s main non-pension attempt to encourage personal savings. Theyreplaced PEPs and TESSAs. Income and gains accruing within both are tax-free. There are two typesof ISA; “Cash ISAs” and “Stocks and Shares ISAs” 8.

(b) PEPs. It has not been possible to make new investment in Personal Equity Plans (“PEPS”) since 1999,but those continuing to hold PEPs can still receive tax free income and gains within the PEPs.

(c) Child Trust Funds. These started in 2005 and have since been in future for most children. They didapply to all children born after 1st September 2002. The Government contributed £250 to the fund (or£500 where household income is low). Relatives or friend could contribute up to £1,200 a year intothe fund. Income and gains in the fund accrued free from tax, and children were able to take themoney when they reached the age of 18.

(d) Venture Capital Trusts (VCTs). Tax relief at the rate of 30% is available for the cost of investment ina Venture Capital Trust (VCTs). VCTS are required under the tax rules to invest in certain types ofunquoted trading companies. The maximum qualifying investment is £200,000. Dividends receivedfrom the trust and gains on the shares are also free from tax.

(e) Enterprise Investment Schemes (EITs). Income tax relief at 20% is available for the cost of investmentof up to £200,000 in any tax year through an EIT. There is no capital gains charge provided the sharesare held for a qualifying period.

3. Several of these schemes carry the risk that tax relief may be withdrawn if the qualifying conditions arebreached, even if the breach is inadvertent. For instance relief for investment in a VCT is withdrawn if theVCT does not invest most of the cash raised by a share issue in qualifying investments within 12 months.Relief for investment in an EIS is withdrawn if the company ceases to satisfy a number of conditions within athree year period—for example by receiving too much royalty income.

4. Some tax vehicles can also distort investment decisions and encourage what may for many beinappropriately risky investment. For example, an analysis at one time of 13 venture capital trusts launched inthe first two years since their introduction in 1995, showed that only half had produced a positive return. Ofthe 66 VCTs with a track record of more than 3 years, only 29 had produced a positive return9.

5. Child Trust Funds did not prove popular, with at one time more than one in three not taking up theirentitlement.10

6. The overall effect of these rules is, to some extent, to discourage investment, by virtue of their complexity.

H. Problems with the 18% and 28% Tax Rates

1. The revival of separate capital gains tax rates after the abolition of taper relief has taken us us back inmany respects to the position before the 1988 Lawson reforms.

2. They have however recreated the problems which the Lawson reforms had ameliorated. When all capitalgains are taxed more lightly than income (18% or 28% compared with a marginal rate for income of 40 or50%), regardless of the length of ownership, the tax avoidance industry is reinvigorated to turn income intocapital. Large numbers of taxpayers will be in substantial doubt as their tax treatment, not knowing whetherHMRC will accept capital treatment for their circumstances, or whether HMRC would argue that the asset waspurchased with a view to resale at a profit. One can expect many more disputes over recent disposals betweentaxpayers and HMRC over this basic issue. This is particularly likely given the constant pressure on the taxauthorities to collect as much tax as possible without being seen to raise revenue by change of tax statute Themany cases which will arise are likely to refocus minds on what really distinguishes capital from income soas to justify substantial differences in tax treatment. The lower rates of capital gains tax also create newexamples of unfairness between taxpayers. The man who goes out to work would appear to benefit the economy8 In a tax year an individual can take out two mini ISAs comprising one cash and one stocks and shares ISA. Alternatively an

individual can take out one maxi ISA which must include a stocks and shares component.9 Survey by Allenbridge Group plc.10 Only 1,478,000 accounts were opened as at 20 February 2006 compared with 2,303,000 vouchers which had been issued at that

date.



more directly than the man who buys and sells shares (perhaps within the same year tax year) on the stockmarket, but who may pay only half the tax on the same amount of profit.

I. Annual Allowance

1. At present every person has a capital gains tax allowance of £10,100 per year. Although this is a subsidiaryissue for the purposes of this paper, there are issues arising from the allowance which should be mentioned:

(a) It is separate from the personal allowance of £6,475

(b) Unlike the personal allowance, a spouse can transfer assets to the other spouse free from capital gainstax before an onward sale to a third party. Those with knowledge of the system, or professionaladvisors, can, and do, use this to effectively double their allowance to £20,200.

(c) The tax bill is very different for taxpayers who have, say, either £40,000 income, or a £40,000 capitalgain, or £20,000 income and £20,000 capital gain. The third taxpayer is better off because of the twoannual allowances available to him.

2. The allowance does have one important practical advantage. If often avoids the need for complicatedcapital gains tax calculations. However, if gains were made easier to compute this justification for a separateallowance would diminish. It is perhaps harder to justify the allowance on the basis that it exempts smallgains—is it right that a Tesco check out lady, doing some extra baby sitting at £6 at hour, should pay tax onthis, whereas another taxpayer who has small capital gains should be exempt if his CGT allowance had notbeen utilised?

3. It appears reasonable to abolish the CGT allowance in due course. This would simplify the system andallow for an increased combined allowance

J. A Proposed Solution For Investors

1. This Section puts forward proposals for an individual life savings account. Such savings accounts couldinclude many forms of assets, such as investment properties as well as financial assets. Under this proposal,both income and capital are “rolled over”, so that tax only becomes due on both forms of profit when withdrawnfor expenditure.

2. What matters (leaving aside tax considerations) to an investor is his total investment return. An investorwill want to make a profit from his activity, but may have little reason to prefer whether the profit is taken onrealisation of the asset or as income during the period of ownership. No investor reviewing the performanceof his pension fund or a with profits bond, for example, is concerned with whether the profit is income orcapital. What is needed is a tax regime that encourages investment, no matter how the profit is taken.

3. These proposals would result in substantial simplification of the tax code. Complicated legislation, suchas the accrued income scheme, the offshore funds legislation, and much other anti-avoidance legislation couldbe repealed, because in general capital gains and income would be aggregated and subsumed into one system.There would be no reason to turn income into capital.

4. Under this proposal there would be no tax to pay on the proceeds of sale of an investment or on incomeif the money is reinvested and not withdrawn for personal expenditure

5. One often reads criticism in the literature of “capital taxes” which serve to reduce the nation’s wealth11.Crucially, however, the criticism is typically levelled at the taxation of capital gains which are then reinvested,not capital gains which are withdrawn for consumption. The proposal to tax capital gains (as well as income)only when withdrawn for expenditure does not therefore seem to be caught by such criticism.

The proposal would be a move towards an expenditure tax in the sense that income and gains frominvestments are taxed on individuals when withdrawn for personal expenditure. This reflects a preference whichis often expressed for the direction of tax reform, at least from the time of the Meade Committee.

6. It is proposed is to adapt the rules for ISAs. As a starting point there would be a substantial increase tothe investment limits and the removal of many of the investment restrictions currently applying to ISAs. Incomeand gains would remain tax free whilst retained in the ISA. However, in contrast to the present rules, profitswithdrawn from the ISA (whether of a capital or revenue nature) over and above an annual exempt limit,would be taxed on the investor at that time.

7. This would build on the good work which has been done by investment managers to establish the ISAbrand. (The continuing value of ISAs has also been recognized by the recent press confirmation that there arenow no plans to phase them out in future.) The existing rules and limits could be retained for those investorswho did not want any tax liability when money is paid out of their ISA.

8. All investors would be allowed to withdraw an annual amount tax free, reflecting the advantages currentlyavailable for ISAs, but on withdrawals in excess of this amount of profits accrued within the ISA the saverwould be liable to tax.11 See for example Patrick Minford “An Agenda for Tax Reform” CPS April 2006



A saver who held all his investments in an ISA would see all the current pages in the tax return which dealwith investment income and capital gains replaced with just one line: the figure for taxable profit withdrawnwhich would be provided by the ISA operator. (The ISA operator would have computer systems availablewhich would make it easy for it to calculate the profit for tax purposes and show the calculation to the investor).

9. Taxpayers could also be allowed to set up their own lifetime savings bank accounts instead of using anISA operator to manage the account. In this case they would, of course, need to carry out their own calculationsof the income and gains accruing to the account in order to calculate any taxable amount on withdrawals fromthe account.

The regime would particularly benefit smaller savers because of the fixed amount which could be withdrawntax free each year.

10. Clearly a proposal such as this would require much work to develop. It would also need consensusacross the political spectrum, so that investors could have confidence that the system would last for a verylong time. An outline of what possible key features of the expanded ISA is set out in Appendix Six.

APPENDIX ONE

HOW TO IDENTIFY A CAPITAL ASSET UNDER CURRENT LAW

There are rules of thumb which provide practical assistance, even though the underlying justification for therules may be weak. For example it is usually accepted that an individual taxpayer who buys and sells sharesdoes so on capital account. This has the practical advantage for the tax authority that losses on sharetransactions cannot under current law be set against other income. In fact, however, it may often be untrue tosay that an individual has bought shares to hold them for their income, rather than with the intention of resellingat a profit. This is particularly so in a case where in the company has a high p/e ratio and/or a low or nildividend distribution policy.

Property sales provide another example of the difficulty of applying the present tax distinction. A propertydeveloper may wish to undertake an office development and to let the completed development to businesstenants. He may well intend to sell the land for a profit at the most favourable opportunity during this process.If he wishes to be in the capital gains tax world rather than the trading world he may well however seek topresent his intentions in a way that gives the best chance of favourable tax treatment. As a rule of thumb thedeveloper might well be advised that if he holds the property for, say, three years, his claim for capital treatmentshould be accepted.

In the example of the apple orchard given above it would be clear that the seller of young apple saplings tothe orchard owner would be a trader. It would also be clear that the orchard owner would own the trees(together with the land) as a capital asset if he was a young man who intended working in the business untilretirement. There would be a grey area, however, if the owner intended to plant the trees and then to sell fora profit after only one or two years’ crops.

APPENDIX TWO

HOW TO TELL WHETHER A RECEIPT DERIVED FROM A CAPITAL ASSET SHOULD BE TAXEDAS INCOME OR CAPITAL

A difficulty is that the investor’s total financial return from the asset is a combination of income and capitalreceipts, and that there is often an inverse relationship between them—ie the capital gain can be enhanced ifless income is taken during the period of ownership, and vice versa. For example, a bond which carries a fixedrate of interest which is less than prevailing interest rates could be purchased at a discount, leading to a highercapital gain on a subsequent sale or on maturity. A higher capital gain could be expected on shares in acompany which applies a low distribution policy, compared with the gain to be expected on shares in a similarcompany which applies a higher distribution policy. An extreme example of this was the recent widespreadissue of zero dividend preference shares issued by companies which declared an intention to go into liquidationwithin a predefined period.

UK tax law often endeavours to distinguish between accrued income and capital receipts on the realisationof an asset. An example is the accrued income scheme which taxes as income accrued interest on the realisationof loan stock. Even this apparently straightforward objective is complicated by such matters as convertibles,default of the debtor, fluctuating or indeterminate rates of interest, sale and repurchase transactions etc, andrequiring many sections of tax law to address. In other situations (eg schemes involving the liquidation acompany, or schemes for rolling up interest in offshore funds) the question of identifying the deferred incomeelement of a receipt on realisation may be even more difficult to determine.

A very large number of schemes have been employed for turning income into capital, which have beenaddressed by further anti-avoidance law and cases decided by the courts. To take one small example, a personwho sells a company to a third party will normally only be liable to tax on capital gains, even thought thecompany could have paid a dividend before a sale which would then take place at a lower price. If the companywere to be sold to another company established by the taxpayer, however, the capital gain would be deemedto be income for tax purposes.



APPENDIX THREE

This appendix addresses the issue of double taxation as it may affect taxation of companies and theirshareholders.

If a company earns £100 profit and pays tax of £28 it can pay out a dividend of £72. Because of the taxcredit associated with the dividend under the imputation system, a basic rate taxpayer has no further tax liabilityon the dividend. A higher (40%) rate taxpayer has a further liability of £18.00 on the dividend. It will be seen,therefore, that a basic rate taxpayer has suffered tax at the rate of 28% compared with 20% if he had receivedthe profit direct. The higher (40%) rate taxpayer has suffered tax at 46.00%, compared with 40% if he hadreceived the profit direct. The imputation system therefore reduces, but does not eliminate double tax. For apension fund the tax position has been seriously worsened of course by the tax credit ceasing to be refundable—such a fund would not pay tax at all if it received the £100 direct, assuming it is not trading income, butreceives only £72 as a dividend. If the full rate of company tax is reduced this would clearly reduce the extratax paid by having a company.

It should be noted also that the ability of the company to reinvest and pay tax at only 28% until the moneyis distributed represents a countervailing advantage for the use of a company for a higher rate shareholder. Ifhe had received the original £100 profit direct, he would only be able to reinvest £60 to earn further profit.

A further double tax issue arises in relation to sales of shares in the company.

Suppose a shareholder subscribes £100 for shares in a company, and the company then uses the money topurchase an asset for £100. The asset then appreciates in value to £300. The company sells the asset, realisesa profit of £200, and pays £56 tax. The company’s assets are then worth £244. Let’s assume that the shares arealso then worth £244. If the shareholder then sells the shares for £244 he will realise a capital gain of £144.After paying tax @ 28% the after tax profits will be £103.68, representing a total tax take of £96.32 on theoriginal £200 profit for a higher rate taxpayer.

This is clearly double taxation. What are the counterarguments in defence of taxing share sales?

Firstly it might be noted that in the above example it would be more tax efficient to pay out the after taxproceeds of £144 on the sale as a dividend (before selling the company for £100 or liquidating it anddistributing the £100 to the shareholder). The tax take would then be as above.

Secondly, and more importantly, it is unlikely that the transaction would have been structured in this way inthe first place. It would have been more tax efficient simply to sell the shares. If it were likely that the purchaserwould cause the company to sell the asset he might argue for a discount on the purchase price to reflect thedeferred tax attributable to the asset. It may be, however, that the company would not be anticipating sellingthe asset, or if it were, that roll—over relief would be available to shelter tax on the profit arising. Much ofthe appreciation in value of shares is typically attributable to the appreciation in value of the goodwill of thecompany, and there may be no prospect of the company selling this. The appropriate discount might thereforebe small.

If share sales were exempt from tax there would be an overriding reason for the company not to sell theasset if at all possible. Indeed there would be an obvious incentive to own all assets indirectly through acompany, so as to avoid paying tax on selling assets by selling the company which owns the asset. If sharesales were exempt it would also be necessary to decide whether to exempt derivatives (options or futures)whose value would correspond to the share value, but which can be created without increasing the level ofdouble tax. (Indeed it is said that more people derive value from derivative contracts over shares in somecompanies than from actually holding shares in these companies).

Thus, by seeking to avoid double taxation by exempting share sales it is possible that no tax would bepayable. In contrast, although there is the potential for double taxation only single taxation would in practiceapply on many occasions.

APPENDIX FOUR

SHOULD TAX INCENTIVISE RISK TAKERS?—FURTHER ARGUMENTS

HMRC is not likely to be adept at assessing risk—it seems from recent events (the US sub-prime mortgagedebacle) that not even the markets are always good at this. One can have little confidence that HMRC wouldbe any better.

(a) If the tax system rewards risk takers with lower tax rates then the market has to reassess risks to takeaccount of their tax consequences. This is a distortive and complex factor, not least because the taxconsequences may themselves be uncertain, thereby introducing a further risk element.

(b) Risks associated with all assets can be reduced or eliminated through insurance—but it would seemmistaken for taxpayers to be discouraged from taking commercial steps to reduce their risk if thiswould increase their tax bill.

(c) Further, in relation to private equity transactions for example, the individuals may in some casesassume minimal risk for practical purposes having regard to their other assets. If an investment of say£50,000 is made in the hope of realising £5 million profit by a person who already has millions in the



bank, it is unlikely that the risk will keep him awake at night, and yet the tax system is quite incapableof taking such realities into account.

It seems therefore strongly arguable that the tax system should not try to confer tax benefits for riskierinvestments as a sole criterion for relief, as was attempted in the distinction between business and non-businesstaper relief. The market should be left to price these risks, without tax considerations clouding the pricingmechanism.

APPENDIX FIVE

PRIVATE EQUITY

A continuing topical issue is the way employees of private equity funds take capital interests in targetcompanies.

This beneficial tax treatment is often justified on the basis that the individuals on the basis of the risksassumed by the individuals. However it is important to point out that the individuals’ investment is not neededto fund the transaction—it is typically dwarfed by the size of the institutional investment. The individuals takeshares on the enterprise because that is the most tax efficient way to provide them with an appropriate incentive.A similar pre-tax effect could usually be obtained by making appropriate adjustments to salary and bonus.

In line with the proposals made in this paper, however, the private equity individuals who took shares wouldbe entitled to the tax relief proposed for employee shareholdings, (which would, as explained above, be lessgenerous than that available to entrepreneurs having control of the company concerned)

APPENDIX SIX

A NEW SAVINGS REGIME

1. The expanded ISA regime might be on the following lines:

(a) each year a saver would be able to invest to a general account and (with a separate maximum) intothe pension account of their ISA;

(b) the ISA could include all savings currently conducted through direct investment, pension schemes,child trust funds and others;

(c) a portion of savings would be put into the pension sub-account;

(d) income and gains accruing to the ISA would not be taxed whilst remaining in the ISA;

(e) the saver would be able to withdraw any amount up to the entire fund (apart from in the pensionaccount) if desired. Of course, it would be necessary to decide whether amounts withdrawn representedprofit or return of capital originally invested.. An amount withdrawn could for example be deemed torepresent realized profit (whether “income” or “capital” profit) within the ISA before a return of theoriginal amount invested;

(f) a certain amount of profit might be withdrawn each year without a tax liability. Unutilised allowancesfrom one year should be carried forward to succeeding years, to encourage long term saving; and

(g) on retirement the pension fund element would be used to buy an annuity or for income draw down.

2. The expanded ISAs regime could increase simplicity, transparency and fairness in several specific ways:

(a) the regime would solve the lock-in problem referred to above. No tax would be payable if aninvestment were sold and another investment purchased within an ISA. There would therefore be noincentive to retain poor performing or inappropriate investments;

(b) ISAs would also alleviate the bunching problem. A gain that had accrued over several years could bepaid out over a period of time. It would not therefore be taxed at a high marginal rate. It would alsogive effect to the principle that (generally) capital gains and income need not be distinguished;

(c) it should become easier for investors to keep an over view of their savings. Each investment madethrough the ISA could be tracked, and an annual statement produced for investors to show the valueof their savings;

(d) ISAs might alleviate the issue of forgotten bank accounts. As deposit accounts could be includedwithin the ISA (and thus included within an annual statement of all an investor’s savings) they wouldbe harder to lose;

(e) existing complex tax exempt or tax preferred regimes, such as EIS and VCT schemes, would nolonger be needed. Over time other savings vehicles referred to above might be conformed to a moreunified tax basis, so that tax on the underlying investment returns only became due on the distributionof funds from the ISA; and

(f) If desired, although there would be additional complexity, qualifying investments attributable ofentrepreneurs could be held within the ISA. It would then be necessary to increase the tax freepayments which could be received from the ISA.



3. This Appendix does not of course seek to address all issues arising from the expanded ISA concept.Under existing dividend rules it would work best if dividend tax credits were refundable to the ISA—or elsea tax credit would clearly need to be made available when dividends received are distributed out of the ISA.Further consideration would also be required to reflect foreign tax credits. If, however, the current rules fordividends were abolished and a withholding tax applied to dividends instead, it would be easy to provide fora refund of the withholding to the ISA.

4. The tax position on the death of the individual investor is not addressed.

5. In due course the ISA regime might be expanded even further. Existing investments could be transferredinto the ISA (on a no gain/no loss tax basis, so that the whole profit or loss subsequently accrued to the ISA).Alternatively the proceeds of sale of an existing asset could be placed in the ISA. The amount of deferred taxprofit would become relevant as the money is paid out.

6. At the heart of the proposal is a designated bank account for making investments and receiving investmentreturns. Tax is payable only when money is withdrawn from the account for private expenditure. In due courseindividuals might be permitted to run their own designated bank accounts and to account to HMRC for theirtax liabilities without the involvement of a scheme manager.

7. This paper does not attempt to address the exchequer costs or benefits of the proposal. It would dependon the annual allowance and the extent that the scheme is taken up. The key feature of the proposal is taxdeferral, however, rather than an absolute reduction in tax. It could be implemented in stages, so that theexchequer risks could be monitored and controlled.

January 2011

Written evidence submitted by the British Air Transport Association (BATA)

1. The British Air Transport Association (BATA) welcomes the opportunity to submit evidence to the inquiryentitled “The Fundamental Principles of Tax Policy”, being undertaken by the House of Commons TreasurySelect Committee.

2. BATA is the trade body for UK registered airlines. Our 10 members cover all sectors of the airlineindustry—including freight, charter, low fare, regional operations and full service. In 2009, BATA membersdirectly employed over 71,000 people, operated two thirds of the UK commercial aircraft fleet and wereresponsible for some 80% of UK airline output, carrying 81 million passengers and 1 million tonnes offreight.12

3. We appreciate that aviation taxation is of only peripheral concern to this inquiry. Nevertheless, we dowish to bring to the Committee’s attention a number of issues which we believe are of relevance.

4. The Coalition Government went ahead with the dramatic increase of up to 50% in Air Passenger Duty(APD)—the tax on flying from UK airports—which came into effect from 1 November this year and was firstannounced by the previous Administration in November 2008.13 After one of the most disastrous years onrecord for aviation, this was a kick in the undercarriage that the industry could ill afford. Aviation alreadymore than pays for the environmental costs of the 6% of total UK CO2 emissions it produces through theimposition of APD and Britain now suffers from the heaviest tax on flying in the world with as much as £170levied on a single ticket. Indeed, the Office for Budget Responsibility calculate that the Treasury now makesmore money from the tax on flying than it does from the Bank Levy or from duties on alcoholic spirits, andwill raise over £15 billion from APD in the next five years.14 This level of taxation is especially damaging toregional airports where routes have been lost over the last few years to our near continental competitors whoimpose little or no similar tax on flying. Instead, our near European competitors are actively building newrunways to accommodate new traffic and the anticipated growth in tourism from the Far East.

5. The Prime Minister has publicly stated an aspiration to grow the numbers of tourists visiting the UK andthus help stimulate the economy, most recently in January 2011.15 Yet the cost of visas and APD totals £612for a family of four visiting from China on a round trip flying economy to the UK. By comparison, it coststhat same Chinese family £212 to visit Paris. In 2008, France received 688,000 Chinese tourists compared tojust 108,000 visiting the UK.16 With such a disparity in tax on tourism between the UK and our continentalcompetitors, the challenge of increasing our tourist numbers is made all the more difficult.12 CAA “UK Airline Statistics: 2009—Annual”, tables 1.6, 1.14 and 1.11.213 HMT Treasury “Pre-Budget Report 2008”, chapter 7, pages 138 &139, table 7.2 and paragraphs 7.55 to 7.5814 Office for Budget Responsibility “Economic and Fiscal Outlook—November 2010”, page 91, table 4.615 Prime Minister’s Speech on Economic Growth, 6 January, published on www.number10.gov.uk16 Visit Britain “Welcome to Britain: Improving the Visa Application Process”, March 2010, page 2, paragraph 2 at

http://www.visitbritain.org/Images/Visas%20final%20Mar10_tcm139–186987.pdf



6. In its recent Budget, the Irish Government reduced their tax on flying on the grounds that the quantum ofthe tax was damaging to tourism.17 It is notable that a Government facing arguably a far more serious fiscalcrisis than the UK has taken the decision to reduce its tax on flying in order to stimulate the economy.

7. BATA would be pleased to provide oral evidence to expand on the points made in this submission.

January 2011

Written evidence submitted by Shelter

Introduction

Shelter is a charity that works to alleviate the distress caused by homelessness and bad housing. More thanone million people a year come to us for advice and support via our website, helplines and national networkof advice centres. This work gives us direct experience of the various problems caused by the shortage ofaffordable housing across all tenures.

We welcome this opportunity to input into the Committee’s review of the fundamental principles of taxpolicy. As housing experts we wish to focus our submission on the taxation of land and property. Key housing-related taxes include council tax, stamp duty, capital gains tax, inheritance tax and income tax from rentedproperties. Each of these taxes is, in their current form, problematic to some extent.

The economic crisis has highlighted the inadequacies of our housing market. Yet the housing taxation system,which plays a huge role in housing and the wider economy, has often been overlooked and long term reformdismissed as too complex or too difficult. With the recent Mirrlees Review describing taxation of land andproperty as “inefficient and inadequate”18 it is clear that housing taxes can no longer be ignored.

What are the Key Principles which should Underlie Tax Policy?

Shelter believes that the property taxation framework should contribute to the following four key objectives:

1. Promote stability in the housing market

Housing booms and busts lead to economic instability. When house prices are over-inflated, too many peopleare unable to access a home and too many need to rely on risky and unsustainable credit, making them morevulnerable to the threat of repossession. When house prices crash, negative equity can become a reality.Instability is also a poor foundation for policies to tackle entrenched problems like the insufficient supply ofnew homes.

2. Reduce housing affordability pressures

Whether it’s young people struggling to get a foot on the housing ladder or families unable to make rentpayments, unaffordable housing is pushing millions to the brink. Recent Shelter research indicated that some2 million people are using credit cards to pay their rent or mortgage.19

3. Balance out tenure choices

Political rhetoric often focuses on subsidies for low income households in the rented sector. But the realityis that government awards huge tax advantages to homeowners,20 which leads households to believe thathome ownership is the only rational option and so distorts tenure choices.

4. Lessen housing wealth inequalities.

Nearly two thirds of households in England are owners and—depending on when and where they bought—many have seen their assets grow substantially and can pass their housing wealth on to their families. Otherswere not so lucky—indeed the divide between housing “haves” and “have-nots” has contributed to a wealthinequality so severe that some commentators have warned of a gulf between rich and poor not seen since theVictorian era.21

At present, the taxation of property does little to help meet these objectives. Council tax, the biggest housingrelated tax, is highly regressive and based on twenty year old property valuations. Stamp duty has no cleareconomic rationale and a highly inefficient “slab” structure. Capital gains tax is currently charged only onsecond homes and not primary residences, but is easily avoidable.

Shelter warmly welcomes the fact that these issues are now being debated and urges the committee topromote further discussion in Parliament. There are a number of wide-ranging reforms that might be suggestedfor property taxation, including:17 Irish Department of Finance, “Financial Statement”, 7 December 2010 at

http://www.budget.gov.ie/budgets/2011/FinancialStatement.aspx18 Mirrlees et al., Tax by design, Institute for Fiscal Studies 2010, accessed via http://www.ifs.org.uk/mirrleesReview/design19 Shelter press release Two million people use credit cards to pay mortgage or rent, shelter reveals, 06 January 201020 Hills, J. Ends and Means: the future role of social housing in England, CASE report 34, 200721 Dorling, D, & Thomas, B, “Know your place: inequalities in housing wealth”, The Great Divide, Shelter 2005



— Reforming council tax, or replacing it with an annual property tax or a land value tax.

— Reforming the “slab” structure of stamp duty tax, or scrapping it in favour of another kind ofproperty tax.

— Reviewing wealth taxes, including those related to housing such as inheritance tax and capitalgains tax.

As discussed in Shelter’s report, Rethinking Property Taxation, it’s clear that fundamental reform isneeded.22 But we have also identified some smaller scale anomalies in the property taxation system that shouldbe addressed. For example:

— The rent-a-room scheme gives a tax exception to owner occupiers who let out a furnished room,ie take in a lodger. This scheme helps to encourage supply of affordable rented accommodation,but the low, outdated threshold discourages would-be landlords. Shelter proposes that the thresholdis updated to better reflect rental inflation.23

— Councils can currently offer council tax discounts to owners of second homes or long term emptyhomes. This practice rewards poor use of the housing stock and loses the exchequer tax income—Shelter believes there is a case for abolishing these discounts.

Conclusion

Given the fiscal context, the lack of affordable housing and the extent of imbalance within the housingmarket, Shelter believes that we must start considering ways to achieve a fairer, more progressive system ofproperty taxation, based on the principles of stability, easing affordability pressures, equalising tenure choicesand reducing housing inequalities.

January 2011

Written evidence submitted by the Coalition for Economic Justice (CEJ)

Executive Summary

1. The Coalition for Economic Justice came into being in 2008 as a result of the economic crisis. The CEJconsists of a number of organisations across the political spectrum together with charities and faith groups, allof whom are committed to working for the establishment of a taxation system based on fundamental principleswhich will encourage an enterprise economy. This brief response makes the case for the introduction of anannual land value tax based on such principles while, at the same time, reducing other inappropriate taxes.

The Key Principles that should Underlie Tax Policy

2. As the classical economists, including Ricardo and Adam Smith, laid down, taxes should:

— bear as lightly as possible on production;

— be cheap and easy to collect;

— be difficult to avoid; and

— bear equitably on taxpayers giving each no unfair advantage or disadvantage.

The Ability of Tax Policy to Best Support Growth

3. The main method of achieving growth through taxation is to limit as much as possible taxes that fall onproduction, that is those that put a brake on labour and enterprise. Taxes such as income tax and corporationtax are a direct onus on employees and employers. The best way is to tax unearned rather than earned incomeand wealth.

Structuring the Tax System to Support Other Specific Policy Goals

4. The tax system should be designed to avoid the boom/bust cycle, create much greater equality and ensuresecure revenue for government provision of infrastructure and other public services.

Taking Account of the Ease and Efficiency of Imposing and Collecting Taxes

5. The easier a tax is to impose and collect the better it is for the HMRC and the Treasury. As indicated,this is one of the key principles of taxation. Taxpayers respond more favourably to clear systems of payment.In consequence, this is an important aspect of a well designed taxation system.22 Crawshaw, T. Rethinking Property Taxation: Options for Reform, Shelter 200923 See http://www.spareroom.co.uk/raisetheroof/what-is-the-raise-the-roof-campaign/



The Aspects of the Current Tax System which are Particularly Distorting

6. The present system is hugely distorted because the huge bulk of taxation is taken from earned rather thanfrom unearned income and wealth. The main taxes that take a proportion of unearned income are national non-domestic rates (the “best worst” tax), council tax (which has serious anomalies because it is based on 1991valuations and discriminates in favour of the more expensive homes) and inheritance tax. Income tax, nationalinsurance and corporation taxes distort the system by undermining production. VAT is regressive and reducesdemand, therefore limiting production.

So What are the Solutions?

7. The unearned income referred to above is that derived in the main through private ownership of land.Companies with property portfolios derive a financial advantage within their declared profits and dividendsfrom the economic rent of land and natural resources. Likewise, a proportion of corporate and individual debtinterest conveys the same advantages to the creditor. The land value is created by the community as a wholebut the gain from this goes to the fortunate owners of land. By introducing an annual land value tax (LVT) atthe same time as reducing other inappropriate taxes the tax system becomes more manageable.

8. An annual LVT complies in full with the principles of taxation set out above. Its introduction would leadto the more efficient use of land and thus an improved environment, would promote more sustainable economicdevelopment, could finance infrastructure and other public services and help to solve the housing crisis and theNorth/South divide. Since the credit bubble was created by investment in the housing market LVT would be amajor factor in avoiding future booms and busts. It is distinguished from the various development land taxeswhich failed because they delayed development and did not collect the necessary revenue.

9. To introduce LVT, ownership and valuation of all land would have to be achieved, neither of which isdifficult. In the meantime, there are short term measures that could be applied. These include a strong seriesof measures by government to clamp down on tax avoidance and evasion, action that requires more rather thanless employees in HMRC, and a fairer grading of existing taxes such as council tax and income tax.

Conclusion

10. Above is set out in brief the case for introducing an annual land value tax. LVT complies with all thekey principles underlying tax policy. It is easy to collect, is difficult to avoid, bears equitably on taxpayers and,importantly, does not bear on production. It may be that other organisations, members of our coalition andothers, will produce more detailed proposals in favour of LVT, based on the fundamental principles whichshould underlie tax policy.

January 2011

Written evidence submitted by the UK Sustainable Biodiesel Alliance

1. Overview

This paper has been prepared by the UK Sustainable Biodiesel Alliance (UKSBA) as a submission to theTreasury Select Committee’s inquiry into the fundamental principles of tax policy. The UKSBA is therepresentative body of the sustainable biodiesel industry in the UK.

Our submission has been put together in response to the OECD’s recommendations that the tax systemshould distort economic incentives as little as possible, and in line with the remit of the committee’s inquiryto examine the desirability of the current arrangements whereby there are currently over 1,000 separate reliefsin the UK tax system. It provides an overview of the sustainable biodiesel industry, outlines UKSBA members’concern about the future of the fuel duty differential currently available to producers of sustainable biodiesel,and provides evidence of how this essential tax relief has helped to: reduce carbon emissions; driveemployment; increase waste retrieval and recycling; and develop essential research and development of greenskills in a small but rapidly growing sector of the UK’s renewable energy industry.

2. Summary

The current 20p duty differential for biodiesel produced from Used Cooking Oil, has been a tremendoussuccess in promoting investment, training, employment and technical innovation in a vital part of the renewableenergy industry, and has also had the added effect of helping to reduce the UK’s carbon emissions and increaseeffective waste management. It provides value for money well beyond its modest estimated £10 million costto the Exchequer, and serves as a case study of how well targeted fiscal measures can drive behaviouralchange, private sector innovation, job creation and contribute to the Government’s aim to be “the greenestGovernment ever”.



3. About the UKSBA

The UK Sustainable Biodiesel Alliance is the representative body of the sustainable biodiesel industry, ledby waste to energy company Convert2Green Ltd. UKSBA members produce biodiesel from Used Cooking Oil(UCO), widely recognised as one of the most sustainable forms of renewable energy, and must meet theRenewable Fuels Agency’s Qualifying Standard for sustainability, either for the biofuel they use or the biofuelthey produce. Associate members must be either producers who have achieved the Qualifying Standard orbetter for a proportion of the biofuel they produce, and who are committed to achieving the standard for alltheir fuel, or organisations that actively support the use of sustainable biofuels.

The RFA Qualifying Standard is a carbon and sustainability reporting system for biofuels based on a fulllifecycle analysis of emissions throughout the production chain. Fuels meeting the environmental standard mustbe sourced with regard to protecting biodiversity, carbon stocks, and soil, air and water quality. To meet thesocial standard, employers’ rights and land rights must be protected.

4. About the UK Biodiesel Industry

There are some 37 medium and large biodiesel producers in the UK using waste products such as UCO toproduce fully sustainable biodiesel for use in transport and in heat and power generation. Customers includelarger petrol companies who use low blend biodiesel, to large organisations such as the Environment Agency,McDonald’s and 3663, who run their captive vehicle fleets on high blends of biodiesel with mineral diesel.Power customers include NHS trusts, which use on-site micro generators, run on UCO based bio-fuels, to powertheir buildings. These customers are also able to become suppliers of renewable energy to the national grid.

Biodiesel producers create local employment opportunities and are developing the green skills vital to theUK’s low carbon economy, including green chemistry, research and development and specialist productionskills. As customer demand for the retrieval of other waste streams increases, these skills are being adapted todrive future renewable energy development from waste, such as anaerobic digestion from food waste. Inaddition, producers are working with Local Authorities to set up waste oil collection and recycling centres fordomestic households—a new service.

The majority of biodiesel producers are based in traditionally industrial areas of the UK. One example of alarger producer would be Argent Energy Ltd, based in Motherwell, Scotland, with a production capacity of 50million litres per annum and employment of 88 people, while an example of a medium sized producer isConvert2Green Ltd, with a production capacity of 13.2 million litres and employing 30 people inMiddlewich, Cheshire.

5. Biodiesel From Used Cooking Oil: A Clean and Sustainable Form of Renewable Energy

There are around 250 million litres of UCO produced in the UK every year. The UK currently has nocollection of UCO from domestic premises as a waste product provided by a national body or by a majorityof local authorities, and so a high proportion of this oil is disposed of down the drain or sent to landfill. Defraestimates that 150,000 blockages per year are caused by fat, oil and grease being poured into the drains, atcost to utility companies of £15m per annum. Meanwhile, landfill sites produce 40% of the UK’s methaneemissions and 3% of the UK’s greenhouse gas emissions.

Biodiesel manufactured from UCO is one of the most sustainable fuels available for transport and heat andpower systems. It use can reduce lifecycle carbon emissions by up to 90%. The use of UCO in biodiesel isalready making a valuable contribution to meeting the UK’s stringent renewable energy targets and is helpingto reduce the amount of waste disposed of illegally or in an unsustainable manner. Some 34 million litres ofbiodiesel were manufactured from UCO sourced in the UK and then used in transport in the last year. Withthe potential to access 250 million litres, more can be done if the industry is given adequate support.

6. The 20p Fuel Duty Differential for Biodiesel Produced From UCO

Currently, biodiesel produced from UCO enjoys a 20p per litre duty differential when compared to mineraldiesel. In 2008, the Government announced that it intended to abolish this differential from April 2010. Thiswas done not out of economic considerations, but out of a fear that tax incentives for biofuels were encouragingdeforestation, land use change and rising food prices in the third world. These concerns do not apply tobiodiesel produced from UCO, which is a waste product that might otherwise be poured down the drain.Following an extensive campaign by the UKSBA, it was announced that the differential would continue untilApril 2012 for biodiesel produced from UCO.

This paper will demonstrate that the relatively modest cost of maintaining the tax differential for biodieselmade from UCO, estimated at some £10 million in the March 2010 budget, has provided excellent value formoney and been successful in providing stability for the biodiesel industry. It has had the effect of: increasingUCO collections and driving the retrieval of other forms of waste; encouraging high-blend fleet managers toincrease their use of biodiesel and so reduce transport emissions; and helping drive employment, research andthe creation of a “green collar” skills base in a sector that is expected to be worth some £150 billion to theUK economy in the coming years.



7. The Benefits of the Duty Differential: Creating Market Certainty

The previous Government announced its intention to replace the duty differential with the RenewableTransport Fuels Obligation (RTFO), a certificate scheme which obliges the larger fuel providers to source 5%of the fuel they use from biofuel by 2014. However, the RTFO is still under consultation in light of theRenewable Energy Directive (RED) and will not be implemented until at least the end of 2011. Further ECreviews of the RED will mean further revisions of the RTFO up to 2014 and continuing uncertainty. Certificatestraded under the scheme fluctuate in value and revenue streams from the scheme are low and highly volatile.This makes long-term planning in the industry difficult and creates a lack of market certainty that discouragesthe capital investment and skills training necessary for renewable energy projects to get off the ground.

The uncertainty surrounding the RTFO has had a massive effect on the profitability and cash flow of UKSBAmembers. RTFO certificates have been trading at well below expected value, and several UKSBA membershave been unable to sell any certificates even through brokers and auctions. One member had certificatesrelating to production of over 3 million litres of biodiesel, but was unable to obtain any value for them fromthe obligated suppliers. Another member, who produces approximately 300,000 litres per month, was receiving£25,000 per month in 2008, but nothing at all in 2009, and went from profit to a loss on the productionof biodiesel.

If the 20p fuel duty differential is removed in early 2012, with the RTFO far from embedded, biodiesel willsuddenly become 20% more expensive, and more expensive than mineral diesel. High-blend users, operatingon a 2% margin, will not be able to absorb this huge increase in fuel costs and will be left with no choice butto abandon their green commitments and return to fossil-based fuels. In turn, producers will close, sheddingjobs and reducing the opportunities for practical skills and training in green skills, as demand for fuel expires.As there are no vehicle adjustments necessary for captive fleets, this could happen literally overnight.

This lack of certainty makes business planning impossible and denies the sector vital investmentopportunities. In August 2010, the CBI estimated that the UK is missing out on some £150 billion of investmentowing to a lack of policy certainty, and the Secretary of State for Energy and Climate Change, Chris Huhne,has said that the global, low carbon economy will be worth some £4 trillion by 2015 with 1 million people inthe UK potentially employed in the sector by the end of the decade.

8. The Benefits of the Duty Differential: Employment, Skills and Training

The production of and research into biofuels is a new and rapidly changing area. UKSBA members havebuilt up considerable levels of green skills in the workplace, but with the removal of the differential, some3,000 direct and indirect jobs could be lost over a five year period. The loss of these green collar and lowcarbon skills from a developing industry with much higher levels of research and development and trainingthan most traditional industry sectors would seriously impede the development of the renewable energy sectorin the UK.

8.1 Chemistry skills

The chemistry skills required to produce biofuels and meet quality standards is a complicated and developingarea of expertise. Even chemists who have qualified in green and organic chemistry need to be trained for upto six months to operate an on-site laboratory. At present, all training is in-house within the private sector, withonly general courses publicly available.

8.2 Research and development

The methods of producing biodiesel and associated products are continually developing. Several companieshave research and development arms which are looking to extend the associated products manufactured andtypes of feedstock capable of being processed into sustainable biofuels. This research is dependent on thecooperation of different organisations and the funding from profitable biodiesel companies to continue. If theduty differential is removed, many companies will no longer be profitable and research and potential advancesin new technology will be lost.

8.3 Biodiesel production

All production personnel in the biodiesel industry are required to undergo extensive training to be able toproduce biodiesel and understand the factors which affect the quality of production. Almost all employeesinvolved in production are trained in-house as external courses are not available on the specific requirementsof the industry. This is unlikely to change any time soon as the specific requirements required by producerscan vary dramatically from company to company. The full training of production staff will usually take six tonine months.

9. The Benefits of the Duty Differential: Reducing Waste and Increasing Recycling

From an initial base of UCO collection, customers will often demand more extensive waste collection aspart of their service—for example, glass, cardboard and food waste. In East Cheshire, HW Martin are now



offering waste oil collection vessels at their recycling centres for domestic customers to dispose of their wastecooking oil—a scheme which other local authorities are now expressing an interest in developing.

The stable support offered by the tax differential has created a platform for growth, which allows producersthe certainty to invest in new services and respond to market demand.

10. The Benefits of the Duty Differential: Meeting Carbon Reduction Targets

The UK is currently ranked 25th of the 27 EU member states in the production of renewable energy and thePublic Accounts Committee have commented that meeting EU targets is “unacceptably slow”.

Chris Huhne, Secretary of State for Energy & Climate Change, anticipates that sustainable bioenergy,including UCO based biodiesel, could contribute up to half of the UK’s target of 15% renewable energy by2020—a greenhouse gas saving of 20 million tonnes of C02 equivalent by 2020. He also states that sustainablebioenergy is vital to the UK’s security of supply, as bioenergy is one of the few renewables that can generateenergy on demand.

The tax support offered to UCO based biodiesel is already working to achieve that aim.

11. The Benefits of the Duty Differential: Small Outlay, Big Returns

While the Treasury estimated the cost of the 20p fuel duty differential at £10 million per annum in theMarch 2010 budget, industry estimates in 2009 suggest that, as a result of enforced business closures, some£36 million in VAT, corporate and personal tax revenues could be lost each year if the differential was to beremoved. Over the next five years, based on the planned increase in production capacity, the expected taxrevenues lost to the Government could increase three-fold, meaning £100m would be lost to the Treasury.

12. Conclusions and Recommendations

The Treasury’s Tax Policy Making Handbook, published shortly after the emergency budget in June, notesthat the tax system needs to be reformed to make it more competitive, simpler, greener and fairer. It also notedthat tax policy needs to be proactive, rather than reactive, and that predictability, stability and certainty shouldbe at the heart of tax reform.

The Government has expressed its desire to be the “greenest government ever”, increasing low carboninvestment, making progress towards a greener tax base and using fiscal measures to drive behavioural changethat helps to meet the UK’s environmental objectives and reduces carbon emissions.

The UKSBA fully agrees that the goal of any tax simplification measures should be to provide transparencyand create the conditions that best allow private sector innovation to drive forward the recovery from recession,while spearheading efforts to develop new and transferable green skills in emerging industries.

With these outcomes in mind, UKSBA therefore requests that the Treasury Select Committee note theeffectiveness and value for money of the 20p fuel duty differential for biodiesel produced from UCO in drivingforward carbon reduction, investment, training, employment and technical innovation in a vital part of therenewable energy industry. The UKSBA believes that the future of the sustainable biodiesel industry in theUK would be best protected by a commitment from the Government to retain the duty differential beyondApril 2012 until the new RTFO has had a chance to demonstrate that it can act as a suitable support mechanismfor the industry.

The duty differential is the most simple, effective and transparent incentive for sustainable biodieselproducers in the UK, and clearly demonstrates that reliefs in the tax system can be used to stimulate investmentin the high-tech green industries that will be so vital in securing the UK’s economic recovery and meeting ourchallenging international obligations for carbon emission reductions.

January 2011

Written evidence submitted by the Scotch Whisky Association

1. Executive Summary

1.1 The Scotch Whisky Association (SWA) is the industry’s representative body, with a remit to protect andpromote Scotch Whisky worldwide. Its 56 member companies—Scotch Whisky distillers, blenders andbottlers—account for over 90% of the industry.

1.2 Annual shipments of Scotch Whisky exceed £3.1 billion in customs value, representing 15% of totalScottish exports (exc. oil and gas) and almost a quarter of total UK food & drink exports. The industry isworth £4 billion a year in added value to the economy, supporting 35,000 jobs.

1.3 Scotch Whisky sales in the UK contribute between £600 million–£700 million annually in excise duty,with the spirit drink sector as a whole generating around £2.4 billion a year in UK excise receipts. There are



of course significant additional sectoral tax receipts from the likes of VAT, National Insurance, and corporationtax liabilities.

1.4 The Association believes that any tax system should be fair, simple, transparent, and not distortcompetition. It should aim to maximise revenue efficiently, whilst supporting growth and not underminingcompetitiveness. In relation to alcoholic beverages, there is also an opportunity to support other Governmentalpolicy goals by putting in place a system that protects not skews consumer choice and which is sociallyresponsible.

1.5 The alcohol excise duty system is a useful case study to help assess the key principles of tax policy.Regrettably, the regime fails to reflect any of these principles in a meaningful way and is no longer fit forpurpose. The application of the current excise duty escalator at the same rate across all drinks categoriescompounds the problem.

1.6 The SWA welcomes the Committee’s inquiry as a timely opportunity to look at the fundamentalprinciples of tax policy in the UK. Our comments are based on the industry’s experience of the UK exciseduty system.

2. UK Excise Duty Regime

2.1 Spirit drinks in the UK are subject to a high excise duty rate of £23.80 per litre of pure alcohol, whichis the fourth highest level of duty applied in the EU. As a result, once VAT is applied, over 70% of the averageretail price of a bottle of Scotch Whisky is tax.

2.2 Whilst the alcohol excise duty system remains based on the market conditions of a century ago, the UKdrinks market and consumer preferences have changed dramatically. The excise duty system has, however,failed to keep pace with these changes. Instead, competition and consumer choice in the UK drinks market isunfairly distorted by tax policy and structures. It also works to penalise a uniquely British industry, ScotchWhisky.

2.3 Alcohol served as Scotch Whisky is taxed 250% higher than the same amount of alcohol served as cider,37% higher than beer and 30% higher than wine. As a result, pub measures containing approximately the sameamount of alcohol, vary in excise duty: compare, for example, a half pint of beer at 3.52% vol. (17.31p induty), a 125ml glass of wine at 12.5% vol. (18p), and a 25ml measure of Scotch Whisky at 40% vol. (23.80p).This tax distortion between alcoholic drinks categories is compounded when the same duty escalator is appliedto all categories.

2.4 The Association supports a gradual move to excise duty equalisation, a system where all alcohol is taxedon the same basis according to alcohol content. This would better reflect the key principles of tax policy setout below.

3. Key Principles of Tax Policy

3.1 Tax arrangements should be simple and transparent for consumers and operators. The alcohol exciseduty system fails to deliver on such principles. HM Revenue & Customs’ annual Budget notice contains noless than 14 separate alcoholic drink categories subject to varying duty rates and reliefs. This is despite theEU’s excise structures legislation providing the flexibility to implement a simpler and fairer system based onan approximation of duty rates across the different drinks categories. The existing arrangements are overlycomplex and should be simplified within the framework of European legislation.

3.2 The SWA works closely with Government to secure fair access and a level tax playing field in exportmarkets. Fairness is a fundamental concept that should underpin any tax system. However, despite alcoholbeing alcohol, regardless of whether it is served as cider, beer, wine or spirits, the excise duty tax systemunfairly discriminates between competing products. This distorts the market and consumer choice.

3.3 It is the Government’s role to structure duty arrangements in a way that secures revenue in the mostefficient and effective way, whilst supporting growth and not disrupting competitiveness. Existing alcohol dutyarrangements fail to satisfy these important principles.

3.4 In the summer of 2010, the Association commissioned two separate studies of the revenue impact ofexcise duty reform, based on the most up to date price elasticities available. The detailed reports byPricewaterhouseCoopers LLP and Optimal Economics Ltd both concluded that reform based on dutyequalisation across the drinks categories would be likely to increase alcohol tax revenues by over £1 billion ayear (the equivalent of around 11% of annual alcohol receipts).

3.5 The PwC analysis suggested duty equalisation could raise additional revenue of between £5.7 billionand £7.5 billion on a cumulative basis between 2011–12 and 2014–15. While taking different approaches tothe direct impact of duty equalisation, the studies demonstrate a consistent directional outcome of higherrevenue from duty and VAT flowing to Government at a time when the public finances are under considerablepressure. The Institute for Fiscal Studies has also advocated reform of the alcohol duty regime, with duty basedon alcohol content (“The Impact of introducing a Minimum Price on Alcohol in Britain”, IFS Briefing Note



109, November 2010.) Disappointingly, the November 2010 Treasury “Review of alcohol taxation” failed tomake any assessment of the revenue implications of reform.

3.6 The system, instead, continues to undermine the competitiveness of a key British industry bydiscriminating against Scotch Whisky in its home market. Domestic tax reform on the basis of the principlesset out above would do much to support the sector’s competitiveness in what is its third largest market. Thiswould remove disincentives to invest in the UK market and support smaller distillers who rely on domesticsales as a foundation for their businesses.

3.7 Tax reform would also support a key manufacturing and export sector at a time when the Government,rightly, wants to re-orient the economy in that direction. It would set a welcome and influential precedent thatcould be used as a positive example in negotiations over tax discrimination in Scotch Whisky’s export markets.

4. Supporting Other Policy Goals

4.1 The SWA supports the long held Treasury position that tax policy is not the best lever to address socialissues, such as alcohol misuse. However, tax arrangements can still be structured to help support specificpolicy goals.

4.2 The Government, for example, believes it important to support the domestic pub trade. PwC modellingindicates that reform could encourage an increase in on-trade purchases of some drinks, delivering benefits tothat sector.

4.3 The duty structure not only distorts competition, but it also erroneously implies that lower strengthproducts are in some way healthier. Approximating duty equally across all drinks, according to alcohol content,would help promote individual responsibility, raise awareness of moderate consumption and help underpin themessage that it is the amount of alcohol consumed and the pattern of consumption that is important, not thetype of drink chosen. It might also encourage a trend to the production of lower alcohol strength drinks whereallowed by law to take advantage of a lower duty rate, in a non-competitively distorting way.

4.4 Duty equivalence offers the Government an opportunity to introduce a more socially responsible system,by taxing the amount of alcohol consumed rather than the type of drink chosen. This approach would directlyaddress concerns around the price of “high strength, low priced” products, but avoids inevitable difficulties indefining what constitutes a “problem drink”. With the Home Office consulting on a UK-wide ban on salesbelow cost, there is also an opportunity to set a legal “floor price” for alcohol by basing the system on no salesbelow tax (excise duty plus VAT on that duty).

5. Conclusion

5.1 The SWA believes a number of key principles should underlie tax policy. Arrangements should seek tobe as fair as possible, as well as simple and transparent. Competitiveness and growth should be supported,whilst maximising revenue in the most efficient way.

5.2 The UK alcohol duty system is a case study of the non-application of such fundamental principles. Itshould be reformed to create a system that promotes consumer choice and fair competition. Duty equivalence—taxing all drinks on the same basis according to alcohol content—offers the opportunity to enhance revenues,support a key British industry, and introduce a socially responsible system.

January 2011

Written evidence submitted by the Forum of Private Business

Introduction

This is a collection of evidence gathered by the Forum of Private Business to be presented to the inquiryinto “The fundamental principles of the tax policy”. The Forum of Private Business is a proactive, not-for-profit organisation, providing comprehensive support, protection and reassurance to small businesses.

We represent over 20,000 small and medium-sized businesses throughout the UK and provide our memberswith a range of services, including representation of their views to decision-makers in Westminster andBrussels.

In this submission we have collected together information and evidence from our members which highlightthe problems with the current UK tax system. We feel that simplification of the tax system is long overdue. Ifthe Government wants to achieve its goal of stimulating small business growth, it must streamline the systemas this will encourage more companies to expand. The cost of compliance is a big issue for small businessesand if the £1.8 billion24 spent by SMEs on compliance could be reduced, this would free up funds whichcould be invested in business growth. In addition, small firms do not feel the tax system is fair and would likethe Government to address tax evasion by big firms. One example would be the low consignment relief VAT24 Forum research on the cost of compliance

http://www.fpb.org/images/PDFs/referendum/FPB%20Referendum%20188%20report.pdf



loophole, which the Forum has been campaigning against since 2005. In this paper we provide research fromour SME members that reveals the impact of tax on business behaviour and how the taxation system could beimproved to help small businesses, along with the principles which should underlie it.

Why do SMEs want simplification?

“We need consistency and simplicity. In the last few years we’ve gone from a logical system to one ofthe most complex in the world for no apparent reason.” Panel member response.

In our recent research (January 2011) on tax and budgets, we asked SMEs whether they would support aradical tax simplification programme even if it meant paying more tax (see figure 1). As the results show, only23% of those surveyed said that they would not support simplification under any circumstance if it meant theywould pay more tax. Small firms support simplification because they feel that the rewards, such as reductionin red tape, less time spent on completing tax forms and more predictable tax for business planning, wouldallow them to grow their business and would outweigh paying additional tax.

Figure 1

WOULD BUSINESS OWNERS SUPPORT RADICAL TAX SIMPLIFICATION PROGRAMME EVEN IFIT MEANT THEY MAY PAY MORE TAX

Impact of Tax on Business Growth and Decisions

As Figure 2 shows, firms feel the tax system is a lot more likely to impede rather than incentivise them.Cost of compliance is the main issue for small firms when it comes to tax, due to the time and money whichhas to be diverted from the business to comply with the complicated UK tax system (according to a WorldBank/PwC survey the UK system is one of the most complex in the world)25. For example, business ownerssaid the computerisation of HMRC had increased the amount of time that had to be spent on administration.A number of panel members wanted PAYE simplified and felt that technology had been introduced prematurely.There have also been complaints about HMRCs VAT extended verification procedure. This is undertaken by acomputer system, which selects some businesses for a more thorough investigation, particularly if they operatein a sector which is at risk of fraud. While we agree with the principle of further investigation, there is evidencethat the system does not select the correct cases for investigation, which has left some firms waiting monthsfor their VAT numbers. Additionally, business owners feel that the requirements on businesses to calculatestatutory sick pay, holiday pay etc are excessive especially as they could then be penalised for miscalculations.25 http://www.telegraph.co.uk/news/1533513/Brown-tax-system-one-of-the-most-complex.html



Figure 2

WHETHER THE TAXATION SYSTEM INCENTIVISES OR IMPEDES BUSINESS OWNERS

Changes to tax, such as recent changes to VAT and National Insurance Contributions (NICs) have alsoimpacted on businesses. This is because it affects business planning and business cost calculations.

“VAT registration is now more complex & staff are poorly trained, both in Company Law & businesspractices. Why can’t VAT registration be automatic with a new organisation formed as a Limited (Ltd)company? That way, only sole traders, partnerships etc would need to apply”. Panel member response.

“National insurance contributions are quite crippling and are a major monthly cost”. Panel member

response.

National insurance was viewed as a stealth tax that hinders recruitment and training. Only 3% felt that thetax system encourages employment compared with 73 % who said the tax system impedes the expansion ofthe workforce. Some SMEs had changed their business model to facilitate the use of contractors rather thanemploying staff, as the costs were more predictable. Unsurprisingly, the majority of those surveyed believe NIcontributions should be permanently reduced or abolished.

However, some respondents felt that NI should be temporarily reduced, particularly during the early stagesof employment. One business wanted to see NICs reduced to incentivise businesses to recruit and train. Themember quote below highlights the burden that some small businesses feel:

“Cutting the NI rate for new employees, regardless of their age, whilst they are in training (perhaps forthe first year). We need to train new fitters but it is a very costly exercise.” Panel member response.

Starting a business was the most controversial aspect of the taxation system with 36% of business ownersfeeling that the taxation system impedes starting a business and around half that number feeling that itincentivises new companies. Some panel members thought that too many resources were diverted to start-upswhich had a detrimental impact on established firms. This highlights that Government policy should focus onsupporting existing businesses in addition to start ups. Policies such as the New Enterprise Allowance26 arewelcome, however taking actions such as simplifying the taxation system also support existing and growingbusinesses.

Perceived Unfairness of the Tax System

Another reason why SMEs want simplification is because they feel the current complex tax system favoursbig business. Panel members felt that large firms have more resources, such as accounting departments, whichthey use to take advantage of loopholes in the system. Therefore members feel they shoulder more of the taxburden than large firms, which puts them at a competitive disadvantage.

“You have to pay it [tax] regardless, unless you’re a big corporation or a major bank. If you pay more taxit’s because you’ve made more profit.” Panel member response.

26 ???



One example of the loopholes which benefit large firms is low value consignment relief (LVCR), an issuewhich the Forum has been campaigning against since 2005. The issue was brought our attention by formermembers whose businesses have since closed directly as a consequence of LVCR. Most large retailers, such assupermarkets, have set up bases in the Channel Islands to take advantage of LVCR which allows goods worthup to £18 to be imported into the UK VAT-free. While some consumers buying items such as online DVDshave seen prices fall, many small shops and UK mainland-based internet retailers are unable to compete ormove off-shore themselves and are being forced to close. In recent months the Government has vowed toclamp down on tax avoidance and if they are serious about doing so loopholes such as this must be closed.

It is not only loopholes, but some of the direct taxes that small firms feel are unfair. Businesses rates areunpopular, which many feeling it adds to already high business costs and is responsible for the empty highstreets. Businesses in town centres are finding it increasingly difficult to compete with out of town retail parksdue to high business rates. It is for this reason that a number of businesses wanted greater clarity over businessrates in the long term.

Such issues must be addressed. The Government is keen to see small firms grow in order to lead a privatesector recovery. If this is to occur the Government must make the tax system fairer to enable small firms tocompete on an even playing field with big businesses.

The Key Principles SMEs would like to see Underlie Tax Policy

Incentivising businesses that employ and train“Employment taxes and business rates are the biggest reasons for not expanding … how we would like.”Panel member response.

The most frequently suggested improvement was to make significant cuts to taxes on employment,particularly as respondents were concerned over the implications of pension reforms. Business owners wouldlike to see Employers National Insurance Contributions abolished as few understood why a small firm shouldhave to pay for the risk of recruiting employees. Another option mooted was for National Insurance and PAYEto be combined and simplified. An outright abolition of Employers NICs would be expensive; howeverremoving it for the first year of an individual’s working life as they learn a trade may be more affordable.

One or two businesses also indicated that the Government should consider introducing low VAT rates forlabour-intensive industries (hairdressing, hotels and restaurants, renovation and repair of private dwellings,domestic care services and a number of household repair services) arguing that it would help increaseemployment and encourage businesses to use local skilled labour.

Some respondents would also like to see the taxation rates for the employed and self-employed more closelyaligned to allow for more standardised rates of personal taxation. This could be done instead of reformingIR35 in isolation.

Incentivising people who want to work

Business owners expressed a wish to see employees earning between £15,000 and £20,000 (the level varied)taken out of the tax system completely. Alternatively, business owners also wanted to see tax relief on transportto and from work for low paid workers to allow them to access greater work opportunities.

Rewarding businesses that grow

A small majority of business owners indicated that they may be prepared to pay more tax if there was greaterreward for growing and developing their business. Some businesses wanted a big cut to small firms’ corporationtax—one respondent wanted to be reduced to “as near zero as possible” to stimulate rapid growth andinvestment. Other respondents however felt that a fairer tax system would be based on greater taxation ofprofits and less taxation of employment or business rates.

Some business owners want an increase to personal allowances for proprietors to reward them for the risksthat they take in owning the business. Taxes such as Annual Investment Allowances and tax reliefs should befixed for five years to allow businesses to plan their medium-term investment decisions more accurately.

Creating fairness on property taxation

Many businesses questioned the fairness of non domestic rates, arguing that businesses often receive nothingin return. With many non-employers operating out of residential properties this form of taxation furtherdisadvantages small employers. Many owners were surprised about the scale of increases last year andrespondents also wanted more transparency in what the rates are used for.

More effective use of HMRC

Business owners would like to see HMRC do more to support small businesses in terms of providingconsistent advice. We believe that HMRC should be treating businesses as customers to ensure that an effectiveworking relationship is established. The overly complex taxation system means that business owners and their



tax advisers need clarification from HMRC itself, however they often find it difficult to get through. Forexample In July 2010 only 60% of telephone enquiries were being answered by the HMRC telephone enquiryservice, the others were simply being left to ring out27. Our members have experienced difficulty inunderstanding HMRC’s written guidance in the past. After contacting HMRC for clarification, they have beentold that the guidance is perfectly clear therefore HMRC does not have to provide clarification. We have beentold that HMRC intends to change this policy; however we have yet to see an improvement. Tax advisers alsowanted a closer working relationship with HMRC so that they can anticipate its judgements. A more flexibleapproach to smaller employers should also be considered for their tax returns and some owners and taxspecialists would like to see a temporary return to paper copies of PAYE for some businesses until HMRC andthe businesses can overcome teething problems in the process. However one respondent felt that thecomputerised system worked extremely well for his business and there is no doubt that technology should beused to a greater extent to help businesses in retaining control of their tax dues and other financial information.

Many of our members felt that HMRC should be focussing on the tax avoidance of larger businesses thatpay proportionally less tax than smaller businesses but can afford specialist accountants and legal teams. LowValue Consignment Relief (LVCR) on goods distributed through the Channel Islands is an example of aloophole that is exploited by larger businesses to avoid paying VAT.

A simpler, more predictable taxation system would be a priority in order to allow HMRC to concentrate onthese two issues.

Allowing small employers to compete on a level playing field

Businesses wanted the tax system simplified to reduce the tax avoidance by competitors or businesses inrelated fields. This included slightly perverse judgements such as the application of VAT on some foods andsnacks but not others or because of they offer specialist services that lie between zero- and standard-rated VAT.Increasingly business owners feel that there are larger companies with more resources who are not paying theirway; this has increased alongside the taxation burden. Some businesses were also concerned that grants andsupport for businesses were not cost effective and distorted competition.

Making taxation more predictable

Respondents wanted fewer surprises in terms of taxation so that they could accurately predict how muchwas being paid out. At the moment unforeseen increases to the tax regime can impact disproportionately onsmaller employers who have proportionately fewer resources to deal with changes.

January 2011

Written evidence submitted by Imperial Tobacco Group plc

Summary

1.1 Imperial Tobacco welcomes this opportunity to make a submission to the Treasury Committee inquiryinto the fundamental principles of tax policy.

1.2 The coalition government has committed to developing a more balanced economy with manufacturingat its heart. We support this aspiration but recognise that it can only be achieved if the government creates amore competitive tax environment for businesses.

1.3 We also welcome the government’s commitment to what is described as “the most competitive corporatetax regime in the G20”. A competitive tax regime is not just about achieving the right levels of taxation butmust also include the way policy is made and the quality of tax law.

1.4 Competitiveness, predictability, stability and simplicity should, as far as possible, be the fundamentalprinciples underlying the UK tax system, supported by high levels of transparency and robust tailored taximpact assessments. We welcome the government’s new approach to tax policy-making and its initiatives todate on simplification.

1.5 In addition to these opportunities, a number of serious concerns remain in relation to the taxation oftobacco products, which we hope the government will address.

Background

2.1 Since first listing on the UK Stock Exchange in 1996, Imperial Tobacco has become one of the world’sfour largest international tobacco companies selling products in over 160 countries and employing some 38,000people (including 2,500 in the UK), with a market cap of over £18 billion and an Enterprise Value (EV) ofaround £29 billion. Imperial Tobacco is the world leader in the sales of rolling tobaccos, cigars, rolling papersand tubes, and is the leading manufacturer and distributor for the UK cigarette market—our principal market—with a share of around 45%.27 This information was provided to the Forum at HMRC’s Joint VAT Consultation Committee meeting on 29.07.10



2.2 Listed amongst the UK FTSE’s top 30 companies, Imperial Tobacco is headquartered in Bristol, whereour UK market operations are also based. Our UK factory is in Nottingham and our international marketingdepartment is in Farnham Royal, Buckinghamshire. Our vending business, Sinclair Collis, is based inWolverhampton in the West Midlands.

2.3 Imperial Tobacco is a significant taxpayer and tax collector. In the UK alone for our financial year ended31 September 2009 Imperial collected or paid some £5.5 billion (thousand million) in excise duties, VAT andemployee-related taxes as well as paying business rates in the local economies of Bristol, Nottingham, FarnhamRoyal and Wolverhampton. For our financial year ended 30 September 2010 Imperial Tobacco collected duties(excise and VAT) of around £5.9 billion, with employee taxes and business rates on top.

Competitiveness, Predictability, Stability and Simplicity

3.1 Imperial Tobacco believes that competitiveness, predictability, stability and simplicity should befundamental principles underlying the UK tax system. The consistent application of these principles supportsgrowth. These principles should be underpinned by transparency on policy, early consultation on changes torates and legislation and robust tailored tax impact assessments.

3.2 Imperial Tobacco wishes to have more certainty over future tax levels in the UK, its principal marketwhere it makes significant investments and collects significant duties. The UK tax system (with the notableexception of corporation tax) is overly complex, resulting in unnecessary compliance costs for business.

3.3 The coalition government’s emergency budget in June 2010 sent a positive message to business that thegovernment is serious about improving the competitiveness of the UK tax system. However, this must only bethe start of a steady programme of significant reductions in the overall tax burden. The reductions in corporationtax, and the fact that these were announced in advance of introduction, are welcomed, as are the implementationof commitments to early consultation on draft Finance Bill clauses.

3.4 Imperial believes that taxes on company profits should be held down as much as possible in order toencourage investment and stimulate growth. We remain concerned by the current high rates of NationalInsurance which effectively penalise companies for employing more people. By providing a more predictabletax system with planned reductions in taxation over time, Imperial Tobacco (and other UK businesses) will beable to invest with confidence as part of our long term strategies.

3.5 For Imperial Tobacco and for many other large UK companies, a key area where predictability has beenand is still lacking is in the taxation of foreign profits. This directly influences whether foreign businesseschoose to locate in the UK and whether business that are already here choose to remain. We welcome the workof the government on reforming Controlled Foreign Companies, including the transparency of the WorkingGroup, and hope that the timetable now set out for the implementation of new rules is maintained.

3.6 Another area of concern to Imperial is the unpredictability in the taxation of our products. Over the lastten years, tobacco excise taxes have risen by some 42%, and changes to excise and to VAT rates have beenmade on no fewer than 13 occasions. As with any business, unexpected changes to the market prices of ourproducts make it difficult to set a clear business plan.

3.7 While successive Health Ministers, encouraged by enthusiastic but often uninformed tobacco controlactivists, have lobbied the Treasury to raise tobacco excise taxes in an attempt to reduce overall consumption,there is no clear statement of intent as to the policy objectives in relation to the taxation of our products andthere are significant unintended consequences directly related to these tax increases.

3.8 The UK now has one of the highest tobacco excise rates in the world. This has created market distortion,damage to the Exchequer, an undermining of common policy objectives such as reducing youth smoking, andcontinuing increases in organised criminal activity with all the associated costs to society. For example, theassociated rise in smuggled and counterfeit tobacco products being distributed in the UK creates tax losses ofsome £2.5 to £4 billion each year, according to HMRC estimates.

3.9 The UK has become a favourite target market for smugglers because the potential profits are so hugeand the penalties relatively insignificant. This in turn increases overall consumption because of the sheervolume of cheap illicit tobacco that is available throughout the country and sold away from the controlledretail environment. The latest HM Revenue & Customs figures show that up to 22% of the cigarette marketand 61% of the hand-rolling tobacco market still avoids UK duty.

3.10 We wish to see a clear statement of intent as to the government’s objective for our products in regardto excise taxes and a more holistic approach to the setting of excise policy, with the interests of the vociferousbut often uninformed tobacco control lobby balanced against those of key departments. In particular we believethat the government should include the following in considering the impact of future developments:

— When considering duty increases, the impact on illicit trade should be a key factor;

— Duty increases should be moderate and not further widen differentials with other EU countries; and

— Over time duty rates should come more into line with those of other EU countries, particularlyneighbouring markets such as Spain, France and Benelux.



3.11 Compared to the other 26 EU member states, the UK has by far the widest retail price gap between themost expensive and the cheapest cigarettes. After Ireland, the UK has the second highest cigarette retail pricelevels in the EU. These two factors combined have resulted in the category also being highly susceptible toconsumer down-trading to cheaper products. Imperial Tobacco estimates that consumer down-trading cost theTreasury approximately £350 million in lost revenue in 2009. A Department of Health paper acknowledgedthis trend, and noted: “…the past decade has seen a proliferation of cheaper brands…” Imperial Tobaccobelieves that introducing a Minimum Excise Tax (MET), based on the Weighted Average Retail Price (WAP),would have significant benefits, including:

— narrowing UK retail price gaps and protecting UK tax revenues from down-trading;

— protecting UK tax revenues from price wars or cheaper brand introductions;

— increasing tax revenues, whereas a higher specific ratio would lower revenues; and

— increasing simplicity, in that when tax rates change, MET would automatically change too.

3.12 Withholding tax can create complexities for bank borrowing and in its application to interest paid tosome overseas banks. In the interests of simplicity, and on the basis that it is sensible to encourage cash toflow back to the UK with knock-on benefits for the economy, the government should consider reviewingthis area.

January 2011

Written evidence submitted by Land Value Taxation Campaign

The Inquiry wished to know the key principles which should underlie tax policy.

1. How can tax policy best support growth?

2. To what extent should the tax system be structured to support other specific policy goals?

3. How much account should be taken of the ease and efficiency with which a particular tax can beimposed and collected?

4. Are there aspects of the current tax system which are particularly distorting?

How can tax policy best support growth?

The tax system needs to be designed so as to minimise the deadweight cost. In other words, it should notdiscourage individuals from engaging in economic activity, for example, by adding friction to the productionand exchange of goods and services. Money transactions should in principle be no different from bartertransactions in which individuals or organisations exchange favours in the form of goods and services. Landvalue taxation has no deadweight effects.

To what extent should the tax system be structured to support other specific policy goals?

The principal policy goal of taxation policy should be economic justice. An unjust system must lead toundesirable outcomes. A just system of taxation may engender a state of affairs requiring little furtherintervention in the way of redistribution of wealth. It is the Campaign’s considered view that a substantial shiftfrom existing taxes to a tax on the rental value of land is based on natural justice and by promoting, in the firstinstance, the just distribution of wealth, would largely eliminate the need for further redistributive measures.

How much account should be taken of the ease and efficiency with which a particular tax can be imposedand collected?

Complexity in taxation should be avoided so far as possible, to reduce compliance and administrative costsand expensive disputes. The cost of running the taxation system is a drain on an economy, and particularly sowhen many of a nation’s most talented individuals are engaged in an unproductive activity such as looking forlegal loopholes and resolving disputes regarding tax liabilities.

Land value taxation is amongst the simplest possible tax systems, requiring only a cadaster, a valuation listand a billing system, and for these to be kept up to date. It is particularly well suited to the application ofmodern geographical information and mapping database systems.

Are there aspects of the current tax system which are particularly distorting?

The current tax system rewards idleness and discourages economic activity. It would be difficult to imagineanything worse, short of forced labour, which is essentially what it is. It is tolerated only because it is nottransparent. If wages were paid in full, and cash-in-hand, and the tax collected on pay-day by teams ofuniformed officials, people would take a different view.

Distortions caused by the tax system arise most at the margins. This arises because, due to the tax system,gross labour costs to employers are around 80% over and above net pay.

Marginal labour is forced out of employment as it is unable to add sufficient value through its work, andpay tax on top. Examples are those with few skills, young people, and immigrants whose English is poor.



Marginal work is left undone or the labour replaced by machines. A current example is the introduction ofscanning devices at supermarkets. Some work may be left altogether undone eg street sweeping takes placeless often, bus conductors are replaced by pay-on-entry systems even though this can result in a doubling ofjourney times.

In contrast to existing taxes, land value taxation does not have a destructive effect on marginal labour.

Marginal locations are forced out of use through the same process. Replacement of existing taxes by LVTwould eliminate this effect. Enterprises that are not economically viable and sub-marginal due to the taxationof employment and enterprise would be lifted above the margin and become viable.

Because land values are low at marginal locations, a system of land value taxation effectively creates taxhavens precisely where they are most needed.

The Ability to Pay Principle

The case for Income Tax, both national and local, is that it is based on “Ability to pay”. It is a flawedconcept, for it takes little account of how the taxpayer has come by his ability. In any case, present-day taxessupposedly based on ability to pay are frequently unfair or worse.

Direct taxes such as income tax, corporation tax, or capital gains tax, are open to anomalies, avoidance, andevasion. Indirect taxes like customs duties, value added tax, or motor fuel taxes take no account of the financialstanding or the obligations of the buyer of the goods affected. It does so happen, however, that landholders arein a perfect position to be able to pay, for they have an asset, land, whose value is derived from and reflectsits capacity to produce a return with the appropriate input of labour and capital.

LVT is thus payment for benefits received, compensation to the rest of the community for exclusive use ofa particular site. What the landholders achieve thereafter, they are free to enjoy untaxed or, depending on howhigh the land value levy is set, taxed at a much lower rate. What could be fairer than that?

The benefits received by virtue of paying rent for exclusive use of a plot of land need not always be forpurposes of economic exploitation. Land might, for instance, be enjoyed for residential use. Indeed, site valueis being paid to-day either in the purchase price of a house or in the rent handed over to its owner. LVTcaptures the rent of land for public revenue and allows removal of taxes from man-made wealth.

“The amenities provided by natural surroundings, society, and government, make some places so obviouslymore congenial than others. Justice demands that those who enjoy these amenities should pay for theprivilege according to the degree of benefit accruing to the position they occupy”—Sir Kenneth Jupp(“Land & Liberty” magazine, Spring 2000).

Essential government services must obviously be paid for somehow. A tax should be:

1. Equal and equitable in its burden.

2. Certain and not arbitrary.

3. Convenient as to the time and manner of the levy.

4. Economical: inexpensive to collect and not unduly obstructive and discouraging to the taxpayer.

Land value taxation (LVT) meets all of these criteria.

There is here a fundamental issue of equity. Should citizens be penalised because they worked hard andapplied their skills and labour? If people acquired wealth by anti-social means, this should be remedied by lawenforcement agencies. Otherwise, if hard work, energy and enterprise are desirable attributes, and if increasedproductivity is a desirable goal, an undiscriminating tax on incomes or wealth per se is illogical and not in thepublic interest.

Income and corporate taxes and (in a time of structural unemployment, perhaps most of all) payroll taxesare inherently ill-conceived. Logically, revenue-raising should not be concerned with ability to pay. The mostlogical taxes are:

1. those which focused on the use or possession of the community’s natural resources (of land, seaand air);

2. charges for the use of services or facilities provided by the community;

3. charges, fines or contributions to offset costs imposed upon the community; and

4. taxes or contributions to offset special benefits conferred upon particular groups or sectors within thecommunity. While many of these contributions to revenue would tend to fall most heavily upon thosewho had the greatest ability or capacity to pay—because they used more resources or consumed moreservices—they would do so coincidentally and not because of their ability to pay.

Considerations of equity and efficiency lead to a fundamental and, in our view, logically unassailabledecision, namely to prefer the benefit principle rather than ability-to-pay. Government should seek to avoidequating revenue-raising with simply taxing wealth. The legitimate generation of wealth through labour, skilland enterprise should be encouraged rather than penalised.



Exemplifying the maxim that taxing capital drives it away while taxing land forces it into use, an improvedvalue tax such as the UBR [ie one on man-made improvements such as buildings] is not neutral in its effectand operates to discourage development by effectively penalising it.

A tax on unimproved land value is efficient. Ownership or occupation of land is primarily, if not exclusively,a benefit the components of which are its natural attributes and the public works and services available to it,together with the less tangible but nevertheless real benefits of membership of a cohesive organised society.

Land, like air and natural water, is a community resource the exclusive use or occupation of which byindividuals should be paid for according to the extent of the benefit they enjoy. If all land in the UK werevalued frequently and accurately and in accordance with the optimum use within the limits set by the planningconsent as described in the planning register, a land value tax should be an accurate reflection of the currentbenefit derived from its use or occupation.

A land value tax bears most heavily upon those who have the capacity to own the most valuable land. Thus,without being aimed at the wealthy, it automatically (and equitably) also performs a redistributive function andeffectively achieves cross-subsidisation.

Income is not a satisfactory measure of ability to pay tax; that because of the opportunities for avoidanceand evasion which it presents the income tax ranks low on the overall scale of tax effectiveness and providesdiffering opportunities for non-compliance for different income classes and groups of taxpayers; that anominally progressive rate structure does not necessarily make the rich pay more tax than the poor, althoughit is likely to make wage and salary earners pay more than other groups with comparable abilities to pay tax;that an income tax is consequently a weak instrument for achieving vertical and horizontal equity.

The virtue of regular taxes on property in terms of their inescapability is underestimated. The fiction thatpeople pay the tax they are supposed to pay ignores the fact of tax avoidance and evasion. The tax system hasgenerally been designed without any thought to the effectiveness of particular taxes, defined as the relationshipof actual collections to nominal or potential collections. If tax reforms are to be effective they must start fromthe position that we will all avoid taxes to the extent that there are incentives and opportunities to do so; andthat many of us will also evade taxes to the maximum extent possible. It follows that tax reforms must haveregard to tax effectiveness—the prevention of avoidance and evasion—as a major policy objective in itsown right.

Capital Value or Annual Value?

It has always been understood that LVT is the collection as public revenue of the annual rental value of land(ARV). However, the Campaign has noticed that in recent months there have been several articles written insupport of LVT, and whilst we naturally welcome this development, we are disturbed to note also that theyappear to be advocating a tax based on the selling price of land, which we refer to as Capital Value (CV)assessment. In our view this is utterly mistaken. It would be unfair, and would consequently raise difficultiesfor public acceptance. There would also be practical problems.

The Campaign speaks from experience. In 2005 it was one of the sponsors of a CV valuation study. Thearea included residential property subject to an annual property tax of around £1,000 per annum, at the sametime as commercial property was subject to about five times that amount per unit of floor space. This led toan under-valuation of the commercial properties relative to the domestic ones as capital values were depreciatedby the capitalisation of the actual amount of the property taxes payable. We then capitalised the actual amountsof Council Tax and UBR payable and added them to the selling prices, which had already had the hope value“stripped out”. Thus the valuations were very much adjusted from actual selling prices.

The fundamental objections to the use of CV assessment (though not of course to the use of CVs as valuationevidence) are:

1. CV represents the capitalisation of the rental value that is uncollected. This is in our view the mostserious objection. CV is not even a reliable proxy for ARV. To levy a tax on CVs will fail to takeaccount of the land rent that is already being collected at the time of valuation.

2. CV includes hope value. This will include expectations of what planning authorities might decide inthe future and therefore allows scope for endless argument. ARV, on the other hand, is the value ofthe consent that has actually been granted. There is no dispute.

3. CV is a tax on a value that can only be realised on sale. It is therefore unfair to landowners and givesrise to a legitimate objection to LVT as an unjust tax. The objection does not apply to ARV assessmentsas rental values can always be realised.

4. CVs are volatile unless rates of LVT are high enough to damp the cycle. This can lead to hardship insome cases. ARVs are by contrast relatively stable.

5. The primary value of land is its ARV. CV is a derivative value, subject to factors such as interestrates, market expectations and hope value based on the possibility of future development.

6. The aim of LVT is to collect rent so why not simply measure the rental value? This is not difficultunless there is very little in the way of a rental market. CVs can be used as part of the evidence toconstruct the data set.



7. LVT on CVs is lumpy—small differences in the rate result in large differences in yield and liability.

8. To make sense and consistency of a CV system, it is necessary to capitalise the property tax actuallybeing paid. Whatever ratio is to be used could equally well be applied to de-capitalising CV data forrental value purposes.

9. When a tax is paid annually, it defies logic to seek to set an annual payment on a capitalised base,especially on one that must inevitably be beset by, frankly, guesswork. Commonsense suggests theadoption of annual rental value assessments.

Local or National?

It is possible to initiate the taxation of land values at the local level (in which case it may sometimes bereferred to as site value rating or SVR) and extend it later to national level. There are complications associatedwith this approach, and the Land Value Taxation Campaign strongly urges the Treasury Committee to introduceand apply LVT nationally from the outset.

January 2011

Written evidence submitted by the NFU

Executive Summary

The NFU represents more than 55,000 farming members in England and Wales. In addition we have 41,000countryside members with an interest in farming and the countryside.

The Treasury Committee recently announced that it had decided to launch its own inquiry into the principleswhich should underpin the UK tax system and invited written evidence on the following questions:

— What are the key principles which should underlie tax policy?

— How can tax policy best support growth?

— To what extent should the tax system be structured to support other specific policy goals?

— How much account should be taken of the ease and efficiency with which a particular tax can beimposed and collected?

— Are there aspects of the current tax system which are particularly distorting?

The NFU wishes to contribute to the inquiry and has set out below points in response to each of thequestions posed.

Response

1. What are the key principles which should underlie tax policy?

1. (a) The key principles of tax policy are that it should be fair, progressive, and support the policy objectivesof other Government departments. Tax policy should be supportive of UK business and encourage and aidtheir international competitiveness, resilience and growth.

1. (b) For example, in the case of agriculture, the Department for Environment, Food and Rural Affairs hasproduced a Structural Reform Plan which highlights that the Government’s policy is to support and developBritish farming and to increase domestic food production. The Government states that it will help to enhancethe competitiveness and resilience of the whole food chain, including farms and the fish industry, to ensure asecure, environmentally sustainable and healthy supply of food with improved standards of animal welfare.

1. (c) We would therefore expect tax policy to reflect these wider Government policy objectives by supportingbusinesses during the recovery period and incentivising investment in food production, environmental andanimal welfare improvements. We would also expect to see further incentives to encourage growth in the greeneconomy and a removal of any existing barriers preventing green growth and employment.


2. (a) Tax policy should encourage businesses to invest in improving their competitiveness, resilience andmaximising their potential for growth. The resulting tax system must however be sufficiently sophisticated toachieve these aims whether the business is within a service industry or a manufacturing/production industryand ensure it is equally fit to suit a range of business scales covering both incorporated and unincorporatedbusinesses.

2. (b) The Government recently announced a review of Corporation Tax with the aim of encouragingbusinesses’ competitiveness, investment and growth. However in formulating tax policy which best supportsall businesses to maximise their potential for growth it is important to recognise that 99% of businesses in theUK are small and that nearly 75% of businesses in the UK operate as unincorporated entities. (BIS statisticsfor 2009).



2. (c) In addition it is important to recognise that businesses structure, business size and entrepreneurialactivity can also be affected by location. For example a higher proportion of unincorporated businesses can befound in rural areas than in urban areas, there are more micro businesses in rural areas than in urban areas(88% compared to 81%) and yet both the highest proportion of businesses trading for 10 years or greater canbe found in the most rural areas and total early-stage entrepreneurial activity is higher in rural areas than inurban areas and similar to that found in Inner London. It is therefore essential that all sizes and structures ofbusiness are equally encouraged by tax policy and that tax policy is effectively rural proofed. (Commission forRural Communities publication—“State of the countryside 2010”)

2. (d) In summary tax policy must be formulated to meet the needs of all UK business and not just businesseswhich operate as incorporated entities.


3. (a) As we have indicated in our response to question 1 above, we believe that in addition to growth taxpolicy should support the policy objectives of other Government departments in areas such as food security,animal welfare and climate change mitigation.

3. (b) The tax system must recognise and support those industry sectors which face specific challenges inorder to fully contribute to the Government’s wider policy objectives and which do not necessarily affect themajority of taxpayers.

4. How much account should be taken of the ease and efficiency with which a particular tax can be imposedand collected?

4. (a) Clearly it is desirable to design taxes which work well and are easy to impose and efficient to collect.However it is also very important that taxpayers are able to easily identify and pay the correct amount of taxand that mechanisms are in place to ensure that the collection of taxation is accurate for all taxpayers.


5. (a) The speed and frequency of change in tax legislation over the past 10 years has created greatuncertainty for taxpayers and has we believe impacted on business confidence. Certain changes have alsoproduced unexpected tax consequences where business decisions have been taken based on the availability oftax relief at the time of investment only for subsequent changes in tax legislation to remove or reduce the taxrelief given.

5. (b) An example of this from the agricultural industry is where investments were made in agriculturalbuildings (which generally depreciate in value) prior to 2007. At that time there was a legitimate expectationthat tax relief, in the form of Agricultural Buildings Allowances, would be given on such investments over a25 year period. However in 2007 an announcement was made that Agricultural Buildings Allowances wouldbe abolished. This announcement was made without any prior consultation and resulted in up to 90% of theexpenditure already made not receiving tax relief.

5. (c) It is important that businesses have a stable tax system if they are to have the confidence to take longterm business investment decisions.

5. (d) In addition we believe that the cost and administrative burden of employment is currently prohibitive,particularly for smaller businesses. The level of employers’ national insurance contributions, future compulsoryemployer pension contributions and the general administrative burden of the PAYE system all act asdisincentives to employment.

5. (e) We do however welcome the announcement that changes in tax legislation will be less frequent andthat consultations on proposed tax changes will be held wherever possible. We also welcome the announcementthat draft tax legislation will be published as early as possible allowing for greater scrutiny.

January 2010

Written evidence submitted by the Joseph Rowntree Foundation

The Joseph Rowntree Foundation (JRF) is one of the largest social policy research and development charitiesin the UK. For over a century we have been engaged with searching out the causes of social problems,investigating solutions and seeking to influence those who can make changes. JRF’s purpose is to understandthe root causes of social problems, to identify ways of overcoming them, and to show how social needs canbe met in practice. The Joseph Rowntree Housing Trust (JRHT) shares the aims of the Foundation and engagesin practical housing and care work.

Introduction

JRF welcomes the Treasury Select Committee Inquiry into the fundamental principles of tax policy. We areconcerned about the distorting affects of current taxation policy within the UK housing system. This submission



highlights the importance of taxation policy in relation to of its impact on house price volatility, people’shousing tenure choices and resulting wealth inequality.

The evidence in this submission is drawn from work commissioned by the JRF Housing Market Task Force.The Task Force was convened to recommend credible policy solutions that would act to avoid extremefluctuations between “boom and bust” in the housing market cycle. The Task Force has reviewed evidence ina wide range of areas including housing taxation and subsidies, the distribution of wealth and increasing thesupply of social housing.

Summary

In considering the underlining principles of tax policy this submission focuses on potential reform of housingtaxation in the UK as a means of achieving wider housing market stability and addressing current distortionswithin the tax system. The additional potential of such reforms to raise revenue and deliver a more progressiveapproach than the current system are also briefly considered.

The key points we make in the submission are:

— The tax treatment of housing is biased towards owner occupation and acts to distort people’stenure choices.

— Although taxation of property currently amounts to 4% of the UK’s GDP; it was estimated in2008–09 that lost revenue from not taxing home ownership was £10.6 billion.

— Housing taxation could be a fundamental tool in levelling out the boom and bust cycle of houseprice volatility which could deliver wider economic and growth benefits.

— A new approach to taxing property could be more progressive across the income scale and betweendifferent local authority areas than the current council tax system.

— More equality between the tax treatments of different asset classes to promote a more level playingfield between different asset classes such as housing, savings, pensions and other forms of wealth.

— Making changes to the tax treatment of home ownership could also act as a brake on the growinginequality within the housing system. A tax and subsidy system designed with housing supplyincentives in mind could have radical stabilisation and distributional outcomes, particularly if thenew instruments were targeted on housing supply intended for lower income households.

Key Principles Underlining Tax Policy Reform

We agree with IFS that a tax system should include a clear vision and be as simple, transparent andprogressive as possible (IFS 2010). OECD also argue that in the current financial context the aim of tax reformshould be to reduce distortions within tax systems and to raise additional revenues from taxes without damagingeconomic growth (OECD 2010). The current housing taxation system in the UK has a clear bias in favour ofhome ownership (Whitehead 2011; Crawshaw 2009; Wilcox 2009). In addition to this taxation bias it is notablethat current patterns of inheritance suggest wealth inequality will widen with those at the bottom of the incomescale being left further behind (Appleyard and Rowlingson 2010). This growing gap between the housing“haves” and “have nots” within the UK system is not simply a consequence affordability pressures, it is alsoa result the way in which gains from home ownership are treated within the tax system. Wilcox (2009) arguesthat addressing the favourable tax treatment of home ownership is likely to lead to a price adjustment withinthe housing market. An international review of housing and subsidy systems supports this perspective,identifying property tax reform as a way of achieving less volatile housing markets and less distortion inpeople’s housing choices (Oxley and Hafffner 2010). Meen (2010) also notes how the favourable tax treatmentof home ownership distorts people’s choices away from financial assets and towards home ownership. Thusthe current system of property taxes in the UK violates the key principle highlighted by OECD (2010) of taxsystems avoiding distortions in people’s choices.

Property taxes have been identified by OECD (2010) as an area of taxation reform that would be leastharmful to economic growth. In addition, housing taxation reform designed with housing supply incentives inmind might also act to stabilise the housing market and improve distributional outcomes (Oxley and Haffner2010). Before considering the reforms that might deliver the objectives of a more progressive tax system, amore stable housing market and improved distributional impacts it is worth dwelling a little on the desiredprinciples of a housing or property tax system.

In addition to the efficiency and equity principles of the wider tax system, the following objectives arecrucial elements of an effective property tax system (Oxley and Haffner 2010; Hall and Gibb 2010):

— Less volatile housing markets;

— A neutral or complementary impact on local housing systems, other tenures and private developers;

— Less distortion of people’s choices between owning and renting;

— Able to work with private funding efficiently;

— Consistent with society’s ideas of delivering affordable rents and prices and supporting lowincome households;



— With the grain of other related social policies relating to, for example, labour incentives,worklessness and mixed communities; and

— Good value for money for the public purse.

As OECD (2010) note the current context surrounding public spending deficits requires a consideration ofadditional revenue raising opportunities. Wilcox (2009) estimates that a failure to tax home ownershipamounted to lost revenue of £10.6 billion in 2008/09. However Oxley and Haffner argue that as property taxescurrently amount to around 4% of GDP in the UK (see Boadway et al 2009) care should be taken to ensurethat any reforms focus on addressing housing market volatility rather than increasing the overall take fromproperty taxation. As Wilcox (2009) notes the downward price adjustment likely as a result of levying taxeson home ownership could well reduce the amount of this “lost” revenue in practice.

Oxley and Haffner (2010) identify four reforms as preferred options for generating additional investmentincentives in housing and addressing house price volatility. They are:

— Additional supply incentives through tax/subsidy enhanced contracts with private landlords.This could include depreciation allowances which would ensure that private landlords wereproviding properties for low income households. This option would require further modelling inorder to establish value for money. However it could be a method of encouraging landlords to letto lower income households, particularly in a constrained local housing allowance framework.Properties would not be held in perpetuity so any modelling to develop this option would need toaddress both shorter and long term outcomes for lower income households and the housing market.

— Additional tax/subsidy incentives for more housing investment (through additional building,conversions and more effective use of the existing stock). This could include reducing VAT onrenovations and conversions within the existing housing stock. As the current VAT system favoursnew build housing, which carries a zero rate of VAT, there are tradeoffs with this approach. Movesto equalise VAT rates between renovations/conversions and new build properties might meancharging VAT on new build housing. Further work on this option would need to be done to establishthe impact on housing supply and the construction industry. Given the need to increase housingsupply this may be a more medium to long term option which is perhaps more relevant to achievingsustainable housing to address the challenges of climate change than addressing house pricevolatility.

— Stamp Duty Land Tax (SDLT) changes that relate payments more closely to property valueswithout banding distortions and with progression through a wide range of values or alternativelythe abolition of Stamp Duty Land Tax which might be linked to council tax reform and/or theintroduction of a property tax.

— A periodically levied property tax (or reformed council tax) system that more closely reflectedcurrent market values (ie updated automatically or at set periodic intervals). This would addressthe preferential treatment of home ownership within the UK tax system and the distortion thiscreates in people’s tenure choices and preferences. The close reflection of house prices within thestructure of a property tax would act as an anti cyclical policy measure that could operate as a“brake” on house prices and create greater house price stability within the market. In practice thisreform might be linked to changes in Council Tax and/or changes in Stamp Duty Land Tax—intheory a functioning property tax system could replace SDLT since transaction taxes such as SDLTmay become less necessary if the real value of house prices were taxed.

Property tax reform is argued to be most likely to address housing market volatility and reduce distortionsin people’s housing choices. Whilst house price adjustments due to the introduction of revised property taxesmight go some way to addressing inequality within the housing market; we accept that other taxes such asinheritance tax reform could also have far reaching re-distributional effects in terms of addressing intergenerational wealth inequality (Appleyard and Rowlingson 2010). For example Appleyard and RowlingsonC2010) call for a fundamental review of the incentives and disincentives linked to different asset classes suchas savings, investments, pensions and housing. They also demonstrate how the pattern of inheritance mirrorsthe distribution of wealth more generally, with those at the bottom falling further behind (Appleyard andRowlingson 2010).

Capital gains tax is also an example of tax relief for home owners which might be worthy of furtherconsideration. However as Oxley and Haffner’s (2010) review found that the impact of capital gains taxchanges was likely to be debateable and risked increasing volatility this is not pursued as a potential area oftax reform within this submission.

Britain already operates a quasi property tax system through its collection of council tax. This tax has beendescribed as a hybrid tax based on property values and a charge for the use of local services (Crawshaw 2009).Crawshaw (2009) highlights how council tax meets the objectives of being difficult to evade and delivers highcollection rates. However he also identifies it’s potentially regressive impact—this is a major flaw of the currentsystem albeit that this impact is cushioned by council tax benefit. For example the Lyons Review identifiedthat even with the current take up of council tax benefit those in the lowest income decile still pay around 8%of their income in council tax compared to 3% in the highest income decile (Lyons 2007). Stephens(forthcoming) also notes the imperfect nature of council tax since it does not accurately reflect or tax up to



date property values and as such it fails to act as a brake on house price volatility. In addition, Stephens notesthe unequal geographic impacts of council tax; for example current council tax is around 0.65% of house pricesin North East England but only around 0.36% of house prices in London.

The Treasury itself has noted that fiscal measures impacting on the housing market could reduce volatility(HMT 2003b cited in Muellbauer 2005). Reforming property tax would of course involve significant reform tolocal Government finance systems. However we would argue that depending on the design of a property taxwithin the UK it could have significant benefits in terms of:

— Reducing housing market and house price volatility;

— Creating a more level playing field in people’s investment decisions between housing and otherproducts such as pensions, savings and investments;

— Reducing the distortion in people’s housing tenure choices as the tax advantages inherent in homeownership were addressed;

— Enabling households to make housing consumption choices that were less dictated by house pricetrends and more suited to life cycle stages and labour market demands.

References

Appleyard, L and Rowlingson, K (2010) Home ownership and the distribution of personal wealth York: JosephRowntree Foundation

Boadway, R, Chamberlain, E and Emmerson, C (2009) Taxation and Wealth Transfers, prepared for the Reportof a Commission on Reforming the Tax System for the 21st century, Chaired by Sir James Mirrlees. London:Institute for Fiscal Studies.

Crawshaw, T (2009) Rethinking housing taxation: options for reform London: Shelter

Hall, D and Gibb, K (forthcoming) Increasing supply in the social rented sector York: Joseph RowntreeFoundation

IFS (2010) Tax by design London: Institute of Fiscal Studies

Meen, G (2010) Home-Ownership for the Next Generation Reading: University of Reading

Meullbauer, J (2005) “Property taxation and the economy after the Barker review” The Economic Journal 115(March) C99–C117

OECD (2010) Tax policy reform and fiscal consolidation Paris: OECD

Oxley, M and Haffner, M (2010) Housing taxation and subsidies: international comparisons and options forreform York: Joseph Rowntree Foundation

Stephens, M (forthcoming) Housing market task force report York: Joseph Rowntree Foundation

Whitehead C (2011) “Owner-occupation in an increasingly uncertain world: the English experience” in RonaldR and Elsinga M Beyond Homeownership: Housing, Welfare and Society, London, Routledge

Wilcox, S (2009) UK housing review 2009/2010 London: Chartered Institute of Housing and BuildingSocieties Association

January 2011

Written evidence submitted by ALTER

Executive Summary

Economic rent, or “resource rents”, are a major component of national income. At present taxes are onlycollected from it very indirectly and without regard to its chief economic characteristic as a surplus. By shiftingtaxes off labour and capital and on to economic rent, growth and employment would be stimulated and manydistortions in the economy would be avoided. Annual land taxes would be the simplest means of collectingrent as public revenue.

In particular, the margin of production, both geographically and in specific areas of the economy, would berelieved of taxation, whilst taxes would be borne instead by recipients of the surplus attributable primarily tolocation. This would be both efficient and fair, since providers of labour and capital would pay less tax andrentiers would pay more.

Simultaneously, excessive rises in land prices would be modified by a tax based on regularly reassessed landvalues. This would prevent the kind of speculation fostered by the banking system that led to the crisis of2008–09 and would also greatly stabilise trade cycle fluctuations.

Taxes assessed on economic rent are certain and easy to collect, unlike most current taxes. They help secureefficient allocation of factors of production and hold down consumer prices. Complicated provisions to make



tax assessments fair are not required. This tax shift would move the U.K. economy away from rent-seekingand towards a genuinely free market economy based upon equitable rewards for those who actually producegoods and services.

1. The basic recommendation on taxation from ALTER is that public revenue from the economic rent ofland, otherwise known as resource rents, should be maximised, rather than taxing labour and capital. Such a“tax shift” would have fundamental beneficial effects on the economy. The case for it is both moral andeconomic. Since the submission that follows is largely concerned with the latter case, the moral case is brieflystated first. The economic case is then made in answers to the questions posed by the Committee.

2. The moral case, acknowledged by virtually all economists since Adam Smith, is that the economic rentof land arises not from the actions of landowners but as a surplus from the nature and location of the particularland itself. Ricardo, Marshall, J S Mill, Henry George, Samuelson and Milton Friedman all recognised thatwhilst labour and capital may receive short-term quasi-rents, only land attracts a permanent surplus over andabove the value of inputs from labour and capital. Such economic rent in relation to a particular site has threecauses: natural resources such as fertility and minerals; local population providing labour and markets; andpublic services in the form of transport facilities, police, schools and so on. Since none of these three are theoutcome of individual effort or capital, there is no moral case for economic rent to be appropriated byindividuals. Therefore it belongs by right to the community which plays a major part in its creation and whichhas an inherent claim to the natural attributes of the land, if not to the land itself. This moral case was clearlyrecognised in the case of North Sea oil, when Chancellor Lawson introduced a system of royalties for oilproduction that took account of the differential value of output from oil wells ie in recognition of economicrent in the North Sea.

What are the key principles which should underlie tax policy?

3. Most important is the principle that taxation should support production and not impede it. Taxes on labourand capital always tend to inhibit production, because both factors require a reward in the form of wages andprofits in order to enter and be sustained in the productive process. Land and natural resources do not requiresuch a reward, since they are present ab initio. Of course, if they can be withheld from production by ownerssome reward may be required, but this assumes that no charge is levied on unused land and resources, whichwould not be the case if a tax on annual land values were introduced.

4. The principle of fairness is perhaps universally acknowledged. In our view, fairness means rewardingeffort, ability and initiative and recognising need, whilst withholding reward from those who contribute nothing.It is hard to see how a claimant to economic rent contributes to the economy, since rent is a surplus arising asoutlined above. On the other hand those who offer labour and capital are providing factors of production thatactively participate in creating value: arguably all taxes on these factors are unfair.

5. Taxation must be adequate to meet current public expenditure needs, both central and local. Currentconditions demonstrate that tax policy is severely strained to meet this requirement. Economic rent is the greatuntapped fund available to remedy this.

6. The tax collection system must to simple, efficient, certain and transparent. The present system has becomeunduly complicated. Taxes on labour and capital are bound to be complex if they take account of individualcircumstances. Taxes levied on economic rent, however, are simple to assess, in so far as particular pieces ofland have a single annual value, which can be updated easily, particularly if a land registry is used.

7. Non-evasion and non-avoidance: both illegal and legal methods of reducing taxes decrease the tax take.A tax on annual land values cannot be nullified by such means, for example, as a change in the domicile ofthe owner or concealment of the asset taxed.


8. Taxes on labour and capital inhibit growth by reducing the rewards for effort, skill, enterprise andinnovation, including the use of new technology. This is especially so in relation to incremental use of bothfactors, since tax rates tend to be progressive. Indirect taxes, such as VAT, have a similar effect by their impacton firms’ revenues, which forces them to reduce demand for factors. By contrast, a tax levied on economicrent has no impact at all on the returns to labour and capital. Such a tax is diverting an income flow from privaterecipients of rent to the public purse, where these recipients are strictly rentiers and not active contributors toproduction.

9. The way in which a land value tax (LVT) would encourage growth is best seen in relation to the marginof production, a concept too often ignored in current economic theory and practice. The margin may be regionalor local. Firms in more remote regions and those on less central sites tend to produce less value added thanthose at more favoured locations. A tax levied on economic rent does not strike at these vulnerable marginalfirms, for the simple reason that it falls only upon the excess of the value of output over that produced at themargin for the same input of factors. Only the rentier who takes this excess, not the productive firm, wouldpay the tax.



10. This principle, that a tax on the economic rent has no disincentive effect at all on production, impliesthat firms could be relieved of present taxes if these were replaced by it. Hence they would immediately havea strong motive for increasing their employment of factors and their output. At the same time, new firms couldenter an industry without the burden of incurring taxes on their production. They would have a permanent “taxholiday”! A complete tax shift of this kind may be politically impossible, but to the extent that it might becarried out there would be a corresponding new dynamic in the economy: growth by existing firms and bynew ones.

11. This cardinal feature of relieving the margin of production is not the only way in which LVT wouldencourage growth. If levied on all sites, including those left out of use, land utilisation would become muchmore efficient. Derelict but potentially productive sites would be brought into use as landowners found thatleaving land idle would incur a cost. (The present empty property tax suffers from the serious drawback oftaxing just the buildings, thus encouraging their destruction.) Occupied sites would also gradually be re-allocated to their most efficient use. At present there is little incentive for this to happen, because economicrent may not be maximised if it gives a good return when it could in fact yield a better one. That this is thecase is proved conclusively by the large increases in the capital value of sites that are granted planningpermission. They are clearly under-utilised until the permission is granted. Of course, planning would remainnecessary under a LVT regime, but it would be carried out within a framework of best land use under pre-existing plans.

12. Finally the situation for business start-ups would be transformed by the tax shift. LVT tends to reduceland prices pro rata, so that land costs, whether as capital payments for land purchase or rent under leases,would be reduced or eliminated for new firms. Moreover, new firms would become more creditworthy, bothbecause they would not need to incur heavy start-up costs and because their growth prospects would beconsiderably better under such a tax regime. Firms that were no more than speculators in land would becorrespondingly less creditworthy, thus relieving the banking system of a major form of risky loans.


13. The tax shift outlined above has other merits besides supporting growth in the economy. Growth impliesincreased employment, reducing social and economic costs of joblessness. Taxes taken off labour mean it costsevery organisation less to employ; taken off capital, it improves employment in manufacturing. Self-employment might also be stimulated by a reduction in start-up costs from a fall in land prices and the easingof bank credit for small businesses no longer burdened by high rents and taxation. Partnerships and co-operatives, as opposed to large oligarchic organisations, might be encouraged. The employment market wouldthus be more flexible and less dominated by ponderous wage bargaining processes.

14. Such changes would go some way to make a fairer distribution of income and wealth a realisable policygoal. Wage rates could rise in keeping with greater labour productivity, and incomes derived from privatecapture of economic rent would diminish. So too would the capital values associated with valuable land nowheld free of any tax on its annual value. Speculative fortunes made from rising land prices would, in particular,be cut back as an annual LVT began to bite. This need not mean that land prices would fall dramatically, if atall. As the economy grew under the impetus given by the tax shift, land might become more valuable, evenwhilst a tax on land value were imposed. This would enable the tax rate to be increased, yielding yet morepublic revenue.

15. LVT would support regional policy goals, tending to significantly “level the playing field” as betweenpoorer and wealthier regions, without incurring public expenditure. There would be a concomitant improvementin the relative economic conditions of poorer regions, such as parts of the North and of Wales, for the reasonsgiven above. Overheating of the economy in more prosperous areas would similarly be modified, for thesewould pay over a relatively higher amount of rent as public revenue, thus reducing speculative investment andthe claims of rentiers. The genuinely productive activities of the City of London, for example, would becomemore easily identified as they were freed from taxation, whilst the rentier activities would become subject tothe new tax. A more balanced distribution of production throughout the country would be the outcome, enablingpopulation, public services, transport facilities and much else to become more equitably distributed.

16. An interesting side effect of the tax shift would help to achieve a further major policy goal. A mostsignificant element in the asset price bubble of 2008 that brought the U.K. economy almost to its knees wasthe huge upward rise in land prices that had developed over the previous decade or so. This led to a great dealof unwise bank lending for commercial and housing ventures. Banks were bewitched by the expected continualrise in land values that underlay the prices of commercial property and private housing. “House prices” were,and are, largely a function of the prices of the land on which they are built. A tax on land values would preventsuch a harmful surge in prices, and a fortiori such a corresponding bonanza in speculative lending by banks.

17. Policy regarding the banking system is closely related to macro-economic stability, another majorobjective to which tax reform is pertinent. How would a shift towards LVT affect this? Present automaticstabilisers, such as unemployment benefits, would be supplemented by a tax levied on inflated rents of land inperiods of rising output and prices and a reduction of LVT yield when these decline. No change of tax rateswould be required. There is a strong correlation between fluctuations in land rents and cycles in the nominalGDP. Indeed speculative motives probably make such rents a leading indicator of GDP movements. There can



be little doubt that the crisis of 2008–09 would have been greatly moderated had there been a substantialannual tax on such rents in the preceding years. The introduction of LVT now would help to ensure norepetition of the same disastrous hyperinflation of land values and its accompanying financial crisis.


18. LVT is virtually impossible to evade or avoid. The land remains through good and bad times, and cannotbe moved, unlike all other assets: even buildings, which can be destroyed or not erected at all, if taxed heavily.Land value registers, necessary for LVT, would improve the transparency and efficiency of the property market.Recent research (Vickers, 2009) indicates that the entire LVT administration system could be financed by theprivate sector (primarily insurance and investment sectors).

19. Initially self-assessment could be used to establish taxable land values. The landowner would have anincentive not to overvalue the land, nor to undervalue it if sanctions were attached, such as the testing ofdoubtful valuations by a public valuation or even the compulsory sale at the market price of seriouslyundervalued land.

20. This compares very favourably with the present tax regime with its thousands of special provisions fora host of taxes imposed on wages, pensions, dividends, interest, company profits, capital gains, value added, etc.


21. Distortion of the productive capacity of the economy and of land use have been mentioned. There are,however, other serious distortions, arising from the unsound principle of taxing labour and capital rather thaneconomic rent.

22. The idea that income is a measure of the ability to pay tax has become deeply embedded in the nationalconsciousness. But income leaves out of account the wealth of the taxpayer, which may differ greatly from hisor her standing as a recipient of taxable income. Wealth, in general, may be concealed, held abroad or otherwiseused to avoid the generation of taxable income. Its owner can borrow against its value, enjoy tax-free beneficialoccupation of property, and afford expert advice as to how to minimise the taxable income derived from it.Increases in the capital value of assets are a greater source of wealth creation than is saving out of income, asevery successful entrepreneur, bank director or speculator knows.

23. A wealth tax would be a complicated and probably inefficient exercise. All real capital (ie buildings,equipment, machinery etc.) has a limited life span. Land values alone provide a permanent foundation for mostprivate wealth accumulation in the long run, often in the form of real estate directly owned, but also throughshares in companies that own valuable land, mineral rights, and other natural resources. Much land value ishidden in various kinds of such claims. Hence a tax on land values would encapsulate most of the benefits thata wealth tax might aspire to, without the serious drawbacks of trying to tax such an amorphous thing as wealth.

24. Income is an especially poor measure of the ability to pay, in a society where homes—their valueslargely comprised of inflated land values—are bought through mortgages unless they are inherited. One personmay have inherited a family house, free of a mortgage; another may be struggling to save a deposit and thenmake mortgage payments for 25 years. If they both have the same income, where is the fairness in thetax system?

25. A more technical point about distortions caused by the present tax system concerns the “second besttheorem”. This refers to the way in which indirect taxes like VAT change the final prices of goods and services,so that a Pareto optimum obtainable without those taxes is frustrated. Taxes on land values have no effect atall on a Pareto optimum, since collecting economic rent does not affect final prices (except, of course, thecapital price of land). Ricardo’s famous adage that price does not enter into rent is the general principlebehind this.

26. Finally there is the enormous distortion in the whole economy arising from rent-seeking activity, ratherthan production of goods and services. Firms of all kinds are drawn into a search for available economic rentin the form of capital appreciation of land—often leading to unnecessary takeovers and asset stripping—investment in land rather than in productive capital, lending by banks for land speculation, and the siting ofbusinesses in areas of high rent, rather than in the most efficient location.

January 2011



Written evidence submitted by the School of Economic Science

Executive Summary

In simple terms, the attributes of “good” taxes are that they do not discourage growth, do not perverteconomic behaviour, are easy to collect and difficult to avoid. On this basis taxes on both income andconsumption are not good taxes since they discourage growth by artificially raising the price of goods andservices. They also discourage employment. Taxes on profits discourage investment and are particularly difficultto levy on international corporations that are free to choice the location where they pay tax. Governmentrevenues taken from surpluses which are not the cause of the price of goods but are determined by the pricehave the attributes of good taxes. A particular recent example of this more effective way of raising GovernmentRevenues was the licensing of the electromagnetic spectrum. Other examples are the taxation of resource rentsand the collection of the economic rent of land.

Introduction

The School of Economic Science is a registered educational charity founded in 1937. It studies thefundamentals of economics and offers public courses in Economics with Justice.

Principles of Taxation

1. The Treasury Committee should be commended for launching an enquiry into the principles that shouldunderpin tax policy. For several hundred years now the basis of taxation in the UK has been expediency ratherthan principle. In that time the proportion of the wealth of the nation that has been taken as public revenue hasgrown to almost half of the total. When such a large fraction of the wealth produced is taken in tax it has sucha significant impact on the economy that it becomes one of the most influential factors in determining thedecisions that businesses take in determining their strategy. In such circumstances if the system does not followsound economic principle but is driven by expediency or is politically motivating it can become highlydamaging to the economy.

2. Most of the questions set by the Committee are succinctly answered by the set of four canons of taxationset out by Adam Smith in his Wealth of Nations: (1) “Tax should bear as lightly as possible upon productionso as least to check the increase in the general fund from which taxes must be paid and the communitymaintained,” (2) “that tax be easily and cheaply collected and fall as directly as may upon the ultimate payers—so as to take from the people as little as possible in addition to what it yields the Government,” (3) “that taxesshould be certain—so as to give the least opportunity for tyranny or corruption on the part of officials, and theleast temptation to law-breaking and evasion on the part of tax payers,” and (4) “that tax should bear equallyon all so no-one gains an advantage.”

3. What these might mean in practice in the twenty first century will be considered below by first examiningthe unacceptable, negative, distorting effects of the main taxes at present levied in the UK, then by comparisonexploring some examples of taxation that follow Smith’s canons and finally eliciting the distinguishing featurethese “good taxes” have in common.

Distorting Effect of Taxes on Production:

4. The Committee’s fourth question supplies a good place to start a practical consideration of how taximpinges negatively on the economy. This last question: “Are there aspects of the current tax system whichare particularly distorting?” implies a recognition that taxes do distort the economy and implied in the secondquestion is a recognition that one of the most damaging ways they distort is that they restrict growth. Smith’scanons suggest this applies when taxation is placed on production. This would include all the major taxeslevied in the UK. Income tax and national insurance are effectively taxes on labour, corporation tax a tax onprofits and VAT a tax on exchange which is also an aspect of the production process.

5. Of the present taxes the one that best exemplifies the distorting effect of bad taxes is income tax, or to berealistic the combined effect of income tax and national insurance since, as the Mirrlees inquiry recentlydemonstrated, national insurance is effectively an additional tax on labour. Although the formal incidence ofthese two taxes is taken to be the individual, in economic terms there is a strong argument for consideringthem to fall on the employer, ie to regard them as a payroll tax. This view coincides with the simple fact thatthe tax is actually paid by the employer. It is supported by the fact that most business liquidations are instigatedby the PAYE authorities. What obscures this view is the undue attention given to the “gross” wage or salary.In economic terms what is of significance is not the figures displayed in job advertisements but the real wageor salary, namely, the actual goods or services that can be exchanged for the work done. In monetary termsthis corresponds to the net wage. It follows that any increase in taxation that reduces real wages is counteredby wage demands that press to restore the previous situation in terms of the actual spending power of theamount received so it is the employer who is worse off. Conversely, in the situation where there is a significantamount of unemployment putting downward pressure on wages the medium to long term effect of decreasingincome tax would not be to increase real wages but to keep them roughly constant as competition foremployment would enable employers to offer reduced gross wages so that the wages received remained roughlythe same. Thus it is employer who benefits.



6. The way payroll taxes produce a deadweight loss can be shown on a simple supply and demand curve.Basic economic theory states that equilibrium price is determined by the intersection of the supply and demandcurve (E1 in figure 1). The effect of income tax is to add to the cost of production. It raises the supply curve.This means it now intersects the demand curve at a higher price and therefore smaller quantity (E1 in figure1). The shaded area in figure 1 represents the loss of production due to increased cost caused by tax onproduction. Reducing production across the economy increases unemployment. This requires additional socialprovision. This puts extra demands on taxation. A vicious circle ensues wherein the additional tax further addsto production costs leading to further loss of production and even more unemployment.

quantity

price

Supply curve

demand curve

Supply curve with tax on production

E1

E2

This represents production lost due to taxation

Figure 1: Simple supply/demand curve showing effect of taxation

7. Taxes on trade such as VAT have a similar effect on production but they work by lowering the demandcurve since tax has to be subtracted from the price paid to the producer.

8. The case of British steel provides a specific example of the destructive effect of taxing production throughtaxing labour. This company made the headlines in 1982 when the figures published by the accountants showedit to have made a loss of £385 million in the previous year, almost £1 million per day. Considering theenterprise from the viewpoint of economics rather than accountancy gives a very different picture. British steelhad taken £2,300 million worth of raw materials and converted it into finished products which were sold for£3,400 million. This difference of £1,100 million represented the value added or wealth created by the 112,000workforce. £700 million of this added value was distributed to the workforce as take home pay and pensioncontributions, £100 million was paid in interest and £250 million was ploughed back as investment. On thebasis of these figures British Steel appeared to be a going concern. Where did the loss come from? In additionto the above BS contributed £64 million in local taxation and £480 million to the Treasury, a large proportionmade of PAYE and NI payments. Thus BS could be regarded as a business that was a going concern beingdestroyed by a tax system that levies tax on production irrespective of the business’s ability to pay. Much ofthe UK’s manufacturing industry has suffered a similar fate, particularly in recent years in the face of stronginternational competition with low labour costs made up of not just low wages but also of low taxes onemployment.

9. The corporation tax, as a tax on profits, has a similar distorting effect since it renders businesses that areviable without the tax uneconomic with it because they provide insufficient return to investors. In these timesof international corporations the taxing of profits meets an additional problem that renders its collectiondifficult. The underlying cause of the problem is that the levying of the tax on profit is disconnected from thelocation where the wealth is produced. Many strategies are available to corporations to reduce their corporationtax liabilities. They can relocate their head office to a jurisdiction with low tax rates. They can make internaltransfers between subsidiaries and make use of offshore facilities. All these have a massive distorting effect onthe way the company does business.

Distinguishing “Good” and “Bad” Taxes

10. In relation to the Committee’s questions and Smith’s canons of taxation the main taxes levied in the UK,viz. income tax, VAT and corporation tax, can be categorized as “bad taxes” in that they distort the economy,they detract from growth, they encourage employment, they are not easy to collect, and their incidence doesnot fall on the ultimate payers. Not all taxes are bad taxes. However, in order to include good taxes are it maybe necessary to widen the remit from “taxation” to consider Government Revenue more widely. By definition



tax is “an arbitrary levy” and so the word “tax” is associated with what has been defined here as “bad tax”.“Good” forms of Government Revenue may not be associated with the word “tax”.

Example of a Good Tax— The 3G Electromagnetic Spectrum Auction

11. One of the most successful revenue raising exercises by the UK Government in recent years was theauctioning of the electromagnetic spectrum for 3G in April 2000. It raised £22.5 billion. This had many of theattributes of a “good tax”. It stimulated rather than hindered production, it was easy to collect and was regardedas fair. What made this tax different from conventional ones was its incidence. The electromagnetic spectrumhas no cost of production, it is a “free gift of nature”. What the licenses were paying for was access to it. TheGovernment could have simply allowed free access and foregone any revenue. In Adam Smith’s terminologywhat was being paid was a “rent.” Since rent is a surplus it enters into the price of a good in a different wayto the costs of labour and capital. Whereas the latter are a cause of the price rent is an effect. What the licenseescould afford to pay for their licenses was based on the excess of the market price they predicted they couldobtain for their 3G services over their costs. If the Government had not charged for the license they wouldsimply have kept the surplus as excess profit, the costs to customers would not have been any less.

Example of a Good Tax—Resource Rents

A second example of a “good tax” is one based on resource rents. A resource rent is the difference betweenthe cost of production of a particular raw material (including normal profits for the extractor) and the marketprice. As such, a key feature of resource rents is that they are site specific (figure 2). The price per unit of theresource is set by the market and is the same for all sites. On a prime site extraction is easy and the resourcerent is high. On a marginal site the cost of production is so high it approaches the market price and so there isno rent. If the cost of production exceeds the market price production is not worthwhile. Resources havetraditionally been taxed on profits or royalties. Both these fall on the marginal site and effectively tax it out ofproduction in the same way that PAYE taxed British steel out of production. A resource rent tax falls higheston the most productive site, the one most able to bear tax, and leaves the margin alone. It encourages full useof the resource and does not deprive producers of a normal profit. As the rent is an effect of price rather thana cause it is none-distorting. Such a regime was put in place in spirit if not in name in the taxing of the NorthSea oil in the 1980s by ring-fencing and giving concessions to the less productive sites. This enabled a muchgreater production to have been achieved than by simply taxing profits.

Range of productive sites

Market price

cost of production

Resource Rent

Marginal site

Most Productive

site

Figure 2: Resource rents

£/u

nit

The same idea has been successfully applied in Australia to their offshore oil and recently extended to theextraction of other minerals.

Example of a Good Tax—Land Leases

12. The examples given so far have only limited application. Can it be extended to a more general form oftaxation/Government revenue? An example that illustrates in principle how this can be done is that of the



former Crown Colony of Hong Kong. This territory’s public finances are the envy of the world, they combinelow taxes on income and profit with a Government surplus whilst at the same having funds to invest in worldclass infrastructure development. One reason for the success is the system of land tenure. When the Newterritories were acquired the land remained Government property and was leased out on short leases. In termsof Government Revenue these leases and the associated rents could be regarded as another example of anaccess charge to a free gift of nature. As the colony grew in prosperity these leases became more and morevaluable providing a useful source of Government Revenue relieving the colony of the burden of conventionaltaxes. The leases have the characteristic of a good tax. They are easy to collect, fall on those who pay and donot hinder production but rather stimulate it since the buildings erected have to generate sufficient income tocover the costs of the leases.

Examples of Good Tax—Taxing Land Values

13. The principle of collecting access charge for land can still be applied when land is privately owned asin the UK. Instead of leasing land an annual levy could be collected on all owners in proportion to the rentalvalue of the land they claim. This would have the characteristics of a “good tax.” The principle is illustratedby a traditional story. Two kings ruled over neighbouring prosperous and fertile lands where dates grewabundantly. They were both in need of revenue. One of the rulers put a tax on the date trees. The effect wasthat his citizens chopped down their date trees and both the king and his citizens became poorer. The othertaxed the land on which the dates grew. Because the citizens wished to stay they could not escape the tax sothey put all their efforts into growing more dates. The king collected his revenue and the citizens were as welloff as they had been before. The principle still applies in a developed economy. The where the most valuablesites are commercial, financial or residential.

14. The quote from the recent OECD report on taxation given in the Committee’s briefing notes contains abroadly similar conclusion to what has been presented here. They report that the tax system should distorteconomic incentives as little as possible and that “corporate taxes are the most harmful for economic growth,followed by personal income taxes and then consumption taxes, with recurrent taxes on immovable propertybeing the least harmful tax.” Chapter 16 of the recent Mirrlees review argues in a similar way but qualifies thelast part of the OECD statement. They quote Nobel Laureate William Vickrey: “The property tax iseconomically speaking a combination of one of the worst taxes—the part that is assessed on real estateimprovements … and one of the best taxes—the tax on land or site value.” This is an important distinction. Atax on buildings is a tax on capital so it is a tax on production and has the negative effects of a “bad tax”. Thetax on the site is an access charge like the 3G license or resource rent and if not collected as public revenuegoes to some individual or organization as an unearned windfall.

15. A site value or land value tax is an annual payment, based on the rental value of a site discounting anybuildings or other modification of the site. It is payable by the owner of the site, rather than the occupier. Ithas the merits of a “good tax” as defined earlier. It is another example of making an access charge but one thatis of general application. It will not have a distorting effect or discourage production since land is not aproduced input. Because good quality sites are inherently in short supply tenant occupiers are already payingas much as they are able to afford so the introduction of a tax would come out of a surplus that at present is awindfall to the owner.

16. At present the effect of successful Government investment such as new transport, schools or hospitals isthat the monetary benefits go to landowners through the uplift in surrounding land prices. If land rent werecollected as Government Revenue it would enable the self-funding of public infrastructure since the cost ofvalid projects would be recouped by the increase revenue corresponding to the increase in land values theybring about.

17. A tax on site rents is very transparent. Unlike a tax on profits the tax-base cannot be hidden or movedoffshore. The location of the owner is immaterial. The obvious penalty for non-payment would simply bereturn of the site to public ownership. The principle of “ability to pay” has come to be associated withincome streams, but it is as fundamental to associate it with ownership of inherently valuable or potentiallyproductive locations.

January 2011

Written evidence submitted by the Labour Land Campaign

1. Introduction

1.1 The Labour Land Campaign advocates a more equitable distribution of the land values that are createdby the whole community. We are a voluntary group working for land reform within the labour movement. Ourmembers are supporters of the British Labour Party, Trade Unions and Cooperatives, or are individuals whosupport our aim to share land wealth through Land Value Taxation.

1.2 Our website is located at www.labourland.org.




2.1 The Labour Land Campaign considers that Section 2.1 of the Mirrlees Review (What Makes for a GoodTax System?) provides an adequate model and does not think it useful to reiterate what is stated there.

2.2 However, we do wish to demonstrate here how all the requirements of a good tax system, as describedby Mirrlees, are fulfilled by the collection of land rent for public benefit (an annual Land Value Tax—LVT).


3.1 The Labour Land Campaign says that land value should be the prime tax base. We show here how LVTwould support growth in the economy, by ensuring that land, that most overlooked of economic factors, isallocated to its best use.

3.2 LVT is levied on the value of land according to its permitted use, irrespective of how it is currentlybeing utilised. If it is underutilised or lying derelict, there will be every incentive to invest capital to makebetter use of the land to generate income, and thus reduce the burden of LVT, or to sell the land to someonewho is prepared to invest that capital.

3.3 LVT would eliminate speculation in land. It would make no economic sense to leave land idle in theexpectation that it might fetch a higher price in due course, because, unlike now, the tax would still have tobe paid.

3.4 Investors and home seekers will be encouraged to relocate to areas where land values are low forwhatever reason, thus helping to develop or regenerate those areas by making better use of the land.

3.5 Shifting the tax burden increasingly onto LVT will stimulate investment and employment, and thereforeeconomic development.

3.6 First, it will allow those taxes that act as a disincentive for investment and employment to be reducedor eliminated. Most other taxes, including taxes on incomes and capital, and on consumption, have a negativeimpact on economic development, because they increase the costs of investment and employment. When thesetaxes are higher, it means that employers have to pay workers more to compensate for the higher taxes workershave to pay, and at the same time the market for goods and services is reduced.

3.7 This would be offset to an extent by government spending on public services, which would create jobsand generate economic demand, thus stimulating investment and employment in the production and supply ofgoods and services to meet that demand. Substituting LVT for those other taxes would encourage this processall the more.

3.8 Second, the more LVT that owners of land have to pay, the more incentive they will have to investcapital in order to make the most efficient use of the land. This would help create more industries or services,and therefore more jobs, or more homes, depending on what the land is used for (subject to planningpermission), which is what economic development is about.

3.9 Furthermore, depending on the rate of tax, LVT will tend to lower the market price for land, first, becausepotential buyers would take into account the LVT that they would have to pay in the future as a result ofowning the land, and second, because owners of derelict sites and property developers holding “land banks”(often for speculative purposes), who would become liable for LVT, would have the incentive to bring the landinto use as quickly as possible, which would increase the supply of land.

3.10 However, this tendency for land prices to be lower would be offset by rising economic activity (partlydue to the introduction of LVT, as such, and partly due to the concomitant reduction of other taxes that havean adverse impact on economic development). This would tend to increase the demand for land and thereforeits value—but less so its price because more of the higher land value would go to the community in the formof LVT.

3.11 The net effect, over time, therefore, would probably be for land prices to be lower than they wouldotherwise be, and less subject to inflation. This would mean that less capital would be needed to acquire land,leaving more available for investments on the land, such as affordable housing or some other productiveactivity, thus creating jobs and enhancing the process of economic development.

3.12 Meanwhile, the more that LVT encourages investment in new productive activities, the more this willincrease the demand for land, and therefore its value, allowing more revenue to be collected from LVT. Thiscould be used to improve public services, or allow other taxes to be reduced further, which would act as afurther incentive for others to invest. Either way, or in combination, it would expand economic activity andjob opportunities, with the cycle capable of being repeated over and again. In short, LVT would help createthe basis for economic development on a more sustainable basis.

3.13 The Labour Land Campaign wishes to emphasise the fact that land is in fixed supply yet it cannot beconsumed, therefore any land for which there is a use but which remains idle represents a loss of output whichcan never be recovered.




4.1 The Labour Land Campaign considers that LVT would address some of the most serious defects of thecurrent economic system.

4.2 Wealth Inequality

4.2.1 Landownership represents a major proportion of national wealth, with less than 1% of the populationowning 70% of British land by acreage (Who Owns Britain?, Cahill). The UK’s wealthiest residents own thehighest value properties, yet are liable to Council Tax at a maximum rate three times that paid by the poorestfamilies. In the case of those non-domiciled for tax reasons, the Council Tax may be effectively the only UKtax they incur.

4.2.2 Residential and commercial land represents a small fraction of the 60 million acres of UK land butthis is the only land which incurs taxation. Therefore, the vast majority of the land, which in many cases hasbeen held by generations of the same families, incurs no tax whatsoever.

4.2.3 LVT would rightly reclaim for public benefit the land value which is provided by nature for free andenhanced by the activities of the whole community and taxpayer-funded investment in public infrastructureand services.

4.3 Environmental Degeneration

4.3.1 LVT will bring about the rejuvenation of land occupied by derelict buildings and so-called brownfieldsites in towns, because the landowner would have to pay LVT on the land according to its permitted useanyway. Therefore, as just noted, he or she would have the incentive to invest capital in the land, to make fulluse of it, subject to planning regulations, or to sell it to someone who will.

4.3.2 By encouraging the use of brownfield sites for housing and commercial activities, LVT will help reduceurban sprawl and the need to encroach on green land.

4.3.3 By encouraging less urban sprawl through the more efficient use of land in towns, LVT will help toreduce long distance commuting, particularly by car, and less will have to be spent on roads and on publictransport, thus saving on energy and reducing atmospheric pollution.

4.3.4 Meanwhile, planning regulations would preserve green spaces and other uses of land for public benefit.In addition, because, as noted below, LVT will lower the price of land over time, local authorities and otheragencies could more easily acquire land to add to green spaces, protect wildlife, create parks and provide forrecreational use—which would be encouraged by the fact that this would add to the value of neighbouringsites, and therefore increase revenue from LVT.

4.3.5 By ridding communities of derelict sites and buildings and increasing job opportunities, LVT will helpto eliminate vandalism and anti-social behaviour.

4.4 The Housing Deficit

4.4.1 The huge increase in house prices in recent years, which has put home ownership beyond the reach ofmany young people, or forced them to borrow far beyond their means, is almost entirely due to the escalatingprice of land in the places where people want to live and work. The cost of building homes has changed hardlyat all.

4.4.2 With LVT in place, because potential buyers would take into account the LVT they would have to payin the future, the price of land would tend to fall, the more so as the rate of LVT was raised. This would makehomes increasingly affordable, and reduce the costs of acquiring land for the building of new homes.

4.4.3 Furthermore, LVT would encourage the building of homes on brownfield sites, and discourage thehoarding of land by speculators, because all land would be subject to LVT according to its permitted use asdetermined by planning regulations, irrespective of how it was currently being used. This would help boost thesupply of land for housing, and keep land prices under control.

4.4.4 Meanwhile, lower land prices would not only benefit those seeking to buy homes, but also make itmore affordable for local authorities and housing associations to acquire land for social housing, thus increasingthe supply of homes at affordable rents.

4.5 The Farming Crisis

4.5.1 Currently, farming in Britain is highly dependent on subsidies in one form or another. However, theirnet effect is that they tend to boost land prices and rent, so that the subsidies, rather than supporting farming,end up as unearned income for the owners of farmland.

4.5.2 The introduction of LVT would reduce land prices and rents, and, if substituting for income tax, wouldlower the costs of employing farm workers. This would enable farm subsidies, which tend to distort agricultural



production away from the optimal use of land, to be abolished. Lower land prices would also encourage smallscale and organic farming as a viable, environmentally friendly way of farming.

4.6 The Boom/Bust Cycle

4.6.1 The 2008 credit crunch had its origins in triple-A-rated mortgage-backed collateralised debt obligationswhich turned out to be junk. The trigger was, as always, an explosion of credit availability, but loose moneymakes its way inevitably towards immovable property.

4.6.2 As land values soared, professional property speculators pocketed their windfall gains, and banks filledtheir coffers with ever increasing mortgage receipts—they were, in fact, collecting the rent.

4.6.3 A land value tax would have tempered the boom and redirected savings towards productive, ratherthan speculative, activities.

4.6.4 The last two UK house price peaks were precisely predicted by LVT expert Fred Harrison in his books:The Power in the Land (1983) and Boom Bust: House Prices, Banking and the Depression of 2010 (2005).


5.1 Once all land has been registered and the infrastructure for valuing land has been established, thecollection of LVT is cheap compared with other types of tax, since the process of assessment is more orless automatic.

5.2 Practical experience in the United States and elsewhere shows that the valuation of land is easier, lesscostly and more accurate than valuing buildings or other developments on the land. Valuing buildings, forinstance, is complicated by their uniqueness in terms of architectural features, state of repair, what the buildingsare being used for, how old they are, and so on. Land value, on the other hand, is determined almost entirelyby its location relative to various amenities and by planning regulations.

5.3 It is impossible to hide land in the same way that income from earnings and trade can be hidden. Allowners of land would have to pay LVT irrespective of their place of domicile or company status. Therefore,there would be none of the costly measures that other taxes require to ensure compliance and to prevent evasionthrough the various loopholes that so-called ‘tax accountants’ are so skilful at finding.


6.1 At local level, the Council Tax is highly regressive in that people on low incomes have to pay a muchhigher proportion of their income in tax than the better off.

6.2 As the Mirrlees Review says, land, whether used for business or residential property, can be taxed at anarbitrarily high rate on economic efficiency grounds. Business property is an input into the production processand, on efficiency grounds, should not be taxed.

6.3 The problem with the Stamp Duty Land Tax is that it discourages the change of ownership of properties.In effect, therefore, it penalises those wishing to move to a more convenient location, or more suitable premises,and therefore encourages the inefficient use of land and buildings.

6.4 The problem with Section 106 Agreement payments is their ad hoc nature, and the lack of clarity ofcriteria used for arriving at such Agreements. Nominally, they can only be levied in order to ‘mitigate harm’that would otherwise arise from the development, such as increased traffic congestion on local roads,overcrowding in local schools, or the tendency for developments to favour luxury housing at the expense ofaffordable housing required by people who work in the area. This, of course, is all a matter of interpretation.

6.5 Section 106 Agreements, therefore, are notoriously variable and unpredictable between—and evenwithin—planning authorities, and half of all planning authorities do not even use Section 106 Agreements.Much depends on the negotiating skills of local planning authorities, which, if genuinely acting in the publicinterest, will want to extract the maximum contribution from property developers. The latter, on the other hand,will seek to keep their obligations to a minimum.

6.6 Consequently, negotiations can be protracted, perhaps involving expensive legal advice and lawsuits, orappeals against decisions made by the planning authorities. This can make Section 106 Agreements costly toimplement, not least because of the delays before society will benefit from the developments being proposed.Furthermore, because of the opaqueness of Section 106 Agreements, it is often hard to dispel the whiff ofcorrupt payment for planning permission, tending to favour big national and international property developersat the expense of local builders who might have a more genuine interest in the local community.

6.7 The Community Infrastructure Levy is a form of development land tax. Under the system, in exchangefor receiving planning permission, developers agree to pay a Levy when told to do so by local authorities, sothat infrastructure can be provided. However, as with all development land taxes, landowners and propertydevelopers would still be able to withhold land from use, watching its value rise, simply by not seekingplanning permission. And Planning Charges are merely a one-off payment, and paid only by the developer,



and not by neighbouring properties benefiting from the development, thus limiting the amount of revenue thatcan be raised.

6.8 The Labour Land Campaign advocates that LVT replaces all current property taxes: Council Tax,National Non-Domestic Rates, Stamp Duty Land Tax, Section 106 Agreements and the CommunityInfrastructure Levy.

6.9 With Income Tax, the more one works, and the more efficiently one works, the more one is taxed.Similarly, with taxes on capital, the more efficiently it is employed to generate jobs and profits that can beused for further investment in the economy, the more it is taxed. Meanwhile, Value Added Tax makes goodsand services more expensive, thus dampening demand, and destroying jobs, and it particularly penalises low-income consumers.

6.10 The potential revenue from one hundred percent collection of land rent would allow these taxes to bereduced, either by decreasing tax rates or by raising thresholds.


7.1 The Labour Land Campaign considers that land value should be the main tax base and that ultimatelyall land rent could be collected for public benefit.

7.2 Labour Land Campaign agrees with the OECD that recurrent taxes on immovable property are the leastharmful. Moreover we say that an annual Land Value Tax positively promotes economic development.

7.3 The Labour Land Campaign also concurs with the arguments for taxing land values contained in Chapter16 of the Mirrlees Review.

7.4 The aggregate annual land rent of the UK has never been measured but there can be no doubt that thisis a huge potential revenue source which has barely been tapped.

7.5 Current taxes on immovable property collect only a small proportion of rent and all are mainly harmful.

7.6 The Labour Land Campaign also advocates the charging of resource rentals for the use of all naturalresources, including those from the sea, as well as such things as landing slots for aircraft, and the use of theelectro-magnetic spectrum and airwaves for telephony and broadcasting.

7.7 LVT meets all the established criteria for a good tax:

— It is fair because owners of land are in effect charged for the benefits they receive.

— It is easy and inexpensive to administer.

— It promotes efficient allocation of resources.

— It fairly distributes wealth and income.

— It responds easily to changes in economic conditions.

— It is transparent (all valuations would be in the public domain).

January 2011

Written evidence submitted by the Investment Management Association

Executive Summary

1. IMA28 is pleased to have the opportunity to submit evidence to the Committee’s Inquiry.

2. Key points:

— Equity in the tax regime is very important, but it should not continue to be pursued at the expenseof every other principle. To do so leads to significant increases in complexity, one consequence ofwhich is actually increased inequity, with the more sophisticated being able to avail themselves oftechnical loopholes.

— The tax regime is a key factor in maintaining the UK’s pre-eminent position as a global financialservices centre. The most important feature is predictability, which has been lacking in recentyears. It is essential that the direction of tax policy should be stable and clear, and rule changessubject to proper consultation and debate.

— A key policy goal should be to stimulate saving. An example of a current disincentive in thecurrent tax system is the imposition of stamp duty on the purchase of shares. Abolishing this wouldincrease returns to investors.

28 The IMA represents the investment management industry operating in the UK. Our members include independent investmentmanagers, the investment arms of retail banks, life insurers and investment banks, and the managers of occupational pensionschemes. They are responsible for the management of around £3.5 trillion of assets, which are invested on behalf of clientsglobally. These include authorised investment funds, institutional funds (eg pensions and life funds), private client accounts anda wide range of pooled investment vehicles. In particular, our members represent 99% of funds under management in UKauthorised funds (ie unit trusts and open-ended investment companies).



— Modest changes to tax rules can have profound impacts on the relative attractiveness of the UK asa location for funds. We have been much encouraged by the dialogue we have had with theTreasury in recent years on this matter, which has resulted in a number of important, if technical,reforms. The major outstanding issue remains Stamp Duty/ Stamp Duty Reserve Tax on UKequities (and its fund specific variant), which is an extremely damaging tax which harms savings,depresses pensionable income, increases the cost of capital to UK industry and harms thecompetitiveness of UK funds.


3. A great deal of scholarly work has been produced on this question, but we suggest that the fundamentalprinciples have not been stated better than as set out by Adam Smith in “The Wealth of Nations” (1776) 29:

“I. The subjects of every state ought to contribute towards the support of the government, as nearly aspossible, in proportion to their respective abilities; that is, in proportion to the revenue which theyrespectively enjoy under the protection of the state.

II. The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time ofpayment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor,and to every other person.

III. Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenientfor the contributor to pay it.

IV. Every tax ought to be contrived as both to take out and to keep out of the pockets of the people aslittle as possible over and above what it brings into the public treasury of the state.”

These were re-stated in the recent interim report of the Office of Tax Simplification (OTS)30 as equity,certainty, convenience and efficiency.

4. In our experience, in the last decade or so years officials have spent much time and energy on the questionof equity. In fact, so over-riding has been the concern to cap potential loopholes, that resulting legislation hastoo often imposed considerable additional complexity and administrative burden on the vast majority ofordinary savers and the industry. Moreover, in many cases the additional complexity has been found not tohave closed down the identified loophole or to have resulted in the creation of new loopholes.

5. Certainty will always prove to be a chimera where the rules are highly complex, but not all complexityis necessary. Frequent changes in the rules are a major contributor to complexity, and we agree with theOTS that:

“.....a complex system can become simple (or at least simpler) if it is left in place for many years so thattaxpayers can learn it, devise ways of complying and become comfortable with requirements.” 31

6. Simplicity is widely regarded as a sub-set of the issue of certainty, since it is difficult to conceive of a taxsystem which can be regarded as certain if the rules are so oblique and complex that it is beyond the wit of allbut a small group of specialists to understand them. Most citizens do not have the income or wealth to justifyengaging tax professionals to assist them in their tax affairs; it is important that taxation does not remain a“closed book” to all but the tax professional. We recognise that complexity is partly determined by the needto minimise the possibility of abuse of the system by those searching for technical loopholes, but, as notedabove, complexity is very likely to create loopholes.

7. It has been argued that the volume of the tax legislation is, in itself, an indicator of complexity. IMA doesnot agree, and supports the position of the OTS that a major factor of increased length has been the rewritingof the legislation in simpler language.32

8. Predictability is also a critically important feature of a stable and attractive tax regime, and is crucial toUK competitiveness. It is thus important in the development of a tax policy to support growth (see below).Currently the perspective is that the UK rates poorly on predictability compared to many other tax jurisdictionsand this is important for economic activities which are potentially mobile, such as significant parts of thefinancial services sector; see the recent report prepared for the City of London Corporation by CRAInternational. 33

9. IMA believes that the Government should aim to develop tax policy within existing establishedframeworks and administrative structures, to significantly increase the certainty of the tax regime as a whole.Moreover, as part of the development of taxation policy, all areas should be consulted upon, including anti-avoidance policy. Anti-avoidance policy has greatly exacerbated unpredictability in the development andapplication of tax policy in recent years. The manner in which highly complex anti-avoidance legislation isintroduced has been problematic, with many changes being made piecemeal and without notice.29 “An Enquiry Into The Nature And Causes Of The Wealth Of Nations”30 p.7 “Office of Tax Simplification Review of Tax Reliefs interim report”31 p.9 “Office of Tax Simplification Review of Tax Reliefs interim report”32 p.p. 8–9 “Office of Tax Simplification Review of Tax Reliefs interim report”33 p.p. 5, 26 and 59 “Taxation of the Financial Services Sector in the UK, October 2010”



10. This produces uncertainty and adds considerably to compliance costs, especially where legislationsupposedly targeted at a specific mischief has unintended consequences on “innocent bystanders”.

11. We comment on the convenience and efficiency maxim below in our response to the Committee’sseparate question on this aspect.


12. We welcome the statement that the Government recognises that major tax reform is necessary to restorecompetitiveness of the UK economy.34 The injection of greater openness, consultation and certainty into thepolicy making process will undoubtedly work to promote growth. We particularly welcome the commitmentto do this in the context of establishing “a longer and more considered policy cycle”35.

13. Turning to the specific position of the investment management industry, tax is a critical factor indetermining the appropriate investment vehicle for clients. This is not a matter of tax avoidance. It is aboutensuring that investors—including those which are tax-exempt, such as pension funds, charities, ISAs—do notsuffer tax that they would otherwise not have to pay. The tax-efficiency of the fund vehicle is thereforeimportant in ensuring that investors pay the right amount of tax.

14. The UK, and London in particular, has traditionally been seen as providing an attractive regulatory andtax framework compared to other locations. These attributes have underpinned the UK as a leading globalcentre for international financial services firms and have delivered substantial private sector jobs growth forthe UK over the last decade. We recognise that a complex and large economy needs to maintain its tax baseand that competitiveness need not be about a “race to the bottom” in respect of tax rates. But the UK needs tobe aware of the rates charged by its main competitors and not to be too far out of line. Certainty in theapplication of the regime and predictability about its direction of change remain key issues in establishing theUK as having an attractive tax regime.

15. In recent years, the UK fund management industry has faced a greater competitive threat, primarilybecause of changes in EU law which impact investment funds. This has opened up the UK market tocompetitors based in other Member States, but has also opened up opportunities for the UK elsewhere in theEU. In this context, a great deal of work has been undertaken in the last four years, following the issue of areport prepared by IMA/KPMG “Taxation and the Competitiveness of UK Funds, October 2006” (the 2006report), to ensure that the UK industry was in a competitive position. We would commend the largely successfuloutcome of this work as a model for the development and implementation of tax policy. The background tothe 2006 report was the UK seeing its relatively competitive position as a fund domicile of choice severelydamaged, with Luxembourg and Ireland overtaking the UK. The loss of funds under management (FUM) hadreal economic impact because the administrative support functions generated taxable profits in the jurisdictionwhere the fund, and therefore those jobs, was located. The subsequent IMA/KPMG Report of November200736 concluded that a minimum of 20 basis points a year of FUM remained with the fund domicile. Thiscovers client servicing, depositary/trustee oversight fees and professional services, and translates into a loss ofnearly £1 million tax a year for every £1 billion of FUM lost by the UK.

16. Following the publication of the 2006 report, a joint Government and IMA working group was set up totake forward its recommendations, and this ultimately led to significant changes to the UK tax legislationdealing with authorised funds. The UK tax regime for authorised funds is now widely regarded as broadlycompetitive with that of the UK’s two main competitors for UCITS (Undertakings for Collective Investmentsin Transferable Securities) funds; Ireland and Luxembourg. Thus, the structure of this part of the tax regimehas already been subject to a “root and branch” reform in the last few years, and in IMA’s view is now clearly“fit for purpose”.

17. A further example of co-operation and openness in the development of tax policy in the investmentmanagement arena can be found in the changes made in recent years to the Investment Management Exemption(IME). The policy rationale for the IME is to ensure that the UK remains competitive, as one of the key basesfor investment managers worldwide. There was a concern that economic returns on funds managed out of theUK, by UK investment managers, could be subject to UK taxation, even where the source of the capitalemployed arose outside the UK and the assets within the portfolio were not UK situs, ie where the only UKnexus was the use of a UK-based investment manager. Foreign clients of investment managers would not havebrought their business to the UK had there been a risk that the investment return on their portfolio managedby the UK-based investment manager might be subject to UK tax. The UK remains the pre-eminent playeramongst European-based investment managers, measured by AUM. For 2008 (the last year for which we haveconsistent European wide data), the UK was number one, with €3,181 billion of FUM, representing 29.5% ofmarket share. The IME has helped maintain this competitive position. The IME is now widely regarded asbeing “fit for purpose”.

18. The one outstanding issue is that of Schedule 19 SDRT (see paragraphs 27–30 below). This is perhapsbecause most of the other reforms we have highlighted have involved negligible short term cost in tax revenues.34 P. 3 “Tax policy making: a new approach”35 p.8 “Tax policy making: a new approach”36 “The Value to the UK Economy of UK-Domiciled Authorised Investment Funds”



Abolition of Schedule 19 would have a modest initial cost, but one which we believe would over time be morethan offset by decisions to locate business in the UK rather than elsewhere.


19. IMA wishes to focus on one aspect of this question: the encouragement of savings by UK citizens. Thedemographic shift underway in the UK and in large parts of the world is resulting in a welfare settlement thatis likely to see a significant amount of responsibility placed on individuals for their economic well-being inretirement. In the UK, the state will provide baseline support. However, the growing expectation amongpolicymakers is that beyond this, the claims on future output that are at the heart of any pension system willbe managed through individual saving rather than collective redistribution through the tax system or throughemployer schemes.

20. It is clear that many millions of individuals and households in the UK are not saving sufficiently fortheir long-term needs, particularly retirement. With respect to shorter-term precautionary saving, it is alsostriking how poor provision appears to be in this area, perhaps reflecting a period of easy accessibility of credit.The Family Resources Survey (2007–08) estimated that almost half of households had savings of less than£1,500, with just over a quarter having no savings at all.

21. The tax rules that apply to savers have developed in recognition of the fact that investors of modestmeans cannot easily access capital markets given the transaction costs, and the difficulty of producing adiversified portfolio when the amount available to invest is small. The range of financial products available onthe market to assist in the objective of encouraging savings is wide ranging and includes authorised funds,ISAs, the predecessor PEP and TESSA products, and pension and life products. Much more needs to be doneto stimulate saving and we suggest that fiscal incentives are an essential tool.


22. Whilst administrative burdens are sometimes a symptom of complexity rather than a cause of complexity,there is no doubt that for many taxpayers the administrative burdens are serious. For industries such as thatrepresented by the IMA, the main problem has been the lack of understanding by government officials on howthe industry operates. This was one of the issues addressed by the joint IMA/Government working partymentioned above, which led to the creation of the specialist HMRC Collective Investment Schemes Centre(CISC), currently based in Sheffield. We would commend the role of specialist teams, such as the CISC, inreducing administrative burdens for industry.

23. There is evidence that there are still, however, concerns in the VAT area, caused primarily, we believe,by the more decentralised and less specialised model of administration. This model results in many VATauditors not understanding the business and having a poorer understanding of the correct application of formalHMRC guidance to their customers.


24. We would draw the Committee’s attention to one issue which is very damaging to the position of saversand to the competitive position of the UK funds industry. This concerns Stamp Duty Reserve Tax (SDRT), theversion of stamp duty levied both on dematerialised trades and on the cancellation of shares/units in authorisedfunds in its fund-specific variant. SDRT, in its generic form as a tax levied on the sale and acquisition ofchargeable securities (mainly UK equities), is known as the “principal charge” and in its fund-specific form,“Schedule 19”, because the rules are found in Schedule 19 Finance Act 1999. Although we refer for simplicityin the rest of this paper simply to “SDRT”, any form of stamp duty levied on UK equities represents adistorting tax.

The Principal Charge

25. SDRT is a tax on saving, which also increases the cost of equity capital and damages the economy, asthe report on stamp duty prepared by Oxera in May 2007 (the Oxera report)37 makes clear. The Oxera reportestablished that over 76% of stamp duty levied on equities was derived from pension funds, savings and otherinvestments managed by insurance firms, investments held within authorised funds and investment trusts, andstocks held directly by individuals. 59% of this was held via institutional funds and collectives. Using thecontemporaneous data in the report, the amounts held via institutional and collective investment vehiclestotalled £1,735 million of the £2,930 million raised. This charge has a significant impact on the value ofpensions and savings products, and much of these costs are ultimately borne by low and middle incomecitizens. 38

37 “Stamp duty: its impact and the benefit of its abolition. Prepared for the ABI, City of London Corporation, IMA and LondonStock Exchange. May 2007.”

38 p.p 5–13 “Stamp duty: its impact and the benefit of its abolition. Prepared for the ABI, City of London Corporation, IMA andLondon Stock Exchange. May 2007.”



Schedule 19

26. There are multiple factors that have led managers to choose to locate funds outside the UK. But theconsistent message from IMA members has been that the impact of Schedule 19 is key, particularly in the lightof the further opening up of the UK market under the “UCITS IV” Directive.

27. Consideration is also needed of the possible impact of the proposed Alternative Investment FundManagers Directive (AIFMD), which will provide a European passport for funds marketed to professionalinvestors. The UK should aim to be the domicile of choice for such funds and for the related administrationand marketing activities, but such funds are most unlikely to consider the UK as their domicile of choice whilethe Schedule 19 SDRT regime continues to exist.

28. Schedule 19 is a “self-assessed” tax charge imposed on a fortnightly basis on UK authorised funds byreference to the cancellation of shares/units in a fund. This additional SDRT charge is factored into the unitpricing of funds and is hence borne by the saver, in the same way as the principal charge. In addition, it is anadministrative burden for funds to calculate the tax liability under Schedule 19, due to the complicated formulaused. Such costs are factored into the pricing of administration costs of running the fund and hence are alsoultimately borne by savers.

29. Moreover, the Schedule 19 charge acts to make UK funds less competitive than their Europeancounterparts, because such a tax does not exist in other European jurisdictions. We understand that the annualtax take from Schedule 19 SDRT for the UK is some £90 million. If there were to be a widespread move offunds out of the UK in the next few years, the tax loss would be significantly greater. In the context of theUK funds industry, therefore, we regard this tax as being particularly distorting and damaging to the UK’scompetitive position.

January 2011

Written evidence submitted by the Publish What You Pay coalition

Executive Summary

1.1 Publish What You Pay (PWYP) is a network of over 600 civil society organisations from resource-richdeveloping countries and international non-governmental organizations working to ensure that oil, gas andmining revenues are used for economic development and poverty reduction. In the UK our members includeOxfam, Christian Aid, ActionAid, CAFOD, ONE, Save the Children, Transparency International, Open SocietyFoundations, Tearfund, Revenue Watch Institute and Global Witness.

1.2 PWYP welcomes the Treasury Select Committee’s inquiry into the principles that should underpin theUK’s tax system. Tax provides essential revenue for public services and infrastructure and there is widespreadand legitimate interest in how much tax companies pay and to which governments the payments are made.Improved transparency of tax revenues should be a key principle underpinning tax policy.

1.3 Our submission focuses on the benefits of improving tax transparency in the extractive industries. Ifmanaged properly, the wealth generated by oil, gas and mining industries can be a pathway to poverty reduction,stable economic growth and development in around 60 poor but resource-rich countries. For example, in 2008exports of oil and minerals from Africa were worth roughly $393 billion—nine times the value of internationalaid ($44 billion). Ironically, countries rich in natural resources are more likely to suffer conflict and povertythan their resource-poor neighbours, as the revenues are fought over, mismanaged and misappropriated undera veil of secrecy. Transparency of the revenues paid by companies to governments is a necessary ingredientfor improved accountability that would help ensure these revenues are used for sustainable development andpoverty reduction.

1.4 Within this context it should be noted that the United States passed legislation in July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires companies engaged in oil, gas ormineral extraction that file annual reports to the US Securities and Exchange Commission (SEC) to report howmuch they pay to all governments in their annual filings on a country-by-country basis. Companies will startreporting this information as soon as the SEC finalise their rules in April 2011.

1.5 PWYP believes that the UK Government should introduce a requirement for companies engaged in oil,gas and mining extraction listed on the London Stock Exchange to report country-specific payments to foreigngovernments (as has been introduced on the US SEC) and should champion parallel legislation across Europethrough the European Union Transparency Directive. This would improve domestic accountability for revenuespaid to governments in resource-rich countries, help investors to assess risk and value companies in a high-risk sector, and foster better governance and a more stable environment for business in resource-rich regionsof the world.


2.1 Tax provides essential revenue for public services and infrastructure and there is widespread andlegitimate interest in how much tax companies pay and to which governments the payments are made.Therefore improved transparency of tax revenues should be a key principle underpinning tax policy.



2.2 In considering the fundamentals of tax policy we must consider if and how the UK and international taxregimes either support or undermine the ability of developing countries to raise revenue. This is in the longterm interest of both developing countries and the UK, as this can help reduce donor-dependency and as thesecountries may be future trading partners.

2.3 For these reasons, transparency of extractive industry revenues should be a focus of tax policy. Thiswould benefit citizens in resource-rich countries, allowing them to hold their governments to account forrevenues received so they are used for poverty reduction and sustainable development; and would help investorsassess the risks and value companies in often high-risk operating environments in impoverished countries withunstable governments.


3.1 PWYP believes that the UK has a historic opportunity to ensure fairness and accountability in the oil,gas and mining industries by supporting the new US SEC extractive industry transparency rules with parallellisting requirements for the London Stock Exchange and by promoting parallel legislation across Europethrough the European Union Transparency Directive.

3.2 Improving tax revenue transparency in extractive industries would support several other governmentpolicy goals, in particular:

3.2.1 Improving governance and reducing donor-dependency in resource-rich developing countries: In manyresource-rich countries citizens have little or no information about the terms of deals signed betweenextractive companies and their governments, how much money is being paid to their countries inrevenue and whether the payments are appropriate in relation to the profits being generated. As aresult, this wealth is often mismanaged or lost to corruption under a veil of secrecy and paradoxicallyhalf of the “bottom billion” poorest people in the world live in countries that are actually rich innatural resources. Transparency of extractive industry payments to governments would allow citizensto hold their governments’ to account for the use of these payments for poverty reduction andsustainable development.

3.2.2 Encouraging long-termism in investment decisions and equity markets: Transparency of extractiveindustry revenues and the stability and good governance it fosters would benefit investors who seekmore detailed information to evaluate risk and value companies. For example, the US SocialInvestment Forum (SIF) and Calvert Investment Management explain the benefits of stock exchangetransparency listing rules to investors in a submission to the US SEC regarding the development ofthe new SEC rules:

“...the world’s exploitable conventional energy sources are receding further into areas wherelarge-scale resource extraction has not taken place recently or in a comparable manner.Unfortunately, many of these resource-producing operating environments pose regulatory,taxation, political, and reputational risks that current reporting required of resource extractionissuers does not address adequately.… investors do not have access to the sufficiently detailed,audited, consistent, and comparable data regarding host government payments, such as taxes,royalties and bonuses to account for the risks mentioned above.”39

3.2.3 Promoting the Government’s transparency agenda: The UK Government’s transparency agenda hasmade great strides in the domestic sphere, such as the publication of local and central governmentspending and senior civil servant pay rates. Introducing a regulation for extractive Industry companiesto publish country specific payments to governments takes this agenda into the international sphereand complements the Department for International Development’s UK Aid Transparency Guaranteeand the multi-stakeholder Extractive Industry Transparency Initiative.

3.2.4 Improving energy security: The UK Government would benefit from reliability of commodity supplies,energy security and greater stability in the resource-rich regions of the world.

3.3 Improving tax transparency in extractive industries through stock exchange transparency rules is one ofthose rare policy changes that will achieve a range of policy goals and benefit a range of stakeholders—thepoor in producing countries that need resource revenue to reduce poverty and foster growth, donors seekingbetter use of domestic revenues rather than aid dependency, companies facing corrupt competitors and investorsseeking better information in this high-risk sector. The PWYP coalition welcomes the Treasury SelectCommittee’s consideration of this important issue.

January 2011

39 Letter and submission from SIF and Calvert Investments to SEC, 15 November 2010: http://www.sec.gov/comments/df-title-xv/specialized-disclosures/specializeddisclosures-49.pdf



Written evidence submitted by David Chester

Summary of Main Points

1. The method for making decisions regarding taxation changes should be based on an exact macroeconomictheory (with experience taken into account, where applicable), which is based on a more scientific approachthan in the past.

2. The current method of making these decision relies on simulations using models that contain econometric(statistical) analysis, that are better suited for studies of a simpler nature, rather than for modeling the wholeof the social system. These inexact methods were originally intended for use in simulating time-series problemshaving a maximum of three variables, not the hundreds currently used in the Finance Ministry EconometricModels of the British macro-economy.

3. These present statistical-behavior approaches to simulation are unsatisfactory due to the lack of precisionand they are unable to provide clearly understood results due to the complexity of their outputs. Consequentlyit is no surprise that HM Government cannot rely on them and seeks new and better information.

4. A simpler method of analysis for policy-making should be used which employs a scientific criterion basedon Ockham’s Razor (as employed by most scientific theories). This is aimed at reducing the complexity of theproblem to an absolute minimum with the aim of representing and understanding the basic reasons for theholistic behavior of our social system.

5. Such an approach and methodology (systems analysis engineering) as applied to macroeconomics, dependon the limited capability for the actual functioning of the complete system. The aggregate properties (as distinctfrom specific sectors in society) are idealized so that response to change (technical as distinct from behavioral)can be directly simulated (rather than artificially introduced from the use of statistical data).

6. This approach to simulating our social system as a whole does not need to be unduly complicated. Theresulting functional model (as developed by the author, see below) contains only 19 variables passing betweensix major entities. This model is suited for simulating the short-term autonomous response to change where itseeks equilibrium according to a number of decision-making criteria that are according to the nature of andcontained within our society.

7. The method will give clear results which are useful for determining tax policy as a result of an exact andscientific technique, which has no political relationship. The author of this Memorandum has adopted it as atopic of his private research. It has been written into the form of a 180 page book “ConsequentMacroeconomics—Rationalizing About How our Social System Works”, that is almost ready for publication.(Examples showing the effects of different tax policies are included in the work.) This written material isavailable and it can be sent to the Select Committee for examination by their experts as may subsequentlybe desired.

Written evidence submitted by Christian Aid

1. Introduction

1.1 Christian Aid is a Christian organisation that insists the world can and must be swiftly changed to onewhere everyone can live a full life, free from poverty. We work globally in over 40 countries for profoundchange that eradicates the causes of poverty, striving to achieve equality, dignity and freedom for all, regardlessof faith or nationality. We are part of a wider movement for social justice. We provide urgent, practical andeffective assistance where need is great, tackling the effects of poverty as well as its root causes.

1.2 We welcome the opportunity to provide written evidence to the Treasury Select Committee on theFundamental Principles of Tax Policy. We are happy to provide further written or oral evidence on any of thesubjects covered in this submission via Melanie Ward, Senior UK Political Advisor on [email protected] or 020 7523 2467.

2. Christian Aid’s perspective on the principles of tax policy

2.1 Christian Aid’s interest in tax policy lies in the role of taxation in strengthening good governance,economic development and provision of essential services in developing countries. There is a growingrecognition within the development debates that developing countries need to move “beyond aid” to financetheir own development.

2.2 Too much dependency upon development assistance is not sustainable, particularly as aid comes underincreasing pressure in donor countries. In addition, over-dependence on aid can result in problems such as lowerincentives to improve tax collection and a tendency of donors to condition aid upon a country’s acceptance oftheir policy “advice”. This potentially undermines the sovereignty of states and governments’ accountability totheir citizens. A further problem is that if aid is channelled towards projects that would otherwise have beenpaid for by tax revenues, those tax revenues may be diverted to corruption.



2.3 Tax systems should be progressive, transparent, predictable and efficient. In doing so they should provideessential revenue for public services and infrastructure without undermining economic development andinnovation. However, in developed and developing countries, the situation is quite different.

2.4 In considering the fundamentals of tax policy we must consider how countries like the UK can assistdeveloping countries in effectively raising revenue. In addition, we must consider if and how the UK andinternational tax regimes either support or undermine the ability of developing countries to raise revenue. Thisis in the long-term interest of both developing countries and the UK, as these countries may be future tradingpartners. Aid is vitally important and the government’s decision to increase the aid budget to 0.7%of GNI by2013 is undoubtedly the right one—but it is clearly in the UK’s own long-term economic interest to movetowards a situation where developing countries are no longer dependent on aid.


3.1 Christian Aid sees four primary objectives to taxation. Revenue: to deliver the services citizens need;redistribution: to address poverty and inequality; representation: building accountability of governments tocitizens; and re-pricing: limiting harmful behaviours and incentivising “good” behaviours.

3.1.1 Revenue: tax is a vital source of revenue for most governments, enabling them to fund essentialservices and infrastructure for their citizens. Of course, revenues will not automatically be used forsuch social goods. But when governments get revenue from tax, citizens are in a far stronger positionto exert pressure that it be spent on the services to which they are entitled.

3.1.2 Redistribution: the provision of services discussed in section 2 above is one way of addressing povertyand inequality through taxation—as it is the poor that tend to depend more on key services such aspublicly funded health and education. In reality tax systems the world over are often regressive. Thisis even more likely to be the case in many Southern countries which tend to have particularly lowlevels of taxation on income and an over-reliance on consumption taxes.

3.1.3 Representation: a broad tax base, and the public debate that accompanies this, creates a “socialcontract” between members of society who are paying taxes and voting for political parties, andofficials who are expected to raise and spend those revenues in a manner that benefits the constituentswho elected the government. Taxes make government more immediate and visible, and ultimatelymore accountable, thus challenging corruption.

3.2 Taxes can be used to ensure that all social costs and benefits of production or consumption of a particulargood are reflected in the market price. The design of a tax system can contribute to the achievement of othersocial goods by making it costly to engage in actions considered socially undesirable, or by incentivisingbehaviour that is considered beneficial to society. For example, in the context of climate change, it is clear thatmarket mechanisms do not price our consumption and production in a way that considers the impact onfuture generations.


4.1 In fulfilling the objectives referred to in section 3, tax systems should encourage rather than hinderinnovation and economic development. As such, tax codes should be simple, transparent and clearly linked togovernment expenditures.

4.2 Tax policy should strengthen the efficient operation of markets through financial transparency. Publicrevenue figures and expenditures should be published in a regular and timely manner.

4.3 Any contracts agreed between governments and business granting tax concessions should be transparent.This is particularly important with regard to the extractives sector. Such contracts should be published inadvance, and be open to scrutiny in parliament.

4.4 The tax positions of companies should be clear and transparent. Companies should publish in theirannual accounts details of their profits, tax payments and other financial details on a country-by-country basisas proposed by the Taskforce on Financial Integrity and Economic Development.40 Such transparency wouldassist in making governments more transparent for the revenues which they receive and would exposepotentially abusive behaviour on behalf of companies in relation to trade-related tax evasion and aggressivetax avoidance. International bodies such as the OECD recognise that this abuse is likely to cost developingcountries more than they receive in aid. Christian Aid estimates this to be around $160 billion annually. Giventhe sums of money involved, taking an international lead to resolve this issue would dovetail with governmentconcerns around value for money for UK taxpayers as in the long term it would help move away fromaid dependency.

4.5 The UK is uniquely placed to negotiate such a standard within the G20, EU and other fora, followingthe lead of the US, which recently implemented a similar standard for US listed companies operating in theextractives sector under the Wall Street Reform and Consumer Protection Act (Dodd-Frank provision).

4.6 In addition, international tax cooperation is crucial. Financial secrecy in Offshore Financial Centres canresult in significant outflows of capital and tax evasion and avoidance in developed and developing countries40 http://www.financialtaskforce.org/wp-content/uploads/2009/06/Final_CbyC_Report_Published.pdf



alike. The UK took a lead on this issue at the G20 London Summit in 2009, but despite significant progress,the commitment to help developing countries benefit from a new co-operative tax environment is yet to befulfilled. The UK is therefore well placed to take a lead in challenging financial secrecy through pursuing anew multilateral agreement for exchange of tax information (including a provision for automatic exchange) atfuture G20 meetings, starting with the forthcoming summit in France in November 2011—this should be apriority goal for the UK government.


5.1 As referred to in section 3, Christian Aid sees a broad range of benefits to the tax system. It is recognisedthat effective revenue mobilisation is the primary objective of tax policy. However, there should always be aconsideration of how this objective interacts with the objectives of equity, governance and re-pricing.


6.1 Complexity in a tax system leaves the system open to abuse and can act as a disincentive for companiesand individuals to comply. As such tax systems should be simple, whilst still ensuring progressivity in bothindirect and direct taxes.


7.1 Christian Aid has no comments on this question.

January 2011

Written evidence submitted by ACCA

About ACCA

ACCA is the global body for professional accountants. We aim to offer business-relevant, first-choicequalifications to people around the world who seek a rewarding career in accountancy, finance and management.

ACCA has 140,000 members and 404,000 students in 170 countries, and works to help them to developsuccessful careers in accounting and business, with the skills required by employers. We work through anetwork of over 80 offices and centres and more than 8,000 Approved Employers worldwide, who providehigh standards of employee learning and development. Through our public interest remit, we promoteappropriate regulation of accounting and conduct relevant research to ensure accountancy continues to grow inreputation and influence.

The expertise of our senior members and in-house technical experts allows ACCA to provide informedopinion on a range of financial, regulatory, public sector and business areas, including: taxation (business andpersonal); small business; pensions; education; and corporate governance and corporate social responsibility.

Executive Summary

1. ACCA has identified 12 principles which can be discerned in, and should underlie, good taxation policy.

2. Tax as a percentage of GDP: Government should rationalise and set a target of taxation as a percentageof GDP as part of its economic management, and then be held to account via objective measurement andvariance analysis.

3. Tax simplification and stability: ACCA believes that tax legislation and operations should be as simpleand straightforward to understand and to comply with as possible.

4. Openness, transparency and accountability: Tax policies should be transparent and non-discriminatoryunless part of a declared discriminatory policy.

5. Certainty: It should always be possible for different taxpayers who look at legislation to come to thesame interpretation of the law.

6. Competition: ACCA supports the principle that nations are free to determine their tax affairs within thecontext of a global competitive environment.

7. Avoidance/evasion: There is a clear division between tax avoidance (or planning, or mitigation), whichis legal, and tax evasion, which is not.

8. Efficiency: Tax systems should be efficient for governments in terms of their ability to secure the revenuedue and to prevent tax leakage and the development of a black economy. It should, however, also be efficientfor taxpayers in terms of their ability to comply with its requirements.

9. Sunset Clauses: Tax systems should have a review principle whereby tax legislation is periodicallyoverhauled and consolidated to bring it up to date and make it easier to follow.



10. Clear link from tax to spend (hypothecation): Although we are not convinced that “hypothecation”of particular taxes to specific areas of spending is practical, we do believe that there should be greater clarityin the public finances showing expenditure projections and how these are to be financed.

11. Avoidance of double taxation: An essential principle of tax law must be that income should be subjectto tax only once.

12. Human Rights: The huge inequality in resources and power between governments and individualtaxpayers places a responsibility on states not to impose their will in the field of taxation in an arbitrary orvexatious way.

13. Tax shifting—Green Taxes: ACCA believes one of the most important examples of legitimatediscriminatory tax policy is to change behaviour that can damage the environment.

Introduction

14. In April 2009, ACCA published its Policy Paper “Tax principles: From Adam Smith to Barack Obama”.In keeping with ACCA’s role as the global body for professional accountants, the paper looks at tax systemsworldwide rather than simply the UK to derive the principles to which all tax systems should aspire.

15. When examining tax principles, it is worth starting with a review of the famous four canons of taxationput down by Adam Smith, who is generally considered (certainly in the English-speaking world) to be thefather of modern political economy. In The Wealth of Nations (1776) he argued that, “the evident justice andutility of these maxims have recommended them more or less to the attention of all nations”.

16. The subjects of every state ought to contribute towards the support of the government, as nearly aspossible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectivelyenjoy under the protection of the state. (EQUITY)

17. The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time ofpayment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor, andto every other person. (CERTAINTY)

18. Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenientfor the contributor to pay it. (CONVENIENCE)

19. Every tax ought to be contrived as both to take out and to keep out of the pockets of the people as littleas possible over and above what it brings into the public treasury of the state. (EFFICIENCY)

20. Translated to the modern era, the first maxim is in some ways the most contentious, as it appears toargue for progressive taxation, where tax is levied according to the ability to pay. On fairness grounds it ishard to argue against this and most modern tax systems follow this principle, but whereas the huge inequalitiesof wealth in Smith’s day made such a position necessary, it is arguable that it is now a political position ratherthan a statement of fact.

21. The other maxims are less contentious. Canon II forms our 5th tenet. A society’s tax system must beknown and understood by all its adult members; otherwise, they cannot play their part to the full. Maxim IIIis hard to argue against though is not always adhered to in practice. Maxim IV forms our 7th tenet—though itcould be argued this is the area where Smith’s theory is furthest from modern reality, given the costs of thestate’s taxation apparatus and the subsequent cost of advisers to represent taxpayers.

22. So it can be seen that, given the complexity of modern economies and societies, it is a challenge toapply the tenets of even the greatest thinkers to contemporary tax systems. Unlike Smith, ACCA does not offerthe following points as universal truths, but believes that if followed by governments these 12 policies wouldrepresent the basis of effective tax systems around the world.


ACCA’s tenets are:

23. Tax as a percentage of GDP: Government should rationalise and set a target of taxation as a percentageof GDP as part of its economic management, and then be held to account via objective measurement andvariance analysis.

24. ACCA accepts that the current unprecedented economic turmoil may require special measures fromgovernments. Notwithstanding current conditions, we believe that levels of taxation should be clearly stated asa percentage of Gross Domestic Product, as far as possible. ACCA does not seek to enter the political debateabout the appropriate level of tax and public spending.

25. Nonetheless, substantial tax increases represent a significant burden on businesses and individuals andshould be subject to an impact assessment before being introduced. These impact assessments should be usedto challenge the need for new regulations and to establish an accurate and updated estimate of costs. Once newmeasures are put in place there should be a means of measuring and evaluating their impact in terms of theirproclaimed public policy objectives.



26. Tax simplification and stability: ACCA believes that tax legislation and operations should be as simpleand straightforward to understand and to comply with as possible. It is also essential that the volume oflegislation is kept to a minimum. Much of the increase in tax law and administration in recent years is due tothe number of new anti-avoidance measures. Small businesses in particular have no time to engage in esoterictax planning and are simply trying to cope with the volume of laws. Changes in tax law—particularly thosethat reverse previous tax breaks or incentives that have formed the basis of business planning—should be keptto an absolute minimum.

27. Openness, transparency and accountability: Tax policies should be transparent and non-discriminatoryunless part of a declared discriminatory policy, such as one intended to encourage new enterprise. ACCA’sview is that this use of tax by elected governments is legitimate but such taxes should then meet the otherprinciples such as being transparent, simple and effective. Governments should be wary of increasing thecomplexity of the tax system by too much tinkering to “reward” certain groups of taxpayers.

28. Too often, consultation processes on tax policy are flawed exercises where government policy has alreadybeen decided, and are carried out largely for appearances’ sake. On major issues of tax policy, there should beclear consultation where the different options are specified at the start, and properly considered with an audittrail including unambiguous minutes and written responses.

29. There should also be openness on the application of tax policy. So-called “stealth taxes”, such as thequiet reduction of tax exemptions, and the phenomenon of “fiscal drag”, whereby personal tax thresholds arenot increased in line with rising prices and incomes, thus bringing more individuals into higher-rate tax bands,cannot be justified. Tax rises should be made openly and subject to debate.

30. Certainty: The tax systems in many jurisdictions can be criticised for the lack of certainty in outcomesor operations. It should always be possible for different taxpayers who look at legislation to come to the sameinterpretation of the law. And it should not be possible for authorities to overturn long-established practice,which businesses are accustomed to, and then seek to challenge them on an obscure point of law. Taxpayersmust have certainty over Revenue authorities’ interpretations. Authorities should establish a proper and efficientclearing mechanism for complex anti-avoidance provisions

31. Tax Competitiveness: The globalisation of business means that each country should ensure its tax ratesare competitive and its regime user-friendly. Tax is a key factor in ensuring the overall attractiveness of alocation to mobile capital (businesses and individuals). It is important to look at the underlying tax base of acountry and not just focus on the rate.

32. The danger with competition, however, can lie in very low tax rates, where offshore tax havens or flattax systems can lead to “beggar thy neighbour” approaches, in which inward investment can be lured from onecountry to another and which may undermine agreed international financial regulation initiatives. They canalso have regressive rather than progressive tax outcomes and so entrench wealth inequality.

33. ACCA supports the principle that nations are free to determine their tax affairs within the context of aglobal competitive environment, but governments must be wary of causing retaliatory action and trade warsby drastic business tax cuts.

34. Avoidance/evasion: There is a clear division between tax avoidance (or planning, or mitigation), whichis legal, and tax evasion, which is not. It is not unethical to minimise one’s taxes. While most businesses tryonly to comply with the law, there have nonetheless been many cases of convoluted tax planning schemes thatare designed not for any proper business purpose but to exploit loopholes in the law and avoid its spirit. ACCAdoes not support this artificial activity, which could be considered the equivalent of the creation of some of theextremely complex financial products, designed to get round banking regulations, which have had such adisastrous effect on banks. Such actions, which may generate short-term financial advantage at the cost of long-term value, cannot be supported.

35. Efficiency: Tax systems should be efficient for governments in terms of their ability to secure the revenuedue and to prevent tax leakage and the development of a black economy. It should, however, also be efficientfor taxpayers in terms of their ability to comply with its requirements. It should not be forgotten that smallbusinesses represent the bulk of economic activity in most countries and regulation can have a disproportionateeffect on small firms, as the smaller the business the heavier the compliance cost.

36. Sunset Clauses: Tax systems should have a review principle whereby tax legislation is periodicallyoverhauled and consolidated to bring it up to date and make it easier to follow. Outdated laws should beremoved.

37. There needs to be a positive prompt for justifying the existence of legislation. All anti-avoidancelegislation should have sunset clauses attached to it. This will ensure that it is regularly reviewed and the needfor it to remain in place is actively considered. Governments and tax authorities should devise clear metrics togauge whether the tax system is being appropriately and sufficiently reviewed.

38. Clear link from tax to spend (hypothecation): There is a lack of credibility with tax systems whentaxpayers do not know why they are being taxed and where the revenue is being spent. It is of benefit tosociety, individuals and businesses if there is a clear link between tax take and its application. Issues such as



“green taxes” have fallen victim to cynicism as the public has not been convinced that the revenue raised hasbeen spent on activities to help the environment.

39. Although we are not convinced that such “hypothecation” of particular taxes to specific areas of spendingis practical, we do believe that there should be greater clarity in the public finances showing expenditureprojections and how these are to be financed.

40. Avoidance of double taxation: An essential principle of tax law must be that income should be subjectto tax only once. This applies both to direct tax, where an individual or business should suffer tax once, andconsumption taxes such as VAT, where input tax recovery should be available at each stage of the transactionchain and only the end user, in the form of a private individual, ultimately pays the tax.

41. Human rights: Taxpayers have rights as well as responsibilities. They are obliged to pay their tax due,in full and on time, as this is the only way governments can generate the funding to provide the public serviceseveryone depends on, and in this sense tax is part of the social contract of any civilised society.

42. Nonetheless, the huge inequality in resources and power between governments and individual taxpayersplaces a responsibility on states not to impose their will in the field of taxation in an arbitrary or vexatious way.

43. Tax shifting—Green Taxes: We have said that elected governments have the right to use taxation incertain circumstances in pursuance of agreed social policies. ACCA believes one of the most importantexamples is to change behaviour that can damage the environment. Accountants should play an active part inefforts to reduce global carbon dioxide emissions, and the concept of “tax shifting” by increasing carbon taxeson the use of fossil fuels but reducing them for payroll, income or corporate taxes should be promoted.


44. Growth is best supported by simplicity and removing the drain on productive time imposed byunnecessary bureaucracy and complexity.

45. Using (reductions in) tax to subsidise particular business sectors or activities is of debatable efficiency.Differential taxation introduces complexity to the system, which acts as a drag on all taxpayers. For example,proponents of SME stimulation through tax incentives often base their arguments on market failure, principallyunderinvestment in SMEs by external investors, caused by a failure to fully value the contribution of SMEs,and increased costs of raising finance, caused by information asymmetry.

46. However in order to effectively deal with the market inefficiencies they must first be valued. Policymakers must then establish the level of tax incentive required to offset that inefficiency. The disconnect betweenproblem and solution leads to further inefficiencies and potential market distortions.

47. Incentives for investors can be aimed directly at them, by giving relief on the tax they pay on theirinvestment, or indirectly by reducing the tax burden on the SMEs and thereby hopefully increasing the returnon investment to the investor.

48. The former type of measure will generally be more effectively targeted than the second type which willtend to influence all SMEs, whether they are looking for further investment or not. Moreover, where theincentives for SME’s are too great they will cause other distortions such as the issues of “disguised employees”presenting themselves as micro businesses in order to access tax incentives made available to SMEs.

49. Measures are notoriously difficult to target, an example being the 0% corporate tax rate for companieswith small profits. The aim was apparently to induce a supply side boom driven by reinvestment of profits notpaid in tax. Among the actual results were complex anti-avoidance measures and a rash of incorporations bysmall businesses which had operated perfectly well as sole traders and partnerships but now saw a financialadvantage in changing legal form, with no particular change in business strategy.

50. If the factor restricting SME growth is lack of transparent information, tax policy is unlikely to be themost effective remedy. Subsidised training for small businesses in how to keep records and present financialinformation will be more effective, and will have a positive impact on efficiency even in businesses with nowish to expand.


51. Tax systems in general are cumbersome instruments of policy implementation, so while use of tax as apolicy instrument can be legitimate, it should be exercised with care and restraint. Once enshrined in law andrelied upon by influential groups a distortion to the system can be remarkably enduring. Specific policy goalshowever can change far more rapidly. Use of the tax system by policy makers as a regular instrument of policyimplementation results in constant change, complexity confusion and cost.

52. Tax as a policy instrument (rather than revenue raiser) broadly falls into redistributive and regulatoryfunctions. Redistribution is usually best served through income taxes, although some academics argue that aproperly formed consumption tax can have redistributive effects. Regulation of consumption meanwhile ismost effective when applied as a consumption tax on the particular good.



53. As a general rule, tax is best used for externalities not otherwise reflected in the taxpayer’s decisionmaking, and which cannot be addressed by other means—for example, green taxes, to reflect the environmentalcost of given behaviours which might otherwise be ignored and where regulation would be ineffective. Thetax can be closely linked to the desired behavioural outcome by seeking to monetise the impact of ie carbonconsumption and increase the cost of consumption accordingly.

54. Other policy measures, seeking to encourage particular types of activity rather than consumption of aparticular good or service are, for the reasons outlined above, more difficult to form. Adjustments toconsumption tax on a particular good or service essential to the desired activity are unlikely to be sufficientlyspecific to be effective, particularly where it is just one sector of the economy that is the target of the proposedstimulus but the goods are widely consumed. The most effective method will generally be the income taxespaid by the businesses or individuals concerned. If the population can be identified and defined an adjustmentcan be made to the income taxes of that population in isolation. An example is R&D tax credits, where thelabour and consumable goods subjected to tax relief could be consumed in any number of ways. The taxincentive is given based on the behaviour of the specific consumer, rather than the goods and servicesconsumed.


55. The extent to which costs of administration are relevant depends on how focussed the particular tax ison being “profitable”. Revenue raising is all about the money; costs need to be kept to a minimum. Internationalexperience indicates that consumption taxes and withheld employment taxes are the most efficient instruments.

56. Redistribution is (mostly) about the money, although not from the government’s perspective. Wastageon administrative costs reduces the amount of money which can be transferred from rich to poor, directlyreducing the efficiency of the tax.

57. Regulatory taxes are not necessarily about the money at all, eg carbon taxes. The important goal isreduction of carbon consumption; if the tax is expensive to administer, those costs can be built into the levy.For many years, the example of capital gains tax was quoted as an instance of a policy instrument, where thecosts of collection outweighed the revenue raised. The alternative cost to the economy in lost income tax werethe gains tax removed was however considered to be even greater.


58. Any level of differential taxation introduces distortion. Some cases (redistribution for example) aredeliberate. Often however the differential treatment of otherwise equivalent behaviours (ie the differing taxcost of Debt finance v Equity finance, or the proliferation of zero rated goods for VAT) exists for primarilyhistoric reasons, often with little objective economic justification. The question of whether any specificdistortion is justified on policy grounds can is one for policy makers themselves.

January 2011

Written evidence submitted by TaxAid

Summary

TaxAid is a charity that advises unrepresented, low-income taxpayers within the category of 3.8 milliontaxpayers that HMRC designates as “Will Always Need Help”. These unrepresented taxpayers are defined byHMRC as those “with low literacy, poor financial skills, lacking English language skills and/or coping withdisabilities, including mental health issues”.

TaxAid’s experience of unrepresented taxpayers who come forward for help is largely because they do notunderstand their obligations. The tax system—from policy to implementation—seems to assume that taxpayershave either a single employer (to meet PAYE obligations) or a tax agent to meet the wide range of requirementsof those in self-employment. This is far from the case. Low-income and vulnerable groups are particularlylikely to have multiple low-paid part-time employments, alongside taxable benefits and small self-employments.We submit that all incoming (and potentially much wider) tax policy should be subject to an impact assessmentthat makes a report on “how easy or difficult is it for this (element of) tax policy for the unrepresented to meetits obligations”.

Ease and efficiency should be considered both from the perspective of the unrepresented and their ability tounderstand and meet their obligations, and with regard to the cost of HMRC implementation and processingwhere small value tax on low incomes of unrepresented taxpayers is concerned.

1. Background

Founded as a charity in 1992, TaxAid aims to help unrepresented taxpayers on low income to understandand meet their obligations under the tax system. In practice this means that the majority of its work is in theprovision of free, specialist tax advice to people on incomes below 60% of median income who are in crisis



with a tax problem and cannot afford to pay for advice. Crises are likely to arise from unanticipated taxdemands, failures of unrepresented taxpayers to understand the complexity of their tax obligations, and/orHMRC error or unsuitability to assist. Last year it resolved over 11,000 tax problems related to a huge rangeof tax issues primarily through tax professionals on the national helpline and email with referrals for moreintensive help in face-to-face meetings or teleconferencing.

1.1 TaxAid’s clients are usually within the category of 3.8 million taxpayers that HMRC designates as “WillAlways Need Help”, defined as those “with low literacy, poor financial skills, lacking English language skillsand/or coping with disabilities, including mental health issues”. However, otherwise capable peopleexperiencing a life-changing event (loss of job, family breakdown, starting a small business, retirement,bereavement) are also likely to struggle with understanding their obligations, and particularly so if poorlyserved by HMRC.

1.2 TaxAid uses its experience of clients’ problems to represent their interests at a wide range of HMRCconsultations. This experience with unrepresented taxpayers also gives us insight into two elements of yourinquiry:


We submit that all incoming (and potentially much wider) tax policy should be subject to an impactassessment that makes a report on “how easy or difficult is it for this (element of) tax policy for theunrepresented to meet its obligations”. Tax Credits as they currently stand are an example that would fail thetest, despite substantial improvements to the system over the years since it was introduced, and recent specificadaptations to standard processes to improve the experience of the “needs help” group (eg, assisted renewals).

2.1 TaxAid’s experience of unrepresented taxpayers who come forward for help is largely because they donot understand their obligations. The tax system—from policy to implementation—seems to assume thattaxpayers have either a single employer (to meet PAYE obligations) or a tax agent to meet the wide range ofrequirements of those in self-employment. This is far from the case. Low-income and vulnerable groups areparticularly likely to have multiple low-paid part-time employments, alongside taxable benefits and small self-employments. Such people are among the most vulnerable both in terms of capability of meeting complexrules, and of complicated working patterns.

2.2 An important group is those with mental health conditions who are encouraged to do some work, notleast for therapeutic reasons. Very often their condition will prevent them from attending a workplace, or doingso reliably and punctually, and so they must necessarily work for themselves and comply with all the obligationsof Self Assessment.

2.3 The viability of self-assessment for the unrepresented is largely predicated on the assumption that mostof the working population is correctly dealt with under PAYE, and no self-assessment is needed. Recentproblems with PAYE have made evident that, where PAYE does not work correctly, the responsibility for thecorrect tax lies with the individual, who can find they are unexpectedly within the Self Assessment system forearlier tax years.

2.4 It also depends heavily on the self-employed paying professional agents (accountants and tax advisers)to apply complex tax rules and prepare accurate returns. Vulnerable groups are least able to afford professionaladvisers, yet often least well-equipped to deal with matters on their own.


As far as tax policy that impacts on the unrepresented is concerned the ease and efficiency should be partof the above impact assessment. Ease and efficiency should be considered both from the perspective of theunrepresented and their ability to understand and meet their obligations, and with regard to the cost of HMRCimplementation and processing where small value tax on low incomes of unrepresented taxpayers is concerned.For example:

3.1 the collection of tax on small (and fluctuating) foreign incomes of UK residents is overlyburdensome—and costly to assess—for both the taxpayer and HMRC; and

3.2 the collection of tax on state pensions through Self-Assessment (where this is the only source ofincome) can also be difficult for the individual to deal with, and inefficient because of the problem ofcollecting tax in arrears from those on low incomes.

3.3 Individuals going abroad to work for short periods are technically liable to UK tax (with credit forforeign tax paid). In many cases, individuals taking up seasonal work abroad (waiters, bar-work,holiday reps, tour guides) will not declare this income in the UK—and inadvertently be evading tax.Others will be shocked to find they should report this income (and pay tax, after claiming double taxrelief ). Where foreign tax has been paid, the UK tax due is often small.

3.4 The application of the 10% savings rate is very complex for a relief which applies in a small numberof cases, with a maximum value of £256.



4. De minimis allowances, in the above and other tax policies, seem to be set with no reference to the costsof collection (let alone the further need for enquiries and possible enforcement).

5. Aspects which hinder basic understanding of the tax system include:

5.1 multiple thresholds (eg £7,475 for income tax personal allowance in 2011–12, £7,225 for Class 1 and4 NI, £6,420 for tax credits, £5,315 for Class 2 small earnings exception etc); and

5.2 aspects which muddy the position between independent taxation and household taxation (tax credits,proposed withdrawal of child benefit for 40% taxpayers, married couples allowance).

6. Because the unrepresented are a special group whose interests are taken up by few individuals ororganisations (the Low Incomes Tax Reform Group of the Chartered Institute of Taxation being an exception),TaxAid would be pleased to be invited to appear before the Treasury Committee to address questions that theabove raises.

January 2011

Written evidence submitted by Low Incomes Tax Reform Group

Executive Summary

1.1 “Tax policy”covers a wide spectrum: international to local taxation (including devolved administrationvariations); the large corporate body to the small sole trader; the high net worth individual to the low-incometaxpayer or benefits claimant. All government policy should consider whether tax is an issue and be designedaccordingly.

1.2 The tax system should be progressive across the board, not just in terms of income tax rates, but alsowealth and consumption taxes.

1.3 We generally recommend aligning rules and definitions, but only where it makes sense to do so in termsof simplifying compliance, minimising distortions and saving administrative costs all round. Tax policy mustalways be workable by design; otherwise it is bound to fail or descend into complexity (in which case it isoften the taxpayer who is willing to comply but inadvertently gets it wrong who suffers the consequences). Wehope that in due course the Office for Tax Simplification will be able to play a role in such further developmentof the system.

1.4 Thorough consultation in advance of policy implementation, where possible, is imperative. Governmentshould over-compensate for the likely inability of the unrepresented and low-income taxpayer to speak forhimself, by proactively seeking views of charities which seek to represent them. LITRG can assist by co-ordinating those efforts, particularly where tax non-specialist charities need to be consulted.

1.5 Each year, a proportion of the Finance Bill and debates should be devoted to addressing problems of thelow-income population. We suggest a HM Treasury, HMRC and voluntary sector working group is establishedto identify key issues, linking also to the Treasury Committee.

1.6 In designing tax policy, simplicity of its administration, communication of its meaning and clarity of thelaw itself should be paramount. If complexity cannot be designed out of the system, it should remain hiddenbehind properly resourced customer service, whether delivered through the civil service or an appropriatelyfunded voluntary sector.

1.7 Tax policy can support growth by linking with welfare benefits policy and its aims to encourage morepeople off benefits and into work. It can also provide reliefs for those who become ill or disabled while inwork to help keep them in work and off benefits.

1.8 Tax policy can also encourage self-employment with flexible payment arrangements and relief for lossesand capital investment, particularly in the early years of a new trade. But this will fail if welfare benefits policydoes not similarly recognise these issues.

1.9 In answer to question five, though by no means an exhaustive list, we have identified below a numberof distortions in the current system. These include: pensioner problems (giving an example of where policyaimed at more wealthy individuals impacts on those of much lesser means); the confusion created throughdifferent rules for tax and National Insurance; and the uncomfortable relationship between independent taxationand household assessment of welfare benefits. In conclusion, these examples illustrate that policy needs to becontinually reviewed to check it remains valid; and that different definitions create confusion for the individualwhich in turn argues for a more cohesive system, not just within tax but looking across to associated fiscal(and sometimes even non-fiscal) policy.

2. About Us

2.1 The Low Incomes Tax Reform Group (LITRG) is an initiative of the Chartered Institute of Taxation(CIOT) to give a voice to the unrepresented. Since 1998 LITRG has been working to improve the policy andprocesses of the tax, tax credits and associated welfare systems for the benefit of those on low incomes.



2.2 The CIOT is a charity and the leading professional body in the United Kingdom concerned solely withtaxation. The CIOT’s primary purpose is to promote education and study of the administration and practice oftaxation. One of the key aims is to achieve a better, more efficient, tax system for all affected by it—taxpayers,advisers and the authorities.

3. Our Response to the Inquiry’s Questions

3.1. What are the key principles which should underlie tax policy?

What is included in the term “tax policy”?

3.1.1 Fundamental to this inquiry is firstly to consider what is meant by “tax policy”. The term couldencompass many things: European taxes such as VAT; other indirect taxes such as excise duties; direct taxessuch as corporation tax and income tax; social security (National Insurance) contributions; taxes on wealthsuch as stamp duties, inheritance tax, capital gains tax; local and devolved taxes; and perhaps even other items,such as student loan repayments, which are collected via the tax system.

3.1.2 The overall impact of tax on a person’s or entity’s situation cannot be considered without looking atthis entire spectrum. In general, alignment of rules and definitions across the different duties creates simplicity;but as we have said during the review of HMRC Powers over recent years, alignment for its own sake shouldnot be not be pushed through at the expense of fairness or where it makes sense to make exceptions.

A progressive system

3.1.3 The tax system should be progressive across the board, not just in terms of income tax rates, but alsowealth and consumption taxes.

Targeted support

3.1.4 One of the key questions is whether the tax system is the best means of offering support where, forexample, the Government wishes to encourage growth or target help at a certain group. Generally, we thinkthe tax system can be useful in either being the key means of delivering such policy intentions or supportingtheir delivery (see comments on welfare benefits in answer to question three below). But inevitably, the moredetailed the rules are in offering reliefs and exemptions, the greater their complexity. There is therefore abalance to be struck.

Thorough consultation in advance, where possible

3.1.5 The consultation process generally ensures that everyone who is in the loop has an opportunity torespond to any proposals. But what about those who are not in the loop who may be equally affected by thechanges? How does government hear their voice?

3.1.6 As we noted in our response41 to the consultation “Tax policy making: a new approach” last summer,we believe that LITRG (in its position looking at how tax policy cuts across to other policy) has a special rolehere in helping government, and indeed the Committee, to ensure that the views of everyone affected aregathered. LITRG is uniquely placed to play a co-ordinating role with “tax non-specialist” charities to makesure that tax issues are considered by them where necessary.

3.1.7 We also recommended in that submission that every year a part of the Finance Bill debate (and spacefor clauses in the Bill itself) should be devoted to solving some of the problems of the unrepresented—variousexamples of which we give in our answer to question five below.

3.1.8 In this respect, we believe that the Government needs to over-compensate for the low-incomepopulation by making a special effort to gather views and analyse their needs in advance of policy decisions.There is a perception that if there are 50,000 low-income people affected by a tax issue then this is likely tobe regarded as “small” by HMRC and the Treasury and not deserving of time being spent compared to if those50,000 were from a high-income sector. We therefore favour creation of a special low-income team in theTreasury linking to HMRC’s Individuals Customer Directorate and the specialised tax voluntary sector toredress the balance. It would be helpful if there were a member of staff working for the Treasury Committeewho could take part in this work.

Clarity of the law and simplicity of administration

3.1.9 We comment further below under the fourth question, but generally a key principle of tax policy designshould be simplicity of administration.

3.1.10 Moreover, we believe the law itself should be as clear as possible and its expansion or interpretationthrough HMRC guidance kept to a minimum. A straightforward rate structure would, for example, go a longway towards simplification. One example is the tortuous 10% starting rate on savings which because of itscomplexity is little known, poorly understood and probably claimed by only a few of those who are entitled.41 See http://www.litrg.org.uk/submissions/2010/tax-policy-making



While at present the role of the Office for Tax Simplification is to look only at the simplification of thepresent system, we hope that in due course they would have the resources to enable them to play a part inthe development of the system.

3.2. How can tax policy best support growth?

3.2.1 As we note in our answer to question three below, tax policy should be joined up with welfare andbenefits policy. Key objectives in so doing are to:

— ensure that the fiscal system recognises the entire financial situation of an individual who is botha taxpayer and a claimant;

— ensure the tax system supports those who become ill or disabled to remain in work, perhaps forexample by offering reliefs so that people can re-train where they are unable to continue in anexisting role;

— simplify the rules, and provide incentives, for new businesses to encourage those wishing to moveinto self employment; and

— provide flexible tax payment options tailored to business needs.

3.2.2 In terms of the third bullet above, the necessity for joined-up policy has been recently illustrated inthe proposed system of the Universal Credit. We have pointed out that the initial idea for the self-employed tobe deemed to earn the equivalent of the National Minimum Wage, even when their business is yielding noprofit, is divisive. Moreover, this would be a retrograde step from the current tax credits rules which basicallyfollow the tax system and allow for the likelihood of losses and capital outlay, particularly in the early yearsof a new business.

3.3. To what extent should the tax system be structured to support other specific policy goals?

Welfare and benefits

3.3.1 In launching the inquiry, the Committee noted:

“The Mirrlees Review, published by the IFS, argues that the tax system should be considered as a wholewith the benefit system, seek neutrality, and achieve progressivity as efficiently as possible.”

3.3.2 One of LITRG’s key principles has always been that the tax system should support, not detract from,the delivery of welfare. In our work, we continually urge policy makers to look across all tax and welfaresystems and assess the impact of any proposed measures on each individual’s or household’s financial situationtaken as a whole. It is vital to ensure that the beneficial effects of a measure designed to help an individual arenot countered by existing rules elsewhere in the tax/benefits system, simply because policy makers had failedto look across the whole spectrum.

Joined-up policy and legislation

3.3.3 Furthermore, we aim to look at other policy changes and see how they might be joined up with taxpolicy (rather than simply looking at the impact of tax policy on other areas). In so doing, we can help toidentify ways of simplifying policy across the board. One recent example of this was where we commented onproposed changes to the National Minimum Wage (NMW) legislation in respect of travel expenses, suggestingthe NMW Regulations should be aligned with the income tax definition; a recommendation which was acceptedand implemented from January 201142.

3.3.4 A further example is our work on independent living43, identifying the tax impacts on people whoare enabled, through direct payments, to employ carers or household help.

3.3.5 We therefore urge that wider government policy should have a “tax check” to ensure there are notunforeseen tax consequences.

3.4. How much account should be taken of the ease and efficiency with which a particular tax can beimposed and collected?

3.4.1 We believe this is important and should be considered at the earliest stages of policy design. A taxmatter might be complex, but compliance with the rules should be made simple for the taxpayer, so as toreduce administration costs for HMRC and foster good customer relations.

3.4.2 Any complexity should therefore be hidden so far as possible, by giving taxpayers clear instructionshow to comply. Therefore, successful tax policy should have its communication strategy to the taxpayer inbuilt;or, where a change is rushed through to counter some perceived mischief, there should be time devotedthereafter to such considerations.42 See paragraph 3.4.2 of our consultation response—

http://www.litrg.org.uk/submissions/2010/travel-expenses-nmw43 See our 2008 report—“Independent living, direct payments and the tax system”

http://www.litrg.org.uk/reports/2008/independent-living-direct-payments-and-the-tax-system



3.5 Are there aspects of the current tax system which are particularly distorting?

3.5.1 In its work, LITRG has identified many areas of distortion. There are areas where the system is illogicaland unnecessarily complex.

Pensions

3.5.2 For example, we have recently been reviewing the issue of small pensions and those who are permitted,subject to certain restrictions, to “trivially commute” their entire pension pot as a partially-taxed, partially tax-free lump sum. This is one area where a change aimed at wealthier taxpayers, to reduce the total pensionslifetime allowance, could have affected those, generally lower income, taxpayers who have only accrued smallpensions. This was because the limit on those pensions which could be trivially commuted was defined byreference to the lifetime allowance.

3.5.3 Thankfully, that link is to be removed; but idiosyncrasies remain such as the need to commute anumber of trivial pensions within 12 months of the first such commutation. We have been unable to determineclearly the rationale for such a restriction, which seems an unnecessary complication where there is already amonetary limit on the overall amount which can be encashed. And indeed the same restriction does not applyto other commutations, such as those which are non-trivial, or trivial commutations arising on winding up ordeath. It can lead to distortions by, for example:

— forcing the encashment of all policies within a short space of time which might not make financialsense for the taxpayer; or

— forcing the purchase of an annuity in the (not uncommon) situation of a forgotten small pensionpot coming to light after the 12 month window has expired.

Thresholds

3.5.4 Distortions can be created where there are differences in thresholds. For example, income tax starts tobe paid at a different point than National Insurance contributions which in turn differ from tax credits andbenefits taper thresholds. Moreover, someone working at National Minimum Wage rates and living below thepoverty line can be liable to tax and National Insurance.

3.5.5 These cross-cutting issues are continually at the forefront of LITRG’s work. But even though theseconsiderations are now coming to the attention of the Government, for example through the review of benefitsand creation of the new Universal Credit, issues of concern remain.

3.5.6 For example, with the Government’s policy of gradually increasing the personal tax allowance to£10,000, it does not seem that the knock-on issue of the higher personal allowances for pensioners has beenconsidered, which continue to be uprated only for inflation. We have urged that the policy be considered as amatter of urgency44.

Tax and National Insurance differences

3.5.7 Recently, increased attention has been focused on possible alignment, or even merger, of income taxand National Insurance. We agree that there is merit in reviewing the two systems to see where consistencycan be achieved.

3.5.8 For example, where an employee is not reimbursed employment-related expenses by their employer,such as for business mileage, they can make a claim against their income tax liability for tax relief on thevalue (although many may not do so because they are not aware they can). However, a similar claim is notavailable for National Insurance.

Independent taxation versus household assessment of benefits

3.5.9 Following on from our response to question three above, one of the obstacles to taking an accurateoverview of tax policy interactions with welfare benefits is the conflict between household assessment of taxcredits and benefits as against independent taxation; and indeed the various definitions of a “couple” fordifferent purposes. National Insurance in some ways straddles the two, with the possibility of claiming benefitsby reference to another’s contributions or even transferring credits to someone else in certain situations (seefor example the recent consultation on transferring NI credits to another family member where the child benefitclaimant goes out to work45). This is an area of tax policy which is indeed overdue a thorough review.

Policy lessons to be learnt from current distortions in the system

3.5.10 From the example of trivial pension commutations above, we conclude that it would be useful toensure reliefs are continually reviewed for efficacy, that the parameters are still right, and to see if there areany rules or restrictions which detract from the economic benefits of the relief.44 See http://www.litrg.org.uk/News/2010/tax-policy-pensioners45 See http://www.litrg.org.uk/submissions/2010/ni-credit-changes



3.5.11 Furthermore, we have illustrated how failure to align definitions, rules and procedures createsconfusion. There are myriad examples of such lack of alignment in the wording of the law, where differentterms and language are used to describe basically the same concept. Also, the same individual may have tosupply the same information to multiple government departments, or multiple silos within a single department,and in varying ways depending on which rules they are complying with.

3.5.12 A single financial transaction can result in income which is taxable but disregarded for tax creditsand possibly treated as capital for assessment of welfare benefits. How much simpler life could be if theseissues were reviewed and aligned if possible, and if in future policymakers were to consider matters in theround when initiating change.

January 2011

Written evidence submitted by Transforming Communities

1. Transforming Communities is a small consultancy concerned with the collection of natural resourcerents as a sustainable and fair method of taxation. The Director is Dave Wetzel (former Vice-Chair of Transportfor London, former Chair of the Greater London Council’s Transport Committee and a former Leader ofHounslow Council) and Heather Wetzel has recently joined Transforming Communities as a researcher andhas a BA (hons) in Economics.


2.1 If the UK were to start a tax system from new, it is unlikely it would resemble the complex, expensiveand avoidable system currently in place.

2.2 The Government’s desire to simplify the tax system offers the opportunity to consider how a good taxsystem should be structured and managed to benefit society as a whole and be an aid for Government tomaintain a sustainable and fair economy.

2.3 The Government should not shy away from making changes that may appear to disbenefit individualsor sections of society simply because they make up a strong lobby opposed to changes that benefit the majorityof society and which improve our economy as well as protect our natural resources and environment for thegood of all today and tomorrow.

2.4 This submission proposes that the key elements for a good tax must include:

2.4.1 It must not discriminate unfairly against one section of society unless it is to right a fundamentaleconomic or social wrong;

2.4.2 It must be transparent, clearly understood, simple and easy to administer both by the collector andthe payer;

2.4.3 It must not be detrimental to the environment and should act as an incentive to protect naturalresources for future use and to reduce all forms of environmental damage including carbonemissions; waste and misuse of natural resources including land, minerals, water and fossil fuels;

2.4.4 Any exemptions should be minimised and must be for a specific purpose and not become aloophole for avoidance of payment;

2.4.5 Any benefit paid to an individual or a business should not be reduced or cancelled out by any taximposed to the same.

2.5 The Treasury Committee, in its deliberations, should also take time to consider what wealth is, howwealth is created and to whom surplus wealth—after costs of production and a “normal” rate of profit—currently goes. The ownership and control of our natural resources including land should also be examinedand considered in this review.

2.6 Because our natural resources are not produced by humans, this paper asserts it is fundamentally wrongfor anyone to benefit economically because they claim to own a part of nature.

2.7 All goods and services are produced through the efforts of humans using natural resources—whether itis a factory producing machinery, a hospital caring for sick people, a bank lending to a new business, a farmerproducing food or a scientist working to create a cure for cancer, all of these activities involve human effortusing tools and equipment of some sort that have been created by other humans using natural resources.

2.8 When contemplating production in the UK’s mixed economy, the economic return to the human effortand to the capital is clear—wages and profit. However, there is a third beneficiary rarely considered—namelythe owners of land and natural resources.

2.9 As land and natural resources are essential to production, their owners can charge a premium to allowproduction to proceed. This premium (economic rent) is derived from the excess surplus of production as firmsand individuals compete for sites and scarce natural resources.

2.10 There is no cost in producing land and natural resources—they are free gifts of nature to us all.



2.11 The rental value of land is not created by any individual land owner but by the collective activities ofall of us.

2.12 This rental value increases with the growth of civilisation and the greater efficiencies derived fromcombined human effort.

2.13 There are good economic as well as social and moral reasons for utilising this rental value to pay forpublic services that are otherwise funded from taxes that fall on producers (both labour and capital) and havea detrimental effect on the whole economy.

3. Overview

3.1 Taxes provide local and national Government with the income they need to finance public services.

3.2 A good tax system should be geared to impact on all individuals, businesses and society as a whole andnot favour or penalise any individuals or groups unfairly unless there is a good reason such as to reducedamaging behaviour that cause high levels of carbon emissions.

3.3 A good tax system must be considered in conjunction with the benefits of the services provided. Forexample, if a new public service adds to the income or capital value of a citizen or company by chance, thenit is incumbent upon the tax authority to create a tax system which directly collects this unearned bonus forthe benefit of all taxpayers and citizens. (eg the HS2 high speed train will increase land values in Birminghamand the other cities it will serve).

3.4 As well as providing a sustainable source of income to local and national Government, taxes should alsobe used to support and encourage economic growth whilst reducing or eliminating behaviour that is damagingto individuals, to the environment, to the economy and to society as a whole.

3.5 There are three factors involved in the public and private production of goods and services—labour

(mental and physical), capital (tools, machinery, infrastructure and buildings etc) and natural resources

(economically termed as land) and each receives an economic return in our market economy—wages to labour,profit to capital and rent to natural resources.

3.6 However, because natural resources are not created by human effort, the income their use generates(economic rent) goes as unearned income to their “owners”.

3.7 In the UK’s current tax system, there are specific taxes applied to labour and capital but there is not aclear natural resource wealth tax.

3.8 This paper argues that taxes on labour and capital are negative, distortionate and the greater they aretaxed the more damaging the impact is on the production of wealth.

3.9 Whereas a tax on the annual rental value of all natural resources such as oil, gas, airwaves etc and anannual Land Value Tax on all land will not only enable the Government to protect our land and naturalresources from waste but will also provide a sustainable source of income to pay for public services thatcaptures at least a part of the unearned economic benefit which is reflected in land values.


4.1 Local and national Government taxation should (i) provide a source of income to pay for good quality,efficient, affordable and accessible public services that benefit society; (ii) be a mechanism that stimulates aproductive and efficient economy and (iii) also acts as a tool to curb our misuse of natural resources whilstcollecting the full cost of pollution and environmental damage caused in the production and consumption ofgoods and services.

4.2 A good tax policy is one where all taxes levied are unavoidable; transparent; fair; easily understood bythose being taxed; simple to administer; keep the impact of social and economic costs to a minimum; helpcontrol and limit the use of natural resources; cause environmental damage to be reduced and the full cost ofenvironmental damage to be recovered; act as an incentive to encourage the growth of beneficial private andpublic goods and services; are used as a tool to redistribute income fairly to individuals and regions; do notcancel out the benefits of increased beneficial investment or increased work input or welfare benefits and donot distort business or trade unfairly amongst individuals, sectors, regions or nations.


5.1 Current business taxes distort business activity and are often one reason for a business closing or notexpanding to its full potential. For example, Value Added Tax (VAT) is unfair to small businesses that reachthe threshold and are then taxed on all income they generate including the part they were previously exemptedon, this can often be a barrier to growth. Many businesses will evade paying VAT either illegally throughhiding income and expenditure or legally by stopping their trade in quiet periods such as is seen with businessesdependent on seasonal tourism but who could afford to operate in the quieter periods if there were no VAT.



5.2 Good business taxes should act as an incentive to encourage investment in worthwhile business in allregions of the UK. Good infrastructure and good public services are essential to good business—well educatedand trained workforces; good accessible and affordable transport networks; good schools and excellent healthcare are all essential ingredients to a prosperous society. If investors are unable to profit from land speculation,they will invest in companies and businesses that create worthwhile products and services. This will in turnhelp create more employment.

5.3 New and existing infrastructure adds to land values. For example the Jubilee Line Extension on theLondon Underground system added £13 billion to land values in the catchment area.

5.4 Where sites remain derelict, unused or underused—because of land speculation or inefficiency—theowners still gain financially from the increased land values that our public services provide to their site’slocation even though those owners pay little or no taxes towards the cost of the public services from whichthey benefit.

5.5 Under the present system businesses pay twice. They pay the full economic rental value of the locationof their premises and taxes to the Government. If, instead of this rental value being collected by private landowners, the Government collects it as a tax applied to the annual rental value of each site according to itsoptimum permitted use, the Government could use this land value tax (LVT) income to reduce or replaceexisting taxes that hit business badly. Thus allowing businesses to pay once—not twice.

5.6 With LVT the land owner is given a financial incentive to bring their site into its full permitted use andthe user of the site will pay the land owner un-inflated rental value of the buildings they occupy. Premises willbe let or sold at their market value and not lay empty because of over-inflated prices due to property speculation.By increasing the supply of affordable premises, more businesses will be able to continue to exist and growand new businesses will be able to afford to start producing thus benefitting the economy, local communitiesand the environment.


6.1 Grants or subsidies given to support or develop businesses must go to the business intended and not beallowed to be diverted into land wealth and therefore go as unearned income to land owners. For example, theEuropean Common Agricultural Policy payments to farmers increase farm rents and farm prices so that CAPis paid to farmers but ultimately benefits farm land owners not the farmers unless they own the freehold.

6.2 Similarly if a policy is for local authorities to purchase land on which to build affordable homes, thatnew demand for land will inevitably increase the buying price that local authorities will eventually pay. Theresult is either fewer homes get built or local authorities will have to spend more to provide the new homes inorder to pay the land owner the asking price. If an annual Land Value Tax were applied to all land, landhoarding and property speculation could be eliminated and, because more land would then be made availablefor good use, the price could not be inflated soaking up the intended benefit for those needing to buy/renthomes in the relevant areas.


7.1 A great deal of consideration must be given to how a tax is imposed and collected on the grounds ofminimising the cost to the collector and the payer; overall efficiency; transparency and accountability; itsrelationship with the benefits systems; unavoidability and fairness to individuals and organisations. To haveresources invested in collecting negative taxes is a lost opportunity for the money and the skills and talents ofthe workers involved being used alternatively to benefit society. The more simple a system is, the moretransparent it is and the less cost there is in administering it both by the tax collecting body concerned and bythe business or organisation being taxed. For example, VAT, PAYE & Employers National Insurance demandspecific calculations and returns be made by businesses—an extra financial burden for businesses, particularlyfor self-employed people and small businesses.

7.2 A good tax should not be avoidable or evadable as is the case with most current taxes particularlyincome tax, national insurance, corporation tax, capital gains tax, inheritance tax and VAT. Keeping a taxsimple helps avoid loopholes that a clever accountant or solicitor will maximise for the benefit of their clients.The full cost of collecting and policing of taxes together with the cost to the person or organisation being taxedshould be fully calculated in any cost benefit analysis of a tax imposed.


8.1 By taxing incomes and profits without taxing the use of natural resources, there is an inbuilt distortionin our tax system. These taxes increase the cost of production or retail prices thus reducing output, reducinglabour input and diverting investment. For example, VAT particularly discriminates against smaller businesses;as the threshold is reached the tax is applied to all income for the business. The tax is added to the costs ofthe business and discriminates against them. To avoid paying VAT, businesses can limit their trading to belowthe threshold level or evade paying it by dishonest accounting; this behaviour can be found in areas dependenton seasonal trading and with self-employed or small businesses.



8.2 As taxes collected are spent on maintaining and improving public services, the demand for businessesand homes in the catchment areas of those services reflects back into land values and therefore land priceswhich create an unearned income or capital gain to land owners who contribute nothing to the economy.

8.3 Because land is not taxed on its annual rental value, taxes collected and provided as grants and subsidiesto assist businesses (eg subsidies paid to farmers through the Common Agricultural Policy) increase the surplusincome over production costs and therefore actually become subsumed in the price of land and therefore go tothe land owner and not the intended beneficiary.

8.4 There are many examples of land values funding public services overseas but in the UK the City ofLondon collects land rent from its tenants to fund services (City Cash) and charities (the Bridge House Fund);the previous Government auctioned the spectrum for 3G mobile phone use on a twenty year lease and weshould be collecting the rental value of landing slots at airports.

8.5 Currently, land owners pay no tax on empty sites. This encourages land hoarding and speculation creatingan artificial shortage of land where occupation is most desirable. Many sites are kept empty for decades. Theconsequences are not only higher land prices and location rents but people requiring homes and businesseshave to locate farther afield thus creating urban sprawl into the countryside. Not only does this incur all theextra infrastructure and other costs but families are disrupted as time spent commuting is increased, road deathsand injuries are increased and Co2 emissions are increased.

9. Conclusion

9.1 The introduction of an annual Land Value Tax will produce the following benefits:

9.1.1 A sustainable and rising source of Government income that is transparent, unavoidable and easyto collect—land cannot be taken to a tax haven.

9.1.2 Recognition that it is our demand for homes, public and private businesses and services whichcreate land values.

9.1.3 It will bring about a real redistribution of wealth on an individual and regional basis. Regions thatare depressed have lower land values and therefore will have lower LVT contributions becomingalmost like a “tax haven” attracting new investment and enterprises.

9.1.4 A more efficient use of land as idle and underused sites are brought into use.

9.1.5 Efficiencies of conglomeration as urban sprawl and unnecessary commuting are reduced becausetown and city sites and empty buildings are better used.

9.1.6 Fairness, as land is a free gift of nature and all of us through our work, enterprise, social andeconomic activities create land values, but currently these only benefit land owners.

9.1.7 LVT will ensure all land owners, who receive an unearned benefit from society, will contributetheir fair share of taxation to the exchequer in future.

9.1.8 The land wealth created by infrastructure investment will be recouped for future investment.

9.1.9 The reduction in other taxes in order to encourage enterprise in the economy.

9.1.10 With more land in use, more jobs would be created and more affordable homes built.

9.1.11 Investment would not be wasted on sterile land speculation that produces no real wealth; investorswill seek real investment in firms and companies providing worthwhile goods and services.

9.1.12 Because the payment reduces with lower land values, LVT would provide automatic compensationfor the owners of those sites which fall in value when they are disadvantaged by a newdevelopment such as noise from traffic or a nuclear power station.

9.1.13 LVT will rid communities of derelict sites and buildings that encourage anti-social behaviour.

January 2011

Written evidence submitted by Michael Learoyd


I have been interested in the principles of political economy for very many years and all my studies andobservations lead me to the principal conclusion set out below.

This memorandum puts forward very briefly the fundamental principle that should be adopted by anyhonest government.

2. The Key Principle which should Underlie Tax Policy

Tax as a charge that is collected for the service of government and official authorities should be what iscreated by the community as a whole. It should not be taken from those to whom it rightfully belongs unlessit is given as a gift.



The tax which I refer to and which is created by the community has been identified as Economic Rent. It isthe only resource which government can be entitled to use as a first resource. It is further referred to as LVT(Land Value Taxation) or LV (Location Value). It was spoken of as a Single Tax in the works of Henry George.

This Single Tax which embodies the principle of Economic Rent is the only legitimate source of governmentrevenue. Efforts should be made by government authorities to identify and quantify this legitimate resourcethat is created by the community as a whole. As this value in some measure resides in the value of land, allland should be valued and the rent collected from the user of the land. At present this value goes to the usersof the land but in truth it does not belong to them.

The challenge to the government and this committee is to take up the quantifying of this value in EconomicRent and collect it for the legitimate purposes appropriate to government.

It may seem to be a very radical change but it is very simple and would be the most simple tax to collectas it would be unavoidable. Once the principle is clear to all or at least a fundamental majority, it could bemoved towards in the certain knowledge that it is just, the only just tax, the only first source of revenuefor government.

There is of course much more that could be said, but I wish to raise before this committee that this must betheir principal area of study, the understanding of Economic Rent (as that which the community creates and isthe principal source of revenue for government responsibilities).

January 2011

Written evidence submitted by TheCityUK

About TheCityUK

The purpose of TheCityUK is to champion the international competitiveness of the financial services sectorand to promote the sector globally.

— Overseas—by promoting the UK in overseas markets as a world-class centre for financial services.

— At home—by working to increase understanding of, and ensure the effectiveness of, thecontribution that the financial services sector makes to the wider economy and society as a whole.

— In regulation and market access negotiations—by providing a voice for the sector and working toimprove access to overseas markets for UK firms.

TheCityUK’s strategic priorities are set by the Board of Directors, chaired by Stuart Popham, Senior Partnerat international law firm, Clifford Chance.

Oversight is provided by the Advisory Council, chaired by Sir Win Bischoff, Chairman of Lloyds BankingGroup.

1. Introduction and Executive Summary

1.1 TheCityUK welcomes the opportunity to submit views as part of the Treasury Select Committee Inquiry.The competitiveness of the UK tax regime has been identified by the TheCItyUK’s membership as a keypriority for the UK Financial Services Industry.

1.2 This is reflected in the recommendations of various industry reports in recent years, including theBischoff Reporti and the Wigley Reportii, both of which highlighted the significant role played by the taxationsystem in sending signals to foreign investors about the attractiveness of the UK as a place to do business.

1.3 TheCityUK welcomes the Coalition Government’s commitment to promoting the competitiveness of theUK tax system in a measured way reflecting the fiscal challenges currently facing the UK.

1.4 This submission has three sections including this introduction. The second section examines how UKtaxation impacts the business environment that financial services firms operate in, and assesses the impact ofthe current tax framework and recent changes in tax policy on the competitiveness of the UK as a location forFinancial Services firms to do business.

1.5 In the final section, the report identifies three specific priority areas for changes in tax policy whichcould substantially improve the business environment for the UK Financial Services sector, recover some ofthe recent loss in competitiveness of the UK, and in so doing support growth in Financial Services and thewider economy.

1.6 TheCityUK looks forward to working with the Select Committee throughout its enquiry. If the Committeehas any questions on this submission, or would like further evidence from TheCityUK, please contact HowardMiller, Director of UK Strategy.



2. Taxation and the Business Environment for UK Financial Services Firms

2.1 Taxation has been identified as one of the most important factors taken into consideration by FinancialServices firms when making investments, and affects firms’ decisions from locating particular teams, activitiesand businesses, through to the location for their European or global headquarters.

2.2 The significance of the taxation environment has been reflected in many studies into the competitivenessof the Financial Services industry, for example a recommendation of the Bischoff report was “to generatestrong engagement between the Government and the industry, in order to ensure that the UK tax system remainsstable, sustainable and competitive in the long term”.

2.3 Financial Services firms and employees are highly mobile, and choose to locate in jurisdictions whichare conducive to their business activities. Important considerations include the legal, regulatory and taxationsystem, openness to trade, immigration and foreign ownership, and a globally-connected communicationsinfrastructure.

2.4 This international mobility has allowed the growth of UK Financial Services into a global leader. TheUK environment of stable & competitive taxation has historically been extremely attractive to financial firmsand to the highly skilled financial services workforce. There are in fact a number of examples of unfavourabletaxation regimes elsewhere causing financial services activity to migrate to the UK, such as the establishmentof the Eurobond market in the UK in the 1960s in response to the US Interest Equalisation Tax.

2.5 Accordingly, the impact of UK tax policy on the Financial Services industry must be set in aninternational context. There are many countries that are seeking to emulate the UK’s success in building aleading financial services sector. These countries are engaged in a global “war of attraction” and are makingsubstantial investments, and reshaping their legal, regulatory and taxation environment in order to attractFinancial Services firms and employees.

2.6 Against this backdrop of increasing international competition for financial services investment, recentchanges to the UK tax regime have undermined the competitive position of the UK.

2.7 Speaking at the Deloitte Tax Directors Academy on 23 November 2010 David Gauke, the EconomicSecretary to the Treasury, commented that “If we look back to 1997, the UK had the tenth lowest main rate ofcorporation tax among the current EU27 countries. By the time we came to office, we’d slipped to 20th”. AsMr Gauke comments “Other countries had cut their rates further and faster than we had, with the UK’scompetitive advantage being slowly eroded away”.

2.8 In its Global Competitiveness Survey for 2010, the World Economic Forum ranks the UK 95th out of139 countries in its league table of the impact of taxation on incentives to work and invest.

3. Tax Policy Recommendations to Restore Competitiveness

3.1 TheCityUK has identified three areas of priority for changes in tax policy which can help to restore UKcompetitiveness, and enable the UK to continue to be an attractive location for investment by global financialservices firms. These priorities are to increase consultation and transparency, to remove disincentives oninvestment in SMEs, and to set out a road map for increasing UK tax competitiveness.

Increased consultation and transparency

3.2 The tax system must offer transparency so that taxpayers have certainty over what they are required topay in advance, to allow for proper financial planning, and to ensure that the government’s process of taxationis not seen to be arbitrary. UK tax policy has departed from this path on several fronts in recent years with alack of transparency and certainty in respect of changes to Capital Gains Tax, the taxation of non-domiciledworkers and the much debated levy on bank bonuses.

3.3 In a report prepared for the International Regulatory Strategy Groupiii, Charles River Associates assessesthe way in which the predictability and competitiveness of the UK tax regime impact upon the financial servicesindustry. The report concludes that “Whilst the scale of overall tax burden is a key consideration, it is clearfrom this report that our top priority must be to restore the perception of predictability and certainty that hasfor so long underpinned the UK tax regime”.

3.4 TheCityUK welcomes the approach taken by HM Treasury in assessing reform of corporate taxation.The pre-legislative consultation of tax professionals promises to be highly constructive in the development ofgood tax policy and in restoring trust between taxpayers and policymakers.

3.5 Whilst the approach taken to corporate taxation reform is a positive step, the Select Committee shouldbe aware that the investment decisions of Financial Services firms take all elements of taxation into account.Although the Financial Services sector makes the largest contribution to corporate tax receipts, personal andother taxes represents 90% of total taxation on the industryiv.

3.6 TheCityUK proposes that the consultative approach to reform of corporate taxation should be extendedby HM Treasury to all future reviews of taxation.



Remove disincentives for investment in small and medium sized enterprises (SMEs)

3.7 TheCityUK believes that increasing the access to finance for SMEs forms an important part of theGovernment’s growth agenda, and proposes the removal of barriers and disincentives to investment in SMEs,such as relaxing restrictions on the Venture Capital Trust (VCT) regime and allowing unlisted securities (eg,AIM and Plus-quoted markets) to be held in Individual Savings Accounts.

3.8 In its response to the joint HMT/ BIS Green Paper on “Financing a Private Sector Recovery”, the LondonStock Exchange Group observes that changes to the VCT regime in 2006 had a negative effect on investmentin SMEs. “These restrictions are putting artificial caps on growth as they may prevent businesses fromrecruiting more staff or expanding through acquisition because, in many cases, they become ineligible forinvestment by the VCT managers that have provided their initial funding.”

3.9 Other taxes on equity investment include Stamp Duty Reserve Tax, levied as 0.5% of the value of everypurchase of UK shares, and the withdrawal in 1997 of the right of Pension Funds to reclaim tax withheld onpayment of corporate dividends (Dividend Tax Credit). These taxes reduce returns for individual investors andpension funds investing in UK companies, and a large amount of research exists showing how their removalwould increase investment in UK companies, and reduce their cost of capital.

A road map for increasing UK tax competitiveness

3.10 By tax competitiveness we refer to both the overall level of taxation and to the complexity of the taxsystem. By both of these metrics, the direction of travel has been a worsening in competitiveness, with anincrease in personal and employment tax rates, and greater complexity such as the proposed pension reforms.

3.11 The CityUK welcomes more recent moves by the Government to address concerns over the need tosimplify the UK tax code. The work of the Office of Tax Simplification has revealed that there are over 1,000reliefs in the UK tax system adding to the complexity of tax administration and compliance. The Government’scommitment to assess the benefits of these reliefs and the streamline the tax system where possible is tobe welcomed.

3.12 Whilst the current fiscal environment may limit the scope for reductions in the overall level of taxationin the short-term, TheCityUK believes that Government should provide a clear road map for reducing theoverall tax burden as the economy and public sector finances recover. The road map should include acommitment to review the 50% rate of income tax in this Parliament.

3.13 Government and the corporate sector have a shared interest in stimulating economic growth. A firmcommitment to restoring UK tax competitiveness would be a significant step to creating a positive environmentfor business investment in the UK, forming the basis for future growth.

January 2011

References

Bischoff Report: UK International Financial Services—the Future, May 2009

Wigley Report: London: Winning in a Changing World—Review of the Competitiveness of London’s FinancialCentre, June 2008

Charles River Associates “Taxation of the Financial Services Industry: Predictability and Competitiveness”,October 2010

PwC, “The Total Tax Contribution of UK Financial Services, Third edition”, December 2010

Written evidence submitted by The Henry George Foundation of Great Britain


1.1 Central to the evidence presented here is the ethical principle not to steal. This principle lies at the coreof civilised economic behaviour and if it is not observed by a nation’s sovereign government the consequencesfor the nation and her people are bound to be bad.

1.2 Evidence is presented to show how existing tax policies involve the theft of private property fromindividuals and firms. It shows that this cannot be justified by necessity since there is an abundant source ofpublic revenue that only requires the collection of value that the community, as distinct from individuals andfirms, is responsible for.

1.3 Attention is drawn to ways in which existing taxes generally inhibit growth and undermine othergovernment policy goals and how the application of the principles advocated would avoid such difficulties.

1.4 Likewise the difficulties and inefficiencies associated with the collection of many existing taxes areshown to be corrosive of public morality and discredit government and civil authority.



1.5 The inability of existing taxes to avoid being a burden on the most economically vulnerable is societyi.e. marginal industries, occupations and areas, is identified as their most distorting aspect.

1.6 Recognising the difficulties associated with the immediate implementation of the radical reforms that aresuggested, practical recommendations are limited to some aimed at educating a new generation of economistsin the existence and relevance of natural law as it pertains to political economy.

1.7 It is further recommended that treasury economists evaluate and critique the approach to politicaleconomy and the raising of public revenue along the lines outlined in this submission. In the event that theprinciples advocated are not found to be invalid the Treasury should be required to prepare, or commission thepreparation of, an appropriate feasibility study. This would be aimed at identifying a brief for the phasing outof various existing taxes on production and replacing them with the collection of equivalent revenue fromlocation value rent.

2. Factual Information—Response to Questions from Treasury Committee

2.1 What are the key principles which should underlie tax policy?

2.1.1 Central to the evidence presented here is the ethical principle not to steal. This principle lies at thecore of civilised economic behaviour and if it is not observed by a nation’s sovereign government theconsequences for the nation and her people are bound to be bad.

2.1.2 The principle “not to steal” did not need to be invented by human ingenuity since it is inherent in thenature of man as a social creature. It is however necessary for human beings to acknowledge it and suchacknowledgement is a feature of the scriptures and laws of every known civilisation. Thus man-made law isrequired to respect and be in harmony with the nature of man and human society.

2.1.3 Implicit in the requirement not to steal is the concept of property, ie a recognition that some thingsmay become one’s own property whilst other things may belong to others or be held in common.

2.1.4 By nature each individual is endowed with life and a human body with physical, mental, emotionaland spiritual attributes and powers. Those attributes and powers are their own and whilst others may besimilarly endowed they are personal not common.

2.1.5 Human nature is such that man is obliged to use these powers in order to survive—he must work.Fortunately nature also provides something upon which, and with which, man may work and provide for hisneeds. The economic terms that refer to nature’s provision and man’s powers are “land” and “labour”.

2.1.6 What a man produces alone, by the exercise of his innate powers on land that is equally available toanybody, becomes quite naturally his property and to take it from him is theft.

2.1.7 Man however rarely works alone since nature has also endowed people with what we might call asocial instinct. Human families naturally tend to live in communities and in doing so enjoy additional valuedue to the benefits of association.

2.1.8 This is nurtured by yet another instinctive attribute—his propensity to exchange or trade. It is notnecessary for anyone to invent or foster exchange or trade it arises naturally with the recognition that bycooperating and specialising in certain aspects of production individuals can be more secure and better satisfytheir material, intellectual, emotional and spiritual needs.

2.1.9 With growth of population, settled communities, development, and specialisation, the provisions ofnature and the benefits of association cannot be made equally available to everyone. In particular land of equalquality that people need to occupy exclusively cannot be equally available to all.

2.1.10 The consequence of this natural phenomenon is that the exertions of those who occupy the betterlocations yield more for a given input of labour and or capital than those obliged to occupy inferior locations.

2.1.11 Recognising this, people are prepared to surrender some of the fruits of their exertions for the benefitand privilege of exclusive occupation of a better location. Thus the phenomenon of rent arises in everydeveloped community.

2.1.12 The obvious questions associated with this are, who creates location value? And, to whom is it due?

2.1.13 The answers are equally obvious—location value is created by the presence, protections and servicesprovided by the whole community and it is thus due to the whole community. It is thus a natural source ofpublic revenue that does not involve theft!

2.1.14 How much public revenue would collection of location value or rent yield?

2.1.15 If, as is conventional we refer to the return to labour and capital as their “earnings” we may note aprimary division of wealth between “rent” and “earnings”.

2.1.16 As we have noted, when communities are small and not concentrated, little or no rent arises. It thenconstitutes a small fraction of the value added by everybody’s labour and capital whilst earnings represent a



large share. As communities develop economically, rent naturally becomes an ever increasing fraction of thevalue generated whilst earnings, as a proportion (but not necessarily as an amount) naturally declines.

2.1.17 Thus as the need for public services increases so does the revenue to pay for them increase.

2.1.18 As we have noted above, the phenomenon of rent arises when people, recognising the advantages ofa better location are prepared to surrender some of the fruits of their exertions for the benefit of its exclusiveoccupation. How much they need to pay for such a privilege is determined by the competition they encounterfrom other likeminded prospective tenants (ie the market) and the relative advantage the location in questionenjoys compared with any site that may be occupied without payment (ie having nil rent).

2.1.19 How much they can afford to pay is influenced by how much of their earnings they are left with aftermeeting any other unavoidable outgoings. Taxes represent an important item here and it follows that the amountthat they and their competitors can afford to bid in rent is reduced by an amount at least equal to their currenttax burden. Other unavoidable outgoings would include any inflated prices they are obliged to pay to themonopoly suppliers of goods and services that they require, together with any losses they might suffer due totheft, fraud, corruption or waste, in their community.

2.1.20 From the above it is evident that, apart from any other advantages that might attend this method ofcollecting public revenue without theft or taxation, it could raise more public revenue than is currently collected.

2.1.21 In conclusion the key principles which should underlie tax policy should:

2.1.22 1. Ensure that theft is avoided

2.1.23 2. Ensure that all value produced by the community is collected as public revenue before any valueproduced by individuals or groups is taken

2.1.24 We may also mark how by achieving this through the collection of location value rent other wellknown principles of a good tax (identified first by Adam Smith and summarised by Henry George in Progressand Poverty) are satisfied including the following:

2.1.25 3. That it bear as lightly as possible upon production—so as least to check the increase of thegeneral fund from which taxes must be paid and the community maintained

2.1.26 4. That it be easily and cheaply collected, and fall as directly as may be upon the ultimate payers—so as to take from the people as little as possible in addition to what it yields the government

2.1.27 5. That it be certain—so as to give the least opportunity for tyranny or corruption on the part ofofficials, and the least temptation to lawbreaking and evasion on the part of the taxpayers

2.1.28 6. That it bear equally—so as to give no citizen an advantage or put any at a disadvantage, ascompared with others

2.2 How can tax policy best support growth?

2.2.1 Tax policy can best support beneficial economic growth by:

2.2.2 Encouraging the efficient production of wealth.

2.2.3 Discouraging negative economic activity.

2.3 To what extent should the tax system be structured to support other specific policy goals?

2.3.1 It is not reasonable to assume that a conflict should arise between the manner in which governmentraises public revenue and other policy goals. If such conflict arises it is more reasonable to assume that one orother, or both of the policy goals are faulty.

2.3.2 It is however easy to see how such an assumption can arise since it is clear that the current tax systemdoes not only fail to support other worthy policy goals it most definitely undermines them!

2.3.3 When employment is taxed as with income tax and national insurance contributions, employmentpolicy is undermined.

2.3.4 Likewise when production, trade, adding value, or capital are taxed industrial policy is undermined.

2.3.5 When labour is taxed and the use of labour saving, more energy intensive, and material demandingmethods of production are encouraged, energy and environmental policy goals are undermined.

2.3.6 When industries and businesses in areas where location values are relatively low are taxed at the samerate as where they are relatively high their disadvantage is magnified and their viability is compromised. Thisis critically important in connection with policies that affect national, regional and local land use planning andregulations, and international trade.

2.3.7 The tax system should be structured to support all worthy policy goals but the most important shouldbe that of ensuring the highest possible degree of security, justice and freedom to all UK citizens.



2.4 How much account should be taken of the ease and efficiency with which a particular tax can be imposedand collected?

2.4.1 The ease and efficiency with which a tax can be collected is very important indeed. If a tax is difficultto collect it will normally be because people are ready and able to avoid paying it.

2.4.2 People are generally ready to avoid taxes that they perceive to be unfair.

2.4.3 They are generally best able to avoid paying taxes that require them to admit to something can bekept secret.

2.4.4 Hence apart from the obvious costs of collection and losses due to failure to collect, taxes that aredifficult to collect are corrosive of public morality. They encourage people to deceive and lie. They makecriminals of people who would otherwise be law abiding and make other criminal activity less abhorrent.

2.4.5 They discredit government and civil authority.

2.4.6 They are responsible for diverting the energies of some of the finest talent in the nation into activitiesthat produce no wealth.

2.5 Are there aspects of the current tax system which are particularly distorting?

2.5.1 Aspects of the current tax system that are particularly distorting are those that inhibit the productionof wealth at the margins of productivity.

2.5.2 Every form of production is naturally marginal somewhere and in every competitive business there islabour and capital equipment employed that is marginal i.e. the value they add only just exceeds their cost.

2.5.3 By definition, production at the margin of productivity is barely viable, and any increase in productioncosts or reduction in revenue leads to failure.

2.5.4 Current taxes levied on production eg agriculture, manufacturing and trade, and on labour or on capitalstock or equipment are not able to distinguish between that which is marginal and that which is not.

2.5.5 Businesses, workers and capital equipment that would naturally be quite viable may be renderedunviable by such taxes.

2.5.6 Value that is not derived from production but from only a property right may be taxed without suchdistortion.

2.5.7 The value of property rights that derive from permissions and privileges conferred by the communityare not diminished by collection and neither is the use that can be made of them compromised.

2.5.8 In contrast where such value is not collected for the whole community but allowed to be retained orcollected by individuals they may be held out of optimum use for speculative purposes as is evident fromland speculation.

2.5.9 As a private asset such value also becomes collateral for private rather than public loans and securityfor the issue of privately issued money rather than government issued money.

3. Recommendations for Action

3.1 It will be clear to the reader that what has been recommended as the key principles which should underlietax policy, and the method by which it is suggested public revenue should be collected, call for the most radicalof changes in tax policy. Nothing less than the abandonment of virtually all existing taxes and their replacementby the collection of location value rent and other values that are created by government on behalf of thecommunity. Examples of the latter might include eg the value of operating licenses and monopoly privilegeswhere individuals and firms are currently able receive a benefit that does not correspond with the value theycreate. The collection of Location Value Rent (LVR) is not suggested as an additional or supplementary tax itis to be in replacement of all current taxes that are levied on production, trade, labour and capital.

3.2 It is recognised that this is unlikely to happen quickly, not least because of the profound impact it wouldhave on the value of assets that currently underpin the entire financial and monetary system. The fact thesesystems are, like the tax system, also in need of radical change, is hugely important. The privilege of beingallowed to create money that is virtually indistinguishable from that issued by government, that is effectivelybacked by government, but which is beyond government’s control is enormously valuable to the banks thatbenefit. The loss to public revenue opportunity is only part of that problem.

3.3 If it is assumed that immediate radical fiscal and monetary reform is not possible but that the principlesidentified are valid, the challenge becomes to prepare and plan for eventual implementation.



3.4 With this in mind the following recommendations are offered

3.5 Require that the curriculum for political economy and economics at A Level and at University Degreelevel be reviewed to include a full appreciation of the existence and relevance of natural law as it pertains topolitical economy.

3.6 Require that treasury economists likewise undergo a programme of continuing professional developmenttraining aimed at acquainting them with a full appreciation of the existence and relevance of natural law as itpertains to political economy.

3.7 Require that the Treasury be required to evaluate and critique the approach to political economy and theraising of public revenue as outlined in this submission.

3.8 In the event that the principles identified in this submission are not found to be invalid the Treasury berequired to prepare, or commission the preparation of, a feasibility study aimed at identifying a brief for aplanning study for the phasing out of various existing taxes on production, and replacing them with thecollection of equivalent revenue from location value rent.

January 2011

Written evidence submitted by ActionAid

Summary

1. In a globalised world, tax policy decisions made in one country can have a profound impact on others, aphenomenon most starkly illustrated by the impact on the UK and elsewhere of the harmful tax practices oftax havens. It is also the case that UK tax policy decisions can similarly have a positive or negative impact onother countries.

2. As a development agency, ActionAid is particularly concerned about the impact of UK tax policy ondeveloping countries. We believe that in certain, high-risk instances, an assessment of the development impactof tax policy decisions should play an important role in tax policymaking. Proposed reforms to the controlledforeign companies regime, which affects UK resident multinational firms, is a current example of such a high-risk area.

Background

3. ActionAid believes that private sector-driven wealth creation which is pro-poor, equitable and low carbonis one of the bedrocks of development. Taxation is essential to ensuring that the development benefits of thatwealth creation are fully realised through the provision of the public services needed to alleviate poverty; anadequately resourced state is also an essential enabling factor for economic growth.

4. Developed countries raise at least 30% of their national wealth in tax, with remarkable consensus on thisapproximate level across the political spectrum, yet many developing countries don’t reach even 15%. If low-income countries are eventually to reduce their dependence on aid as a part of their public revenues, this needsto change.

5. The UK government has been at the forefront of efforts to increase “domestic resource mobilisation”,through the provision of bilateral funds and technical assistance to countries such as Rwanda, where revenuegeneration increased fourfold over a 10 year period. Recent DFID funding for research through the InternationalTax and Development Centre, in which ActionAid is a partner, will ensure that DFID continues to lead onthis agenda.

6. One aspect of the ITDC’s research agenda is to study the mechanisms through which multinationalcompanies can be taxed more effectively in developing countries, including by clamping down on internationaltax avoidance. This is an issue on which it is harder for developing countries to act in isolation, and UK taxpolicy can help or hinder developing countries’ own efforts.

Tax Avoidance and Multinational Companies

7. UK-owned companies are major investors in developing countries, with investments of £30 billion, withearnings remitted to the UK of £3 billion, in Africa alone.46 The tax revenues on these companies’ earningsin developing countries, raised through a combination of corporate income tax and withholding tax on cross-border transactions, make a significant contribution to funding for poverty alleviation in those countries. InGhana, for example, one pound in seven of tax revenue comes from corporate taxation, mostly from largetaxpayers including subsidiaries of UK multinationals.

8. ActionAid’s recent report Calling Time: Why SABMiller should stop dodging taxes in Africa (enclosed)illustrated the difficulties faced by developing countries in taxing multinationals effectively. OECD transferpricing guidelines permit companies to make large payments—with the result of shifting profits—fromdeveloping country subsidiaries where genuine economic activity is taking place to companies based in tax46 ONS, Foreign Direct Investment Statistical Bulletin 2009 http://www.statistics.gov.uk/pdfdir/fdi1210.pdf



havens. In the case of SABMiller, these included royalty payments for the use of trademarks, management andservices fees, procurement payments and interest on loans from a sister company which in turn were treatedas tax deductible.

9. The overall impact of the large outflows from subsidiaries in developing countries is that their tax receiptsare dramatically diminished. The net effect of the outflows from SABMiller’s Ghanaian brewing subsidiary in2008 and 2009 was an overall pre-tax loss. ActionAid estimates that royalties, management fees, and lossesfrom other tax haven payments by SABMiller’s subsidiaries in Africa and India resulted in a total tax loss togovernments in those countries of £20 million, equivalent in Africa to almost one-fifth of the company’sestimated tax bill.

Case Study: UK Controlled Foreign Company Rules

10. Because UK companies’ income from their foreign subsidiaries is only taxed when it is remitted backto the UK, controlled foreign company (CFC) rules are employed by the UK to prevent companies fromavoiding tax by failing to remit, or delaying the remittance of, profits that have been shifted to tax havens.CFC rules deem the income and profits of tax haven subsidiaries to have been earned by the UK parentcompany or other major shareholders unless certain exemption criteria are met.

11. The current UK CFC rules offer some protection to developing countries from tax avoidance by UK-based multinationals. Tax avoidance techniques such as those employed by SABMiller are more difficult andless lucrative as a result; broadly speaking, it is necessary to show some real economic activity underlyingsome corporate structures that employ tax havens. Because developing countries’ legislation and enforcementcapacity on transfer pricing and thin capitalisation are not as comprehensive as those of the UK, the effect ofUK CFC rules is to reduce the incentive to implement some tax avoidance strategies that may otherwise bepermissible in developing countries.

12. Changes proposed by the Treasury and currently under consultation (in particular the proposed IntraGroup Activities Exemption, Non-UK Intellectual Property Exemption and partial finance company exemption)are designed to restrict the effect of CFC rules so that they apply only to arrangements with an impact on UKtax. ActionAid is concerned that these changes will make it significantly easier for developing countries toavoid tax in developing countries.

Recommendation: Development Impact Assessments

13. The committee asks two questions of particular relevance to ActionAid’s analysis in its call for evidence:

— What are the key principles which should underlie tax policy?


14. ActionAid believes that UK tax policy should be consistent with the UK’s development priorities, whichinclude promoting the mobilisation of domestic resources through taxation in developing countries. The taxsystem should be structured so as not to create incentives for tax avoidance in developing countries bymultinational companies that are UK taxpayers.

15. Specifically, we believe that high-risk changes to tax policy such as the proposed changes to the CFCregime should be accompanied by a development impact assessment to analyse the extent to which tax revenuesin developing countries might be impacted, along with recommendations for mitigation if the impact isnegative.

January 2011

Written evidence submitted by the Law Society of England and Wales

1. The Society is pleased to be asked to comment on the Mirrlees Review, a detailed consideration of theeconomic theory and evidence on which a tax system operating in the 21st century should be based. TheReview contains many ideas and points of discussion. It is still at a draft stage and will not be finalised untilthe spring. The Society has therefore restricted our comments to a few key areas and our comments can, atthis stage, only be very general. The Society would be happy to assist with any development of MirrleesReview proposals in the future.

2. The Society should also like to take the opportunity to say that many improvements to the UK tax systemcan be made in advance of structural reforms of the type proposed by Mirrlees. The Society has previouslymade a number of suggestions to improve tax law and would urge that these also receive consideration.47

47 Law Society Tax Good Governance and Better Law Making—a manifesto for improving tax law (2010).



Introduction

3. The Mirrlees Review states that:

“By international standards, the UK system has fewer loopholes and opportunities for avoidance thansome. For most people, for most of the time, the tax system works: it is not overtly intrusive and doesnot require vast effort to comply.”48

4. The Society would urge the Government to keep these comments in mind when proposing substantialreforms or adjustments. In our experience, it is ill-thought out policies which cause the most difficultiesexperienced by taxpayers and their advisers, particularly so when policy is made and then reversed.

Taxation of Earnings

5. The Society agrees with the arguments put forward in the Mirrlees Review that the case for some formof integration of income tax and national insurance contributions (NICs) has become overwhelming.

6. As identified in the Review, the advantages of integration would be increased administrative simplicityand transparency in the UK tax system and consequently reduced compliance and collection costs. Completeintegration would inevitably result in an increase in the “headline” rate of income tax and could thereforeexpect to be unpopular with the electorate. This would be particularly so given the general attachment to the“contributory principle”—the widespread belief that there is a link between the payment of NICs and statebenefits received—albeit that that link is virtually broken.

7. As an alternative, a more limited reform could be accomplished by aligning the tax bases of income taxand NICs.

8. The treatment of state pensions, which are currently exempt from NICs, could be a particularlycontroversial area since those in receipt could well argue that such pensions should be received free of the NICelement of the merged tax as the pension had been “paid for” during working life. The Mirrlees solution—ofan intermediate tax rate for such income—seems sensible at first blush, but rates might have to be low. A highrate could be seen as imposing disincentives on saving for retirement.

9. A difficult question remains with regard to the treatment of employers NICs since the rate rise requiredto transfer the burden of this element of NICs to employees might be too high. Mirrlees considers a separateemployer tax as a solution but notes that this would be distortive as it would only apply to employment income.These distortions can already be seen in the current system where businesses can reduce employer NICs by,for example, re-structuring as a partnership. (Partners are usually self-employed for NICs purposes so noemployers NICs are payable in respect of the individual partner’s profit shares.) Such distortions would eitherhave to be accepted or additional taxes introduced on self-employed income and, possibly, returns on capital.

10. The Society considers that the Mirrlees proposals for a single integrated benefit, eliminating the highmarginal tax rates (90% or more on low earners) and ending the current practice of tapering personal allowanceshave some merit. Any revision to the present system would, of course, create “winners” and “losers”.

Reforming the Taxation of Saving

11. The Mirrlees Review considers a number of economic models of saving and proposes, inter alia:

— Taking bank and building society accounts out of tax altogether.

— Introducing a rate of return allowance (RRA) for substantial holdings of risky assets.

— Taxing capital income and capital gains above the RRA at the same rate as earned income withreduced rates for dividends and capital gains on shares to reflect corporation tax already paid.

— Maintaining the current system of pensions taxation but ending employers exemptions from NICson pension contributions and replacing the tax free lump sum.

— Introducing a comprehensive lifetime wealth transfer tax.

12. The Society is not able to comment on the pros and cons of these proposals from an economicperspective, although the Society assumes some level of saving for some purposes (eg retirement) should beencouraged, as should investment that will lead to economic growth. Whatever the economic rationale, theSociety recommends that any reforms should be both simple to implement and easily understood by saversand investors. It should also be straightforward for investors to comply with their obligations and for the taxauthorities to monitor compliance. Any reforms should be for the long-term as the set up and withdrawal ofallowances in quick succession undermines investor confidence and discourages take-up.

Tax on Land and Property

13. The proposals here are perhaps the most radical in the whole of the Mirrlees Review involving theabolition of Stamp Duty Land Tax (SDLT), reform of Council Tax and the creation of new taxes—a housingservices tax on domestic property and a land value tax for business property. Perhaps unsurprisingly the Societyurges caution here. The Society would prefer that Government undertakes to remedy some of the obvious flaws48 Mirrlees Review “Tax By Design” Chapter 1 page 8.



in existing systems—for example the “slab” rate structure for SDLT—rather than engage in wholesalereplacement of taxes.

Corporate Taxes

14. The policy questions behind corporate taxes are well known. Should companies be taxed at all? If so,should taxes be based on corporate profits or on turnover? How should taxes on companies and shareholdersbe integrated? Again these are not issues where the Society can usefully add to the discussion in the MirrleesReview. The Society does, however, have some comments on the Mirrlees Review proposals for theintroduction of an Allowance for Corporate Equity (ACE).

15. ACE is intended to level the playing field between borrowing, retained profits and equity finance byproviding a tax deduction for the cost of equity finance. It was first proposed for the UK 20 years ago49

although there seems to have been little appetite for its adoption.

16. It seems to be commonly agreed that ACE systems reduce the corporate tax take because they narrowthe tax base. Indeed the Mirrlees Review states that the introduction of ACE would “almost certainly”50 resultin lower corporate tax revenues. Any Government which decided to introduce this system would need toconsider whether it intended to re-coup this revenue loss from the corporate sector. The Society would commenthere that international groups in particular have generally been hostile to real, or perceived, unfavorable taxchanges. This has been aptly demonstrated in the recent years by the high profile departures of internationalheadquarter companies from the UK in the light of the discussions surrounding the reform of the taxation offoreign profits.

17. The Society believes that a number of countries have tried ACE-like systems. Some have then abandonedthem although the Society understands Belgium currently permits Belgian companies to calculate a deductible“notional interest” expense based on the company’s aggregate equity amount as determined from the company’saccounts. The Society notes that the European Commission opened infringement proceedings against Belgiumin 2009 on the basis that this notional interest regime violates the free movement of capital because it does notpermit deductions in relation to foreign branches or foreign real estate.

18. If the UK were to go down the ACE route, policy makers would need to decide whether they wanted toimplement a full or partial system as well as cope with the restrictions imposed on its structure by EU law. Itis possible, for example, that a system providing a tax deduction for dividend payments and other distributionsmight achieve at least some of the objectives claimed by ACE more simply. Transitional issues would need tobe addressed—for example, would ACE apply to existing equity or only that created after introduction? Howwould group shareholdings be treated? The interaction with the UK’s Substantial Shareholding Exemption(SSE) would need to be considered, as would the taxation of international groups and the use of funds raisedto finance overseas acquisitions and businesses.

19. The ACE system envisaged by the Mirrlees Review appears to contemplate distinct rules for debt andequity and would therefore encounter difficulties in determining the correct tax treatment of “hybrid”instruments which have characteristics of both debt and equity. A deduction or an allowance for the cost ofcorporate capital might have to be considered to alleviate such issues.

20. Finally, the introduction of ACE into the UK would only have the full advantages hoped for by theMirrlees Review if the tax treatment for shareholders of debt interest, dividend income and returns on capitalwere equalized. This would necessarily require radical reform of the taxation of personal income and gains.

VAT

21. The Mirrlees Review recommends removing nearly all exemptions (such as on financial services), zerorating (such as on childrens clothes) and reduced rating (such as on domestic fuel) and compensating thosewho lose out through the tax and benefits system. Such a change may be controversial.

22. The UK’s current willingness to zero rate or exempt entirely from VAT certain goods and services raisesdifficult boundary issues—the Jaffa Cake dispute is a notorious example. Removing exemptions andstandardizing rates (as permitted by EU law) will reduce these issues but will increase the number of collectionpoints—the times at which VAT must be charged and may be re-claimed. VAT will remain a complicated taxto administer and HMRC’s administration and compliance systems must be fully prepared for the increasedworkload produced by any extensions in scope.

23. The Society is pleased that the Mirrlees Review acknowledges the practical difficulties in imposing VATon financial and insurance services. Given that removal of this exemption would require change in Europeanlaw and international co-ordination the Society awaits more detailed proposals before commenting on thisaspect of the Review.

24. The Society notes that the European Commission has independently launched a wide-ranging review ofthe VAT system51 and raised similar questions. The Society is mindful of the pressure on Member States’49 By the IFS Capital Taxes Group in 1991.50 Op cit Chapter 18 page 20.51 The Future of VAT: Towards a simpler, more robust and efficient VAT system (2/12/2010).



exchequers and suggest that to obtain agreement of all member States to radical changes to the VAT systemmay prove challenging.

January 2011

Written evidence submitted by the Systemic Fiscal Reform Group

1. The Systemic Fiscal Reform Group was formed in Cambridge in 2008 by a small group of individualsled by Dr Adrian Wrigley. Operating as a “think tank”, we study the systems of taxation, money, subsidy andwelfare as they operate in practice as well as the political economy behind them. We develop and advocatereforms we believe can be implemented by governments around the globe to improve living standards whilereducing environmental damage.

2. Dr Adrian Wrigley is an entrepreneur trained in natural, engineering and computer sciences. Now workingas a financial trader, he promotes a scientific understanding of the fiscal system as a whole with a view toestablishing a new reform agenda. He is the principal author of this evidence.

Executive Summary

3. Historically, tax policy appears to have been based on the principle of serving powerful interest groups atthe expense of the public interest. The adverse consequences of this include damage to the economy, politicalintegrity and public well-being. These worsen over time as the private interest embed themselves in the politicalsystem expanding their power until serious failures become apparent.

4. Reform of the tax system has become imperative, moving from the present system of taxation for privateinterests to one where the public interest is served instead. Achieving this is only possible if the fundamentalprinciples of tax policy and its path to reform are based both on economic and political realities. Most existingcomponents of the tax system are neither necessary, nor fit for serving the public. They should be consideredobsolescent and rapidly phased out.

5. The modern tax system is based around the repayment of privately created debt money. This is transferredthrough the banking system mainly from economic producers according to the market value of their productionor labour. The direct effect of this choice is twofold. Firstly, the suppression of productive economic activity.Secondly, the promotion of the banking interests which operate a cartel setting the terms and conditions forissuing fresh debt money needed for public spending and payment of taxes. Unemployment, poverty, debtbubbles, poor public services and inflation are the follow-on consequences.

6. Legitimate government spending generally provides infrastructure, services and welfare payments toresident people and businesses. To benefit from this government spending, a person must own or rent a homeor operate a business in the area. The monthly amount people pay to occupy their homes is set in themarketplace, based upon location and the value of natural, commercial and government amenities provided.Landlords charge monthly for these location amenities while home sellers charge a lump sum.

7. Public interest is harmed greatly by two aspects of the tax system. Firstly the granting the power to issuethe the money to pay taxes (the medium of taxation) to a private banking cartel. Secondly the collection ofthe tax according to production contributed rather then benefit conferred to the ultimate beneficiaries, theland/homeowners.

8. Reform of the tax system will be unsuccessful unless based on sound economics and sound politics.Economics dictates the abandonment of the ill-defined “Ability to Pay” principle in favour of the “BenefitPrinciple”, recognising that the benefits of legitimate government accrue to land/home owners and thosecontrolling natural resources. Politics dictates that proposals creating many obvious losers cannot beimplemented

9. The Systemic Fiscal Reform Group recommends a fundamentally new approach to reforming the taxsystem—elective reform. Taxpayers should have the right to opt out of the current system into a new systemdesigned around sound principles.

10. Allowing people to switch out of the harmful tax system for a much sounder, simpler system would allowthe economy to recover rapidly solving the toughest financial, human, environmental and economic challenges.

Principles of Tax Policy are Economic and Political

11. National success can only be sustained with a sound system of taxation. Sound taxation must be basedon policy principles thoroughly understood by those empowered to maintain it. These must be based on anunderstanding of the economic principles underlying taxation. Equally important is an understanding of thepolitical principles behind taxation.

Understanding Taxation

12. Taxation is central to the interests of every citizen, business and special group. Each group has its owneconomic interests and perspective foremost when it analyses the economy and promotes a particular viewpoint.



Politicians, economists and business people rarely promote analysis which conflicts with their group interests.Clarity and analytical integrity generally work against private interests and are usually absent.

13. In this response, it is assumed The Committee is seeking to further the public interest, even where thismay conflict with the private interests which usually dominate the analysis and debate. This will pose a majorchallenge to those who have learned their analysis exclusively through channels devoted to promoting privateinterests, and must “unlearn” erroneous but pervasive assumptions and principles.

What are the Economic Principles of Taxation?

14. Taxation is at the economic core wherever government supplies significant services such as civil andmilitary protection of property rights, infrastructure, education or healthcare. The UK is no exception.

15. Taxation comprises three fundamental economic parts:

— Creation of the medium of taxation and issue into the economy

— Distribution of the medium of taxation through the economy

— Collection of the medium of taxation

The Medium of Taxation

16. Over the course of history, the medium of taxation has changed several times. Under the earliest systems,taxation was paid in cattle, later moving to grain—generally rice or wheat (tithe systems) or labour (corvéesystems). Whenever payments moved to metal tokens issued by the rulers, a money system was born. Thesetokens were usually made out of scarce and distinctive metals to prevent counterfeiting—silver, sometimesgold. The tokens would move through the economy through economic exchange, but would be demanded backby the rulers as the means of collecting taxes. Wooden tally sticks were the most successful English taxmedium. The public demand of tokens to pay taxation ensures a sustained demand and maintains their exchangevalue across the economy.

17. Modern taxation systems are still based around the creation, distribution and collection of tokens, butthe tokens now take electronic rather than physical form. These tokens are bookkeeping entries in the bankingsystem. The structure of the taxation system and the economy it controls is determined by the rules underwhich these electronic bookkeeping tokens are created, distributed and collected. Coins and notes are stillissued in small quantity, but are subsidiary to to the banking system’s bookkeeping entries.

18. The economic power of the tax system is determined both by how and where in the economy the mediumof taxation is created and where and how the medium is collected.

19. Contemporary governments grant the exclusive power to issue the medium of taxation to a statesanctioned banking cartel. The banking cartel comprises a central bank and private member banks. The centralbank is responsible for price fixing, information sharing, promoting member interests and preventing memberdefaults. Serving the public interest is not a primary goal of a central bank. The cartel holds the exclusivepower to set the price of and issue the medium of taxation. Governments generally prohibit the issue ofalternative media for exchange and mandate payments of taxes only in the cartel-issued medium.

20. The collection of the medium of taxation is under direct government control. Most tax is collectedwhenever economic production takes place. This places a burden on producers, who must acquire the mediumof taxation directly or indirectly from the private banking cartel. The economic effect of taxation is dependenton the rules for calculating the amount of tax which is paid, regardless of who the tax is collected from.Usually, the person from whom the tax is collected can pass the burden of acquiring the medium on to others,generally by paying less for economic inputs, but sometimes by charging more for economic outputs.

21. The spending power derived from taxation is shared between the government and the private bankingcartel. This spending power is transmitted through the economy by banking cartel to their favoured associates,and by the government and their favoured associates. The system is effectively one of dual sovereignty sincethe sovereign powers of tax collecting and the corresponding issue of money is shared between the governmentand the banking cartel. This is the most distorting aspect of tax policy.

Change the Medium of Taxation

22. The spending power derived from taxation should accrue wholly to the government, and not be sharedwith the private banking cartel. The only satisfactory ways of achieving the involve abandoning the collectionof taxes through the medium of money created by fractional reserve lending. Taxation defines and underpinsthe money system.

23. Principle: Taxes should only be payable in government issued money:

— Money should be issued into circulation exclusively by the government when it pays wages,suppliers, pensions and welfare.

— Money should be withdrawn from circulation by the government when taxpayers pay taxes.

— Money created by private businesses should no longer be accepted in payment of taxes.



Introduce Free Markets, Abandon Production Penalties

24. Principle: Taxation should not interfere with free markets in labour, goods and services.

25. The following taxes depend on economic production and therefore act as production penalties: IncomeTax, National Insurance, VAT, Corporation Tax, CGT, Stamp Duties.

26. By design, they impair the free exchange of labour, goods and/or services. They conflict with the aboveprinciple. They have no role in any sound tax system, and constitute major distortions in the economy. Harmfuland unnecessary, they should be phased out.

Charging the Beneficiary

27. Businesses generally charge each customer a market price for the supply of goods or services whichbenefit that customer. The market price balances the overall forces of supply and demand. The governmentshould use the same principle for taxation. Understanding the nature of “the customer” is a central issue.

28. The legitimate “customers” of government activity are the owners of houses and land in the areagoverned. The owners of houses benefit from nearby roads, schools, hospitals, parks, police, flood defences.The owners are the ultimate beneficiary whether or not the house is owner-occupied or let to tenants. Peoplerenting property may receive these amenities, but pay for their value in their rent. Renters should not pay taxtowards these amenities in addition to paying rent for them as at present.

29. Principle: Taxation should only be levied on the ultimate beneficiaries of government, in particular,owners of land and houses.

30. An alternative principle is sometimes advocated, that of “ability to pay”. Superficially attractive, thisconcept is entirely without merit. The ultimate burden of tax is transmitted through the economy so thesuppliers of economic inputs whereupon the ability to pay cannot be measured for taxation. Whenever taxexceeds the ability to pay production is lost or transfers to the black market.

31. Where the government confers a benefit exceeding the tax paid for the benefit, an implicit subsidy exists.Implicit and explicit private subsidies tend to undermine the public interest goals of tax policy and should tobe avoided.

32. Principle: Taxation should be levied for the full market value of the benefit conferred by government, soavoid implicit subsidies.

Welfare Payments must be Considered with Tax

33. Principle: The welfare system should be fully integrated with tax.

34. The welfare system functions in ways similar to the tax system, but with the financial flows reversed.While taxes like Income Tax act as production penalties, welfare payments such as Jobseeker’s Allowancefunction as idleness rewards. Means tested welfare payments reward profligacy, penalise saving. There is norole for rewarding idleness in a sound tax and welfare system. Means tests induce fraud and bureaucracy whiledisempowering citizens.

35. Principle: Means-tests and employment tests should not be part of policy.

36. The consequence of excluding means tests and employment tests is that any welfare payments shouldbe made equally to all persons. This concept has been developed by welfare reform advocates who call it a“Citizens’ Income”, or a “Citizens’ Dividend”. It is a universal welfare comparable to universal healthcare oruniversal school education.

37. Principle: A universal “Citizens’ Dividend” should be paid equally to all.

38. Such a Citizens’ Dividend does not distort economic incentives because it is independent of any changesto economic behaviour. It neither rewards nor penalises economic activity, nor does it reward any particularfamily structure. It empowers ordinary people facilitating their investment in study, business or family life. Itimproves negotiating power with employers, and eliminates the need for a statutory minimum wage.

39. A Citizens’ Dividend is exactly analogous to the dividends paid to shareholders of a business. In thiscase, it is the return to citizens as shareholders in society. It is paid for entirely from payments made by thebeneficiaries of government amenities and services.

Political Reality must be Fundamental to Tax Policy

40. Countless efforts at tax reform have been attempted across the globe. Each has been guided by principlesand political pragmatics. The result has been a dramatic increase in the complexity of tax and welfare systemsto the point where ordinary people cannot understand it. Even top experts consistently fail to predict how taxrevenues, welfare payments will develop over time. Individuals generally have mistaken concepts about howmuch they pay, how much they are entitled to and how proposals would affect them.



41. Because people are generally mistaken about the impacts of policy changes, any reforms proposalsquickly produce anxiety and opposition, while vested interests stoke deliberately confusion and misdirectpolitical opinion.

42. Proposals like Land Value Taxation (LVT) have been discussed for many decades, but failed to overcomethe political difficulties and obstacles presented by the vested interests.

43. Tax complexity has become a major problem to deal with, but attempts to simplify the system haveconsistently failed. A new approach to tax and welfare reform is essential.

44. A tax and welfare system based around the fundamental principles here is very simple. Money is spentinto circulation by government for the supply of services to property owners. Money is collected from propertyowners according to the full monthly amenity value of the site locations. The surplus is distributed as a dividendto citizens on an equal per-capita basis.

45. Principle: Changes to existing tax policy create instability, confusion, political uncertainty, financial riskand must be minimised.

46. The transition of the tax system to one based on these fundamental principles must avoid creatingeconomic and financial turbulence. It must avoid giving out big windfalls at public expense. And it must avoidcreating losers and people who believe they are losers.

47. The new principle of tax reform is the creation of a right to opt in to a new system of taxation andwelfare. People should not receive a big windfall from the public when they choose to join the new systemand leave the old. As people leave the old system, it will become clear to all that the new system is superior,and in consequence the transition can be rapid. This principle overcomes political barriers.

48. It will not be usually be possible for a person to leave the entirety of the old system in a single step.The transition involves contracting with government not to pay particular types of tax in exchange for acceptingan equivalent burden.

49. Payments from property owners should be regular, index linked to market values and based upon contractlaw, not on politically determined tax laws. Payments are independent of legal residence or personality.Citizens, corporations, non-domiciles are treated equally, removing a major cause of distortion and complexity.Establishing such payment contracts should be voluntary act which releases the person from defined obligationsunder the old system.

50. The Systemic Fiscal Reform Group calls these payment obligations on property “Location ValueCovenants” (LVCs), which are legal covenants running with the land. They obligate the owner to paygovernment a defined perpetual revenue stream.

Recommendations

51. We recommend the Committee:

— investigates the principles and implementation of Location Value Covenants;

— investigates the impact of private money issue in the tax system;

— investigates the Citizens' Dividend as an alternative to welfare payments;

— makes public interest the sole determinant of tax principles and rejects the advice of vested interestsin the financial, real estate and accounting industries;

— declares the present tax system to be not fit for purpose and beyond repair; and

— adopts the principles contained here for transitioning to a new system.

Conclusion

52. Development of the tax system has been constrained by political reality and driven by the demands ofvested interests in finance and real estate. The fundamental principles of tax policy should explicitly incorporatethe money system and the welfare system. The tax system is not fit for purpose and is beyond repair. It shouldbe replaced by an efficient, neutral and distortion-free system based around clearly defined recurrent paymentsfrom owners of land, immovable property and natural resources based on contract law. Means-tested welfareshould be replaced by a Citizens’ Dividend distributing the financial surpluses of government arising fromsuch reforms.

53. The transition to a new, principled tax system should be on an “opt-in” basis where people can chooseto permanently leave the old system when they can benefit from so doing. The effect of such a transition wouldbe an rapid and dramatic revival in economic performance without battling political headwinds.



54. The principles outlined here fully meet all the objectives of the OECD tax report and the MirrleesReview. They meet Smith’s canons of taxation and adhere to orthodox and common heterodox academicanalysis. They are comprehensible and achievable.

January 2011

Written evidence submitted by the Institute of Chartered Accountants in England and Wales (ICAEW)

Introduction

1. The Treasury Committee launched an Inquiry on 24 November 2010 into the fundamental principles oftax policy. The call for evidence refers to the publication of recent detailed reports into the fundamentals oftax policy by both the OECD and Institute for Fiscal Studies (IFS). Reference is also made to the publicationof the list of over 1,000 tax reliefs published by the Office for Tax Simplification (OTS).

2. The Committee has invited written evidence on the following five questions:




4. How much account should be taken of the ease and efficiency with which a particular tax can beimposed and collected?


3. We have set out below our comments on these questions. As part of our response to question 1, we havealso set out some comments on the OECD and IFS reports and, in our response to question 2, we have alsoreferred to the work of the OTS.

Who We Are

4. The Institute of Chartered Accountants in England and Wales (ICAEW) operates under a Royal Charter,working in the public interest. Its regulation of its members, in particular its responsibilities in respect ofauditors, is overseen by the Financial Reporting Council. As a world leading professional accountancy body,ICAEW provides leadership and practical support to over 136,000 members in more than 160 countries,working with governments, regulators and industry in order to ensure the highest standards are maintained.The ICAEW is a founding member of the Global Accounting Alliance with over 775,000 members worldwide.The Tax Faculty is the focus for tax within ICAEW.

Executive Summary

Question 1—What are the key principles that should underlie tax policy?

5. In 1999 we identified ten principles that provide a framework for evaluating the tax system and we haveused them subsequently to evaluate tax policy changes. Our key principles are that the tax system should be:certain in operation with changes kept to a minimum; simple and understandable; easy to collect and tocalculate; fair and reasonable; statutorily based, properly targeted and subject to parliamentary scrutiny andproper consultation; it should be regularly reviewed and competitive so as to encourage investment.

6. A good tax system also needs to be administered efficiently and effectively. This is subject to a separateTreasury Sub-Committee Inquiry but we are very concerned that HMRC’s efficiency and effectiveness havefallen and that they need to be improved.

7. The OECD and IFS Mirrlees reviews are valuable contributions to the debate on what is the best taxpolicy. Tax policy should be broadly based with reasonable tax rates and reliefs kept to a minimum. The OCEDsuggest moving towards increasing taxes on consumption and residential property taxes and reducing incometaxes and corporation tax, but in the current climate we do not think this would be right approach for the UK.

Question 2—How can tax policy best support growth?

8. The tax system should be competitive, fair and reasonable and not subject to constant change. Tax policyshould be decided at an early stage and major changes kept to a minimum.

9. There should be a review of the tax and administrative burdens on businesses that hinder growth byreference to the life cycle of a business and the pressure points that arise.

Question 3—To what extent should the tax system be structured to support other specific policy goals?

10. The tax system should be designed to raise revenue efficiently to fund spending requirements. Using thetax system to support other policy goals is at best problematic and may result in unexpected behaviouralchanges and prejudice revenue flows.



11. Where specific policies are adopted in order to change behaviours, there should be post implementationcost/benefits reviews and greater use made of “sunset” clauses.

Question 4—How much account should be taken of the ease and efficiency with which a particular tax canbe imposed and collected?

12. Ease and efficiency of collection are an important part of the design process and there should be greaterconsultation at an earlier stage into the likely admin burdens and compliance costs incurred by taxpayers, theiradvisers and HMRC.

13. Tax policy changes should be evaluated against specific cost/benefit criteria and if the policy fails thecriteria it should be rejected or modified.

Question 5—Are there aspects of the current tax system which are particularly distorting?

14. There have always been distortions in the tax system and we have identified a number of the moreimportant ones. Most of these distortions are not new. Many of them are also interrelated and resolving themis likely to be politically sensitive.

Question 1—What are the Key Principles which Should Underlie Tax Policy?

15. Since its foundation in the early 1990s the ICAEW Tax Faculty has been at the forefront of the debateto improve the UK tax system and the way UK tax policy is developed. As part of this work, in 1999 the TaxFaculty identified ten principles (the Ten Tenets) that should underpin a good tax system. These are set out inAppendix 1.

16. We have used the Ten Tenets in the intervening period to evaluate subsequent policy changes and webelieve that they continue to offer an appropriate framework to assess the overall tax system and to evaluateindividual tax policies.

17. We have set out below what we consider are the key principles (tenets) of a better tax system and thenecessary processes (see our comments at para 23 below) that we believe need to be in place to ensure thatsuch a system can be maintained and developed.

Key principles of a better tax system

18. A key principle underlying tax policy is that it should be certain. The importance of this principle isconfirmed consistently in feedback from members and businesses. Taxpayers in general and businesses inparticular need to know where they stand and make plans for the future, with a clear understanding of the taxconsequences which will result from their decisions. Clear and certain tax laws minimise the likelihood thattaxpayers and the revenue authority will become involved in disputes about the tax effects of transactions andthe need to resort to the appeals system.

19. The tax system needs to be designed to be as simple as possible while achieving its various objectives.It also needs to be fair and reasonable. The maintenance of a proper balance between these two tenets canmost obviously be a source of tension: if the system is too simple (for example a flat-rate of tax rather than amore progressive system of rates) it may not be generally perceived as fair and reasonable but on the other handa tax system that seeks to ensure that all taxpayers are treated fairly will inevitably result in greater complexity.

20. Tax law also should be properly targeted so that it can best achieve the underlying policy objective.We also believe that tax policy should be constant, in other words tax policy should be set and then not besubject to constant changes every subsequent year.

21. The purpose of the tax system is to raise money for government expenditure in the most efficient way.We do not think that the tax system is best suited to encouraging changes in behaviour. Such changes oftenresult in considerably increased complexity but may have little impact upon behavioural change—an examplebeing the rates of capital allowances, where business’s investment timescales are not likely to be influenced byregular changes to the rates. Conversely, changes to encourage behaviour may have adverse effects, for examplethe policy behind the introduction of the 0% rate of corporation tax was to encourage companies to reinvestand grow but the absolute tax saving resulted in considerable numbers of businesses incorporating solely tosave tax, with the result that the policy had to be changed.

22. Finally we believe that tax needs to be easy to collect and to calculate. It should be relatively easy forthe majority of taxpayers to understand and calculate their tax liability without the need for external assistance.

Processes

23. The formulation of tax policy and resultant legislation needs to be subject to proper consultation andit needs to be statutory i.e. enacted by statute and subject to proper Parliamentary scrutiny. It also needs to beconstant so that changes to the underlying rules are kept to the necessary minimum but it is also importantthat there are regular reviews so that when the economic and commercial reality changes the law can besuitably updated.



24. We have set out our detailed comments on appropriate processes in Appendix 2.

The need for a competitive tax system

25. The current Government has as its aim to create the most competitive tax system amongst the G20countries. In a globalised world where businesses in particular have real choices as to where they operate, theUK needs to provide a tax system which is attractive for businesses which already operate in the UK andwhich encourages future inward investment. However, a balance needs to be struck between a sufficientlyattractive tax regime and the need to protect the UK tax base while ensuring that businesses make a fair andreasonable contribution to the public finances.

26. The UK is currently coming towards the end of a major review of the way in which it taxes internationalbusiness. The final part of this process is an interim amendment of the existing CFC (Controlled ForeignCompany) legislation, in FA 2011, with a recasting of the rules in FA 2012. This is coupled with a change tothe taxation of foreign branches to be completed in FA 2011. It would be appropriate to review these changesin the light of the move towards a more territorial approach to UK taxation in order to determine what aspectsof the current, and proposed, legislation are crucial to maintaining the competitiveness of the UK tax system.

The administration of the tax system

27. However good the tax system is in design, in order to deliver its potential benefits it needs to beadministered efficiently. We have been extremely concerned in recent years by the drop in service standardsand efficiency of HMRC. This is a major concern of our members. At the end of 2010 we published the resultsof a member survey52 that sets out the concerns in detail.

28. In December 2010 we submitted written evidence to the continuing Treasury Sub-Committee Inquiryinto HMRC’s efficiency and effectiveness. In view of the critical importance of this aspect of the tax systemwe would be happy to assists the Sub-Committee further with that Inquiry.

The OECD and Mirrlees review

29. The OECD and Mirrlees reviews are valuable contributions to the debate on what is the best tax policy.These detailed and comprehensive reviews are written primarily from a macro economic standpoint and wewill be studying them and their conclusions in more detail over the coming months.

30. As professional accountants closely involved in advising on tax and the proper operation of the taxsystem, we also believe it is vital to ensure that whatever tax policies are adopted, they are designed to beefficient and that they work properly in accordance with the ten tenets referred to above.

31. As a general principle, we believe that tax policy should aim to be broadly based, that rates are keptreasonable and that the number of reliefs is kept to a minimum needed to ensure that it operates fairly.

32. We agree with the view expressed in the Mirrlees Review that the tax system should be considered as awhole with the benefit system, seek neutrality, and achieve progressivity as efficiently as possible. We alsoagree with the OECD that the tax system should distort economic incentives as little as possible.

33. The OCED report suggests moving towards increasing taxes on consumption and residential propertytaxes and less from income taxes and corporation tax. The 22 June 2010 Budget “Red Book” shows thatCouncil Tax, Business rates and VAT combined raised £131 billion (23%) of total revenue and that stamp dutyland tax raised a further £5.8 billion. In contrast, income tax, NIC and corporation tax raised £292 billion orabout 53% of total revenues. Our initial conclusion is that, even if such a move was desirable economicallyand let alone whether it would be politically acceptable, it would involve a major rebalancing of the UK taxsystem which would take to time to achieve and risks introducing considerable distortions and behaviouralchanges.

34. Ultimately, the relative proportions of tax raised from the various sectors of the economy are policyquestions for the government of the day to decide. In the current fiscal climate, we believe that the overridingneed is not to rebalance the tax system but to ensure that existing revenue flows are stable and not put at risk.

Question 2—How can Tax Policy Best Support Growth?

35. As noted above, a key requirement of businesses is that they want certainty year on year. In relation tothe tax system, this suggests a competitive but fair and reasonable system which is not subject to constantchange. Tax policy and rates should be set at an early stage in the Parliamentary cycle and thereafter majorchanges in tax policy should be kept to a minimum.52 See http://www.icaew.com/index.cfm/route/175054/icaew_ga/Faculties/Tax/Publications_and_technical_guidance/TAXREP_43_

10/TAXREP_43_10/pdf



36. The government is pursuing a growth agenda and we believe that there is a need to review the tax andadministrative burdens on businesses that hinder growth. Such a review could be integrated with the work ofthe Office for Tax Simplification (OTS). The call for evidence referred to the work of the OTS and theidentification of over 1,000 tax reliefs—this work is proving valuable but there is a need for a more detailedreview of where are the real pressure points in the tax system.

37. One approach would be to review the burdens by reference to important events and decisions thatbusinesses are required to make, for example: starting a business and adopting the most appropriate businessstructure; taking on your first employee(s); registering for VAT; buying capital equipment; raising externalfinance; selling internationally etc. The precise burdens at each stage should be identified and quantified andconsideration given to how the burdens could be reduced.

38. We also believe there needs to be a clearer recognition that the policy approach needs to recognise thatthere is a significant difference between micro, SME and large businesses.

Question 3—To what Extent should the Tax System be Structured to Support other SpecificPolicy Goals?

39. As noted above the overriding aim of the tax system should be to raise revenue efficiently to fund thegovernment’s spending requirements. This requires a stable and reliable tax system that produces a predictableflow of revenues within the limitations of forecasting error and the stage in the economic cycle. In ourexperience, supporting other policy goals is at best problematic and often results in unexpected behaviouralchanges that may prejudice revenue flows, for example by encouraging tax avoidance. It will often be moreefficient to achieve other policy goals by different means that can be better targeted, for example the use ofgovernment grants.

40. There would be merit in examining the UK rules for capital allowances and the extent to which thesystem should, or should not, be used to encourage behaviour. There are competing pressures to encourage UKbusiness to invest in additional productive capacity while at the same time achieving other policy objectives,such as encouraging innovation and addressing the Government’s environmental goals.

41. Where specific policies are adopted in order to change behaviours, there should be post implementationreviews to consider whether the policy outcomes have been achieved and whether the benefits outweigh thecosts (i.e. revenue foregone).

42. In order to instil this discipline into the tax policy making process, greater consideration should be givento the use of “sunset” clauses. These would operate so that after a fixed period of time, say five years, aparticular measure will lapse unless Parliament extended it but that should only be done if a clear and positivecase is first made for the retention of the particular provision.

43. We recognise that this approach conflicts somewhat with our tenets about the need for certainty and forthe system to be constant. The two approaches can be reconciled by ensuring that the time limitation is statedat the outset and that the measure is not changed once it has been introduced.

Question 4—How Much Account should be Taken of the Ease and Efficiency with which aParticular Tax can be Imposed and Collected?

44. As mentioned above one of our ten principles is that tax should be easy to collect and to calculate. Itfollows that the ease and efficiency with which a tax can be collected is a very important part of the designprocess and needs to be considered in detail at the design stage and before tax policy decisions are made.There should be greater consultation at an earlier stage into the likely admin burdens and compliance costs ofproposed measures.

45. While impact assessments seek to assess this efficiency, we are not convinced that the figures andcostings used to compute the assessments are always realistic and they tend to underestimate the costs incurredby businesses in implementing changes. Further, the approach only takes account of cost incurred by businessesrather than taxpayers as a whole.

46. We believe it would be worthwhile when evaluating tax policy changes to develop a minimum cost/benefit ratio that compares expected tax revenues with the costs of compliance. This should include costsincurred by taxpayers, their advisers and HMRC and it should cover all taxpayers not just businesses. If theproposed tax policy change fails to meet the minimum standards then it should either be rejected or amendedso as to ensure that it does meet the test.

Question 5—Are there Aspects of the Current Tax System which are Particularly Distorting?

47. There have always been distortions in the tax system but resolving them is often politically sensitive.Areas of the tax system where there are particular distortions include:

— the taxation of smaller businesses with particular reference to different taxes paid by an employee,the self employed and a person operating through a company, where all undertake similar work;



— the general interaction between the income tax and national insurance rules and in particular thehigher taxation of earned rather than unearned income because of the impact of national insuranceon the former;

— the difficulty in determining whether a person is employed or self employed for tax purposes andthe different definitions applied for non tax purposes;

— the 22% difference between the top rate of income tax and the CGT rate favours capital returnsalthough we appreciate that the current Government has reduced this from 32%;

— the impact of higher marginal rates of tax, for example the withdrawal of personal allowances forincome over £100,000 results in a marginal income tax rate of 60% on income between £100,000and £113,000, when either side of this band the rate is 40%;

— liability to tax depends upon residence but the UK continues to have unclear residence rules basedlargely on out of date case law; and

— VAT Low Value Consignment Relief, in particular in relation to goods despatched from the ChannelIslands which enables goods to be sold in the UK VAT-free.

48. Most of these distortions are not new and have been with us in some form for many years. Many ofthem are also interrelated so policy changes in one area are likely to have repercussions in other areas thatneed to be factored in to any decision making process.

APPENDIX 1

THE ICAEW TAX FACULTY’S 10 TENETS FOR ABETTER TAX SYSTEM

The tax system should be:

1. Statutory: tax legislation should be enacted by statute and subject to proper democratic scrutinyby Parliament.

2. Certain: in virtually all circumstances the application of the tax rules should be certain. It should notnormally be necessary for anyone to resort to the courts in order to resolve how the rules operate inrelation to his or her tax affairs.

3. Simple: the tax rules should aim to be simple, understandable and clear in their objectives.

4. Easy to collect and to calculate: a person’s tax liability should be easy to calculate andstraightforward and cheap to collect.

5. Properly targeted: when anti-avoidance legislation is passed, due regard should be had to maintainingthe simplicity and certainty of the tax system by targeting it to close specific loopholes.

6. Constant: Changes to the underlying rules should be kept to a minimum. There should be a justifiableeconomic and/or social basis for any change to the tax rules and this justification should be madepublic and the underlying policy made clear.

7. Subject to proper consultation: other than in exceptional circumstances, the Government shouldallow adequate time for both the drafting of tax legislation and full consultation on it.

8. Regularly reviewed: the tax rules should be subject to a regular public review to determine theircontinuing relevance and whether their original justification has been realised. If a tax rule is no longerrelevant, then it should be repealed.

9. Fair and reasonable: the revenue authorities have a duty to exercise their powers reasonably. Thereshould be a right of appeal to an independent tribunal against all their decisions.

10. Competitive: tax rules and rates should be framed so as to encourage investment, capital and trade inand with the UK.

These are explained in more detail in our discussion document published in October 1999 as TAXGUIDE4/99; see http://www.icaew.com/index.cfm?route=118111

APPENDIX 2

THE PROCESSES THAT NEED TO BE IN PLACE TO CREATE AND MAINTAIN A BETTER TAXSYSTEM

1. In formulating tax policy there needs to be appropriate Parliamentary scrutiny and outside experts needto be involved. There should be proper time for consultation and a clear timetable—the proposals of the currentGovernment are a considerable improvement and should lead to improved tax legislation in the longer termbut it will require sustained effort and processes to be locked-in for the future. We therefore believe that theapproach should be enshrined in a binding code so that a future government will be held to account. Thereshould also be external monitoring of how the government of the day has complied with the code and wesuggest that there should be a periodic review of new legislation, either by the Treasury Committee or someother suitable oversight body.



2. It is also worth considering whether the House of Lords could be given a role in examining and improvingFinance Bill measures without undermining the long established principle that the House of Commons shouldbe the arbiter on Money Bills. The deliberative process should be carried out in collaboration with those whohave to operate and actually run the systems, including agents and the professional bodies. There is an argumentfor disengaging many of the measures, particularly those of a technical nature, from the traditional FinanceBill timetable and putting such measures through a separate process. The current Government approachdemonstrates that such an approach should be possible and has resulted in improved opportunities for scrutiny.

3. Drafting of tax law should be clear, properly targeted and generally included in primary legislation. It isparticularly important that anti-avoidance measures are properly targeted and are not “catch all” measureswhose scope is then cut down by HMRC guidance. This is not a satisfactory approach for a number of reasons.First, following the 2005 House of Lords decision in the Wilkinson case ([2005] UKHL 30) this approach islegally doubtful. Second, such guidance cannot be relied upon and may be changed at any time so is of littlepractical help in the event of a dispute.

4. It is important that tax law is subject to proper Parliamentary scrutiny. It is for this reason that we believesubstantive tax legislation should be set out in primary tax legislation and not in secondary tax legislationwhere the level of detailed Parliamentary scrutiny is lower. There has been a tendency in recent years to includewithin the primary law powers for the executive to in effect rewrite the tax legislation by way of secondarylegislation. It is reasonable for Parliament to delegate minor and administrative measures to the executive butnot otherwise. We believe that as a matter of principle any changes to tax law which are not merelyadministrative should be put through the Finance Bill process and subject to proper Parliamentary scrutiny.Such principles and practice could be set out in a binding code and again subject to a review process.

5. Our proposals above are designed to ensure that substantive tax law is subject to proper scrutiny throughthe Finance Bill process. Whether this approach is adopted or not, we believe that more generally there is aneed for greater scrutiny of Statutory Instruments. The number of tax related Statutory Instruments has grownconsiderably over the years and Parliament needs to be satisfied that they are subject to a thorough review.

6. The role played by guidance is an important consideration. It should not be used as a support forinadequate primary legislation but it clearly has a role in helping taxpayers and their advisers better understandwhat legislation means in practice and, as a result, guidance can help to create the required certainty. Webelieve that there should be a presumption that all guidance is consulted on before it is finalised and published.

7. It is also clear that a proper understanding of tax legislation and the manner in which it will beimplemented require any guidance to be produced at the time that the proposals are being debated and beforethey are enacted. Again, the Government appreciates the need for this approach and we believe that it needsto be enshrined in a code so as to ensure that it is followed in the future. There should also be consultationwith interested parties on that guidance so as to ensure that it is clear and correctly reflects the primary andsecondary legislation which it explains.

January 2011

Written evidence submitted by the Unquoted Companies Group


1.1 The Unquoted Companies Group (UCG) is a group of approximately 30 Chief Executives of owner-managed (unquoted companies). The family businesses we represent are spread across the United Kingdom(not only in the prosperous South-East). The defining characteristics of our membership are a focus oncontinuity and delivering long-term sustainable value. Our area of particular interest and expertise is the wholeof the unquoted sector of the British economy, which includes most of the UK’s small and medium-sized firms.

1.2 The UCG is pleased to have the opportunity to contribute to the Treasury Select Committee’s importantand timely inquiry into the fundamental principles that underpin the UK’s tax policy.

1.3 As the Government recognises, private sector growth will underpin the UK’s economic recovery and thefamily businesses and unquoted companies represented by the UCG have a central role to play in this. The taxsystem has to play the role of enabler and facilitator and consequently it is essential that the opportunity toevaluate the strengths and weakness of the current tax regime is taken now to enable the private sector to fulfilits potential and for as many of the benefits of such growth to remain in the UK.

1.4 The key principles for tax policy are: stability; clarity; empowerment; certainty; transparency; andcompetitiveness, and we consider these principles in greater detail below. Tax policy must also better recognisethe value of other forms of company organisation. Family businesses for instance, take a long-term approachto investment and the generation of growth and have clear commitments to the communities and environmentsin which they operate. Tax policy must recognise and encourage such wider contributions and longer-termperspectives.



2. Key Points

2.1 Private sector growth (in employment and total tax take) will be central to the economic recovery—taxation policy must be geared towards supporting this. The tax system needs to be oriented towards thedelivery of sustainable commercial activity which will secure job creation and wealth gain. That is not the casecurrently and the system needs to change as a matter of priority. The family business sector is one of the fewsectors where the benefits are clearly seen to stay in the UK. The ultimate benefits and rewards of ownershipof other forms are either less clear or are dissipated overseas.

2.2 Key principles of tax policy

— StabilityOne of the key elements of a system of taxation that fosters private sector growth and developmentcomprise stability and a clear direction of travel. Having been through a period of near-constantchange, reform and tweaking of the tax system, the private sector needs this to cease so that it canplan effective growth and investment strategies.

— ClarityAs a consequence of the previous lack of stability in the tax system, uncertainty and confusionhave hindered business decisions and added to business costs.

— EmpowermentReducing the burden of taxation on businesses and individuals will reduce the level of dependencyon the state. This will encourage an empowered culture with reward reflecting effort.

— CertaintyThe Government needs to send a clear message to the business community that the UK is revertingto a low-tax environment and provide a clear timetable for it. A clear direction of travel must beset and this will provide the certainty required to encourage domestic and inward investment.

— TransparencyIn line with the Government’s commitment to more open and transparent policy-making, theunderlying principles of tax policy should be published in an accessible format and in an easilyunderstood manner, with the result that everyone can identify the Government’s aims. There needsto be clarity as to those tax areas that may be abandoned or reduced. This approach would bothfoster activity domestically and attract new inward investment.

— CompetitivenessAs a general point, the UK needs a tax regime that is fair and transparent and which is alsocompetitive internationally.

2.3 How does tax policy support growth? By supporting

— Organisations contributing to UK GDPSustained commercial activity will increasingly be generated by both long-term global investmentand more locally-based enterprises. This process delivers continuity and commitment to the long-term future of businesses, providing, in turn, for the needs of the local community and theworkforce.

— EnterpriseAn entrepreneurial culture and an environment for investment require a tax system that explicitlyrecognises and facilitates the achievement of these goals. An enterprising economy fostered by aproperly structured and incentivised tax policy, recognising equity investment as a fundamentalstarting point (especially with low banking confidence), would increase the internationalcompetiveness of the UK.

— A focus on the generation of long-term value rather than a pre-occupation with short-term (moreconcentrated) gainsFamily-based businesses are the embodiment of long-term commitment and investment. Returnsare not simply maximised to secure drawings for a few key individuals in the short-term; insteadsuch businesses look to the vitality and viability of the company (and of the wider social role itplays) in the long-term. The adverse consequences of a pre-occupation with short-term gains,which are often ephemeral and occasionally notional, have been universally highlighted all toofrequently in recent years. Family businesses need to be seen as a separate class from otherunquoted businesses that have fundamentally short term objectives.

— Long term sustainabilityWhilst the tax system is designed to secure revenue for Government, it is also an important policy-making tool in its own right. It should encourage the development of a long term and economically,socially and environmentally sustainable approach to growth.



— The broader economy (manufacturing, construction, service, financial services)The principles of an effective tax system would foster growth across a range of sectors. We wouldencourage HM Treasury and HM Revenue & Customs to work closely with representative bodiesfrom all sectors to consider how the tax system can be used to encourage greater levels of growthin the UK’s key industries and a balanced economy. We would discourage policies thatfundamentally play to one sector as history has shown that it is not possible to second guess themarket place.

— Recognising and encouraging diversity of economic actors and business modelsThe tax system needs to value the role that different types of organisations can play within the UKeconomy and society. Obviously we are thinking specifically of the family run companyconstituency that we represent and we have a number of specific recommendations to make as tohow the tax system can better recognise the wider value that these represent, not least the conceptof a “Family Business Trust”. However we would also note that the tax system will have animportant facilitation role to play if the concept of the Big Society is to have any success.

2.4 Adaptation to support other policy goals— Facilitating the Big Society—building social and community equity

The tax system tends to be more flexible or responsive to the requirements of larger, typicallylisted, companies than to other less prominent and less vocal types of company or organisation.As we understand it, the vision of the Big Society involves facilitating and enabling a range offormal and informal organisations to deliver socially and economically positive outcomes. The taxsystem has an obvious role to play in ensuring that such different “delivery models” are realisticand are not hindered by burdensome taxation.

— Social and environmental sustainabilityEncouraging a long-term approach (and commitment) to all aspects of the contribution and impactthat businesses have.Whilst the delivery of growth is, of course, a key role for business, that growth has to be sustainableand those that recognise their social and environmental responsibilities are more likely to take along-term view and not be pre-occupied with short-term returns. Again, the tax system needs tobe supportive of those organisations that are inclined to adopt this orientation.

— Promoting international growth & national self sufficiencyAs highlighted above, a stable tax system based on clearly defined objectives will encouragegrowth and attract investment—the tax system can help promote the long term needs of theeconomy.

— International competitivenessThe tax regime has an essential role to play in supporting the competitiveness of the UK economyinternationally as in many sectors we are competing for investment with jurisdictions that are moreattractive in tax terms.

2.5 Importance of ease and efficiency

The tax system, as it currently operates, is too complex. The ease and efficiency of the system needs to beimproved. The implications of the way in which the system works at the present time can probably best bedemonstrated by reference to:

— Compliance costs—an ever increasing drain on valuable resources that would otherwise beavailable for investment.

— Impact on senior management time—any business would recognise the benefits of freeing up timeso that senior management are able to deal with important issues which will deliver sustainablecommercial activity. Time spent dealing with the tax system is time away from running the businessand this especially affects family-run businesses.

— State apparatus—the growth of an impersonal and difficult to navigate bureaucracy.

2.6 Distorting aspects of current system

There are a number of ways in which the current tax system imposes distortions into markets. Some of thesesimply comprise unintended consequences but others appear to occur more through design. These include, forexample, the capital tax treatment of JVs, which hinders their viability at a time when they could offer greatbenefits, especially to small and medium sized businesses and family businesses. The tax system, in effect,undermines the viability of entering into JVs for family-run businesses.

The operations of the tax system introduce distortions which need to be addressed:

(a) sectorally—different sectors facing different tax regimes. Whilst this pattern has led to the activeencouragement of some sectors, it has been to the detriment of others;

(b) capital requirements—similarly a lack of consistency has hindered many capital intensive industriesand undermined their investment; and



(c) geographically—a pre-occupation with London and the South East (and with financial services) meansthat there is now a clear requirement, as recognised by the Government, to rebalance the economy.

The tax system also needs to reduce the “transactional friction” which places unnecessary obstacles in theway of efficient transmission of ownership, whether between generations or to third parties and the generalfreedom of movement of capital.

3. Overall

We welcome the Committee’s inquiry and the opportunity to contribute to this debate. It is especiallyimportant that the nature and focus of the tax system are comprehensively reviewed at this time so that it canbe re-designed with the long term requirements of businesses and a healthy economy treated as key priorities.

January 2011

Written evidence submitted by HM Treasury

What are the key principles that should underlie tax policy?

1. Defining a sound basis for tax policy making is critical—taxation affects the decision making processesof business, households and individuals, reaching into all aspects of life and the economy. In 2009–10, NetTaxes and Social Security Contributions were equivalent to 34% of GDP.

2. There is not a fixed set of principles underlying tax policy, but there is a broad consensus which has beendiscussed since at least the days of Adam Smith53.

— Sustainability: the tax system should be sustainable to long-term trends.

3. The core aim of a tax system is to raise revenue for the Government to spend on its priorities. However,the underlying structure of the tax base is subject to constant change. Demographic, economic, social andenvironmental trends all impact on the sustainability of the base. The Government is committed to reinforcingthe sustainability of the fiscal position, and as part of this Budget Responsibility and National Audit Bill setsout the main duty of the Office of Budget Responsibility (OBR) to examine and report on the sustainability ofthe public finances.

4. Tax policy should also be flexible enough to respond to a changing economic environment. Part of thisresponse is determined by automatic stabilisers which can help provide a boost to the economy when growthslows, but also moderate economic expansion when growth is above its trend level.

— Efficiency: the tax system should place the minimum economic cost on society and markets whilehelping provide the right incentives growth.

5. The tax system should aim to be as non-distortionary as possible. In order to maximise efficiency, theideal tax policy should be consistent with the principle of “fiscal neutrality” in the sense that it does notinterfere with the workings of markets or the decisions of households while minimising disincentive effects onthe level of economic activity.

6. The overall economic impact of the tax system will depend on how revenue raised gets spent. Governmentspending can have a positive or a negative effect on growth, and so, taken with taxation, the overall fiscal mixcan have a positive or negative effect.

7. The efficiency of the system is also dependent on the mix of different taxes, their associated bases andrates. The conclusions of a large body of academic and institutional evidence as well as the recently publishedOECD54 report is that taxes on property and consumption are more economically efficient than taxes onincome and business inputs. However, an efficient tax system will rely on mix of different taxes rather thanany one. The Government is committed to improving the efficiency of the tax system to support the long-termgrowth potential of the economy.

8. The efficiency of the tax system is critical in determining its competitiveness. But other factors, such aspredictability, help provide certainty to enable households and businesses to plan and invest for the future.Businesses in particular have signalled that they place significant value on this certainty.

9. Alongside the June 2010 Budget, the Government published proposals to improve the way tax policy ismade55. Following extensive engagement with taxpayers and tax representative bodies over the summer, theGovernment published its response on 9 December 2010. In that document it set out a number of concreteimprovements designed to improve predictability, stability and simplicity in the tax system, with consultationon policy design and scrutiny of draft legislative proposals as the cornerstones. The Government has alreadyput some of these improvements into action through publication of:

— the Corporate Tax Road Map; and53 Smith, A. “An Inquiry into the Nature and Causes of the Wealth of Nations” McMaster University Archive for the History of

Economic Thought54 ???55 Tax Policy Making: a new approach, June 2010. http://www.hm-treasury.gov.uk/tax_policy_making_new_approach.htm)



— draft clauses for Finance Bill 2011 with accompanying Tax Information and Impact Notes foreach measure.

10. The new approach to tax policy making has been widely welcomed by business and tax representativebodies.

— Fairness: the burden of tax should reflect to the ability to pay while incorporating principles ofintergenerational equity.

11. Fairness is a subjective concept and will depend on the judgements of the Government, Parliament andthe public.

12. There are a number of different ways of considering fairness. In particular, horizontal and vertical equity.Horizontal equity refers to the burden of tax on individuals, households and businesses with the same abilityto pay, while vertical equity refers to the relative burden of taxation on individuals, households and businesseswith differing ability to pay. The Government has looked at the tax burden using a range of different measures(the June Budget used income and consumption), as well as the impact on different groups and changes in thetax burden over time.

13. The Chancellor stated in his June Budget speech “My priority in putting together this Budget has beento make sure that the measures are fair. That all sections of society contribute, but that the richest pay morethan the poorest. Not just in terms of cash, but as a proportion of income as well”.

14. A well designed tax system will also support fairness by minimising opportunities for avoidance andevasion.

— Value for Money: the tax system should be cost effective. Costs of compliance and collectionshould be kept to a minimum.

15. The costs of administering the tax system are not only those incurred by government in collecting taxes,but also those incurred by business and individuals in complying with them. These costs should be taken intoaccount when developing policy.

16. An effective compliance and collection regime helps reduce evasion and avoidance. HMRC will invest£900 million of efficiency savings into activities against tax avoidance, evasion and criminal attack to collectadditional revenue of £7 billion per annum by 2014–15. HMRC will also ensure resources are more effectivelyfocused on collecting revenue and providing better services for taxpayers.

17. As part of the Government’s commitment to improving tax policy making, it has introduced TaxInformation & Impact Notes (TIINs) which set out the impact of changes to the tax system and are publishedat each Budget.

18. Finally, the tax system should be accountable to the public and Parliament. As part of its commitmentto greater transparency in public policy, the Government is committed to greater transparency in the tax system.As set out above, consultation on policy design and scrutiny of draft legislative proposals are cornerstones tothe new approach to tax policy making. The Government has committed to develop tax policies over a longerpolicy cycle, and to publishing more legislation in draft. Increasing the degree of transparency and consultationin the policy making process helps make it more effective.

19. It is important to note that there are trade-offs within and between the principles described above. TheGovernment is committed to a balanced system that reflects these principles appropriately. The appropriatebalance is a judgment that is—rightly—a matter for debate and discussion.


20. The Government’s priority is returning the UK economy to balanced, sustainable growth. Aneconomically efficient tax system that is both competitive and stable helps minimise distortions and providesbusinesses with the confidence to invest and expand. The tax system should also consider the internationalmobility of capital and labour in the context of a highly competitive global economy.

21. The extent to which the tax system impacts on growth depends on the overall fiscal mix. The economiccosts of taxation must be balanced against the economic benefits of government spending. If the balance oftaxation is biased towards less economically efficient taxes there is potential for the fiscal system to act as along-run drag on growth.

22. Tax policy can help support growth through both macro and microeconomic channels. At the macrolevel tax policy might best be used to support growth through:

— Helping create confidence through a stable and sustainable fiscal system. The Government’s deficitreduction plan, including the structural changes to the tax system, has helped restore confidence inthe UK’s fiscal position.

— Through structural reform and rebalancing away from more distortive taxes towards less distortivetaxes. The corporate tax reforms at the June 2010 Budget are an example of this restructuring.



— To help correct against trends that might damage the UK’s long-run growth potential and to captureexternalities where there are market failures, in particular, environmental degradation.

— To help increase confidence in the competitiveness of the UK economy. As well as reforms topolicy itself, a commitment to stability and certainty can help strengthen the system’scompetitiveness.

23. At the micro level tax policy can support growth through incentives to both increase both the level andquality of economic activity while reducing negative externalities:

— To help increase the quantity and quality of labour and investment entering the market. Thegovernment has improved work incentives through (amongst other things) increases in the personaltax allowance and investment incentives through reducing corporate tax rates.


24. The main aim of the tax system is to raise revenue. This should be done in accordance with the principlesset out above and should be consistent with the Governments goals.

25. The tax system can be used to support wider objectives, but if tax policy is used to support theseobjectives it should be judged as representing the best value for money with respect to alternatives such asregulation or spending. In trying to achieve these objectives, the Government considers the impact on the taxsystem as a whole.

26. An example of where the tax system is used to support a specific policy goal relates to the externalitiesassociated with environmental degradation. Tax has the particular advantage of creating a dynamic incentiveie if agents reduce emissions below a prescribed target they can reduce their tax liability.


27. The Government believes that the compliance burden and collection cost are critical components of taxpolicy design, and as set out above, considers minimising these cost to be a core principle of the tax system.HM Treasury and HM Revenue and Customs work closely through a joint set of Ministers and a prescribedpolicy partnership to improve the interface between policy design and delivery while ensuring that issuesrelating to compliance, avoidance and implementation can be carefully considered. The Government hasintroduced a new tailored process for impact analysis of all tax measures. This will embed impact analysis inthe policy development process and broaden the range of impacts explicitly assessed. This will ensure thatcompliance burden and collection costs are more systematically considered in the policy making process. TaxInformation and Impact Notes will be published for all tax policy changes.


28. Any tax that affects the decision making process will provide a distortion. The Government aims toeliminate any distortions as far and as quickly as possible. Some distortions are an inevitable consequence oftensions between principles and the complexity of an advanced economy and society.

29. The Government is, however, committed to a simpler tax system and has set up the new Office for TaxSimplification (OTS) to help achieve this. Giving weight to simplicity and convenience in policy design helpsensure that, as far as possible, reforms minimise transitional costs on business and the burden of complyingwith the tax system.

January 2011

Written evidence submitted by Retailers Against VAT Abuse Schemes (RAVAS)

Low Value Consignment Relief (LVCR) is a relief created by European Union Directive 1983/181, whichexempts from VAT any import from outside the EU of a value below a certain threshold. Member states arefree to set that threshold anywhere from £10 to £18, and the UK has always set it at the maximum £18.

The original purpose of LVCR was to expedite the transit through customs of perishable and urgent goods,and to reduce the administrative costs on fiscal authorities of collecting small amounts of VAT that are oftenless than the cost of collecting them. Unfortunately, since the advent of Internet-based mail order, large UKretailers have been using it to ship products to the Channel Islands—outside the EU for tax purposes but insidethe UK mailing system, so shipping is cheap—and back, often within 24 hours, in order to undercut theircompetitors by totally avoiding VAT. This has resulted in a group of Islands, across an inconvenient stretch ofwater close to France, becoming the major hub for internet fulfilment in the UK a situation that makes nosense at all. Many industries are affected, including ink cartridges, computer memory cards, computer gamesand DVDs. Because my personal experience and knowledge is of the music industry, I will largely restrict myevidence to that particular industry.



LVCR was clearly not created for this purpose and, in fact, the Directive creating it recognises the possibilityof abuse. In its recitals the Directive makes clear that any distortion of competition arising from the reliefwould be contrary to its intentions. The Directive contains an article giving member states the latitude toremove mail order goods from this relief. In its very first article, the Directive contains a stipulation thatmember states implement it to ensure that no evasion, avoidance, or abuse arises. Furthermore, the principleof fiscal neutrality enshrined in the EU’s principle VAT Directive (2006/112/EEC, formerly 1977/388/EEC)stipulates that similar goods should bear the same tax burden.

Before 2005, the existence of LVCR did not have a huge effect on the UK CD market. The only offshoreoperator was Play.com, which simply matched UK-based prices, offered free postage and pocketed the VATdifference.

The shape of the market changed from 2006 onwards, after HMV moved its online operations to Guernseyin 2005, in order to be able to compete with Play.com. The effect, known as the “Play Effect” was a stampedeof UK retailers to the Channel Islands. HMV, WHSmith, Asda, Amazon, Tesco, Dixons, Thehut and Argos allnow operate their Internet mail order operations from the islands.

One effect has been to accelerate the normal shift that was underway towards online retail. On the followinggraph, the light blue line traces the trend line from before 2005 through to the present. It is clear that onlineretail’s share of the physical music market is much higher now—and has been on a much steeper trajectorysince 2006—than it would be if the pre-2005 trends had continued.

For clarity, when I speak of Internet retail or online retail, I mean CDs ordered on a website to be deliveredto the customer’s home, not downloads, a subject to which I will return later.

0

5

10

15

20

25

30

2001 2002 2003 2004 2005 2006 2007 2008 2009

Pre-2005 trend

Actual share

Internet’s share (%) of the UK physical music

market, 2001-9

Source: Entertainment Retailers’ Association (ERA)

The graph above shows that the trend in favour of online retail seems to be steepening rather than levellingoff. Indeed, while the last figure on the graph above is the 29.6% market share that Internet retailers enjoyedin 2009, the latest figures for 2010 indicate that its share has grown once again. Market research firm Kantarestimates that in the 52 weeks ending 3 October 2010, Internet retailers accounted for 42% of the physicalmusic market.

In a shrinking market, Internet retailers were the only segment enjoying growth through 2009, as shown bythe graph below.



-100

-80

-60

-40

-20

0

20

40

TOTAL MARKET TOTAL

MUSIC/VIDEO

SPECIALIST

GENERALIST GROCERS MAIL ORDER INTERNET OTHER

-13 -14

-95

0

-59

22

-25

% growth in sales volume in UK physical music market, 2008 to 2009

Source: Kantar

As the contraction in the UK music market continues, the Internet segment is suffering the smallest losses.

-80

-70

-60

-50

-40

-30

-20

-10

0

% growth in sales volume in UK physical music market,

52 weeks ending 4th October 2009

to 52 weeks ending 3rd October 2010

Source: Kantar

One effect of this shift has been the demise of over half the UK’s independent music stores, who have goneout of business disproportionately to the overall decline in album sales from 2006 to 2009.



-30

-25

-20

-15

-10

-5

0

5

% change:

Number of independent music retailers

Versus sales of physical albums

Source: Entertainment Retailers’ Association

The above graphs all relate to physical album sales. However, while many commentators would like to pinthe blame for the demise of so many independent retailers on to music downloads, the figures show thatdownloads, while they are ubiquitous in the music singles market, have yet to enjoy real penetration in thealbums market, which was the staple of most of the independent retailers—and certainly the independentInternet-based retailers. Downloads may now be on their way to achieving the same status in album sales asthey have in single sales, but they are not there yet, and certainly were extremely minor when most of theindependent Internet-only stores went out of business around the end of 2007 and the beginning of 2008.

The two graphs on the next page compare album downloads to single downloads, and album downloads toalbum sales on the Internet over the last three years.

0

20

40

60

80

100

120

140

160

2006 2007 2008 2009

Albums

Singles

Sales of digital music, millions of units

Source: British Phonographic Industry (BPI)



0

5

10

15

20

25

2006 2007 2008 2009

DownloadsInternet retail

Source: Entertainment Retailers’ Association (ERA)

Share of overall UK album market (%)

The purpose of the information given thus far has been to show that Internet retail has been adisproportionately fast-growing segment of the UK music market since 2006.

It could fairly be argued that this would have happened anyway without the abuse of LVCR, although ourvery first graph shows that the growth since 2006 has been out of proportion to the growth before that year.

Normally, such conditions would benefit independent online retailers. Even traditional independent retailerswould have been able to catch up with the shift because many of the bigger independent stores, such as Foppand Music Zone, did indeed have websites.

However, the general growth of Internet retail stands in stark contrast to the fact that every significantindependent Internet-only CD & DVD retailer based on the UK mainland has gone out of business since 2006.

In comparison books which do not attract VAT have also seen an increase in sales on the internet howeverbook retailers are not located on the Channel Islands in any significant numbers (due to the fact that there isno VAT to be avoided and logistically the islands are inconvenient) and since there is a level playing field ofno VAT in the book trade, retailers compete on price and service and therefore can still be found spread acrossthe UK mainland and even in the high street.

I repeat, for clarity. Despite the strong growth of Internet retail demonstrated over the last few pages, thereis no independent Internet-only CD & DVD retail remaining on the UK mainland of any significance.Additionally a number of specialist genre music retailers who should have easily been able to benefit andtransfer to the internet have disappeared.

Indeed, my business, Delerium Mail Order, was an Internet-only specialist genre business and, through 2006,I was enjoying strong growth, until the effects of the stampede to the Channel Islands took hold. It is nowimpossible to run a mail order operation selling CDs and DVDs on the UK mainland since the Internet mailorder market for these products is almost entirely VAT free and based in The Channel Islands, as is commonknowledge within the music industry.

Although figures do not exist in the public domain that split out the Internet retail part of the CD marketinto onshore and offshore, the last quoted estimate from a knowledgeable source was that Channel Islandsretailers account for 96% of the online CD & DVD market. This was the estimate of Matt Moulding, CEO ofthehut.com, which provides logistical fulfilment services to UK companies using the loophole. He told theGuardian in March 2009: “Everybody does it. If you look at the main players you’ve got Amazon, HMV andPlay who have got 80% of the entertainment marketplace and they’re offshore. And we make up pretty muchthe balance; we have about 15%, 16% now.” The Entertainment Retailers Association has described this as a“concentration” of internet retail in The Channel Islands.

Unlike other forms of tax avoidance which are not always visible, VAT abuse is immediately apparent, as ithas an immediate effect on retailers who are obligated to pay VAT. I know from my own experience runninga successful mail order and online business from 1991 to 2007 that customers soon become aware of the factthat your prices are higher than those of VAT-free competitors, but they do not understand why this is so. Theyimmediately assume that you are overcharging, causing misunderstanding with customers and seriously



damaging reputation and profitability. If a UK retailer buys an item at £10 and sells it for £12 then he hasmade no profit and has to pay £2 in VAT to HMRC. However an offshore retailer selling the item at the same£12 price can pocket the £2 profit margin or undercut the UK retailer forcing them to sell their item at a lossif they wish to compete. Such a huge trading advantage means that offshore retailers now regularly priceproducts within the 20% VAT advantage knowing that it is impossible for any UK mainland retailer to matchthe price, other than the likes of Amazon who have been price matching offshore products and losing moneywhen they have been unable to supply them though their offshore partner Indigo Starfish in Jersey. This unjustand damaging practice has been allowed to develop unchallenged by HMRC to levels of abuse that canonly be described as industrial creating a complex market distortion that has been highly damaging to UKmusic retail.

It is for this reason that Matt Moulding, CEO of thehut.com, told the Guardian newspaper in March 2009:“If you aren’t offshore you couldn’t possibly compete. Your cost price would be above what people would beretailing at”.

In response to HMRC’s failure to deal with LVCR abuse I have set up Retailers Against VAT AvoidanceSchemes (RAVAS), which includes 20 members from various mail order sectors. It is supported by a numberof major Music Industry Trade bodies including IMPALA (Independent Music Companies Association) AIM(Association of Independent Music) The Musicians Union (MU) The Music Managers Forum (MMF) andMusic Publishers Association (MPA) who represent 90% of UK copyrights. I also have contacts through UKmusic retail both traditional and online.

This issue is highly relevant to the terms of reference of the Committee’s inquiry, because it relates to oneof the fundamental principles of taxation on which free and competitive markets are based: namely, fiscalneutrality. Similar goods should bear similar tax burdens. If an onshore retailer has to pay VAT and an offshoreretailer does not, the offshore retailer will win the customer even if the product is not as good, causing amarket distortion. The OECD has said that a tax system should distort economic incentives as little as possible.

I feel that I would be able to provide a great deal of information to The Treasury Select Committee regardingthe abuse of LVCR and its impact on UK internet retail. HMRC has, until recently, actually not been aware ofhow this abuse operates, and officials within HMRC have not always provided the full information to ministers.Indeed, I can provide several examples of demonstrably factually incorrect statements made by ministersplaying down the extent of the abuse of LVCR.

January 2011

Written evidence submitted by the Child Poverty Action Group

1. Introduction

1.1 “Taxes are what we pay for a civilised society”

1904—Oliver Wendell Holmes Jr, American associate justice, Supreme Court, Compañia de Tobacos v.Collector

1.2 CPAG welcomes the Committee’s inquiry into the principles of taxation. We recognise that differentapproaches to taxation can have very different economic and social impacts. This means that decisions ontaxation are not simply about the most bureaucratically efficient way of collecting revenue.

1.3 Taxation policy can reduce, or worsen economic inequality and poverty. It must be an explicit andtransparent policy objective of government to ensure the system of taxation has a progressive impact reducingeconomic inequality and poverty.

1.4 Taxation policy must also be firmly guided by principles that accord with the national aim for the goodsociety, supporting aspirations and policy goals in areas like social justice, social cohesion, public health andenvironmental protection.

2. Principles for Taxation

2.1 The most fundamental principle of taxation must be fairness. In the last three decades we have seenmoves away from direct and progressive forms of taxation, such as income tax, to indirect and less progressive,or even regressive, forms of taxation such as VAT. This has taken place at the same time as rising economicinequality, partly driven by the fact that the poorest income decile now pays a higher proportion of their incomein tax than the richest decile.

2.2 Much attention must be paid to the proportion of income paid by different income towards specific taxes,and towards a household’s total tax liabilities. Fair taxation means that the total combined burden of

taxation as a proportion of income must increase up the income distribution.

2.3 A second key principle must be that tax policy should always be looked at in the round as part of

fiscal policy; and in particular that the vital role which taxation plays in tandem with universal benefits mustbe understood and applied. For example, in the case of a payment like Child Benefit, it is readily acknowledged



that it is sometimes received by people who are not in a situation of great financial need. But the higheramounts paid in tax by those households mean that the overall fiscal policy ensures need is targeted withoutwealthier households receiving an unnecessary net boost to their income. This allows the full benefits ofuniversalism to be realised, such as high take up, horizontal redistribution (recognising all children equally),cheap administration and providing a life raft in times of change like redundancy or the need to flee an abusivepartner. It is highly inefficient to have means testing flourishing in both the benefits system and the tax system.Greater use should be made of means testing in the tax system where efficient structures are already in place.The encroachment of means testing into the benefits system in tandem with a move away from progressivetaxation has helped reduce benefit take-up and raised overall administrative costs across benefits and taxation.

2.4 We strongly support the principle of recognition of children and basic need in the tax system. Forexample, VAT exclusions apply to food and children’s clothing. Child Benefit previously existed as a taxallowance and the equivalent support for children is still applied in the form of a tax allowance in many EUcountries. We believe this kind of principle should continue to be applied as extensively as possible.

3. Collection of Taxes

3.1 The rate of revenue collection is appalling. The official estimate of the tax gap is at least £40 billioni,but other estimates put it as high as £175 billionii. This means that a very significant proportion of the deficit,perhaps the great majority of the deficit, could be attributed to failure to collect revenue that is due.

3.2 Tax fraud alone accounts for at least £15 billion; compared with annual benefit fraud of £1.1 billion, thisis a much greater loss to the tax payer.iii It is therefore concerning that the strategic objectives published bygovernment departments for the current parliament seem to indicate a lower level of interest and softer touchat the Treasury on tax fraud than is shown toward benefit fraud by the Department for Work and Pensions.High profile public information and advertising campaigns have targeted benefit fraud, but there has been nosuch effort to stigmatise and discourage tax avoidance and evasion. The Government has a duty to make

the positive case for taxation as a social good and a social obligation and should consider a high profile

public information campaign to stigmatise tax avoidance and evasion.

3.3 Collecting taxes from wealthy individuals or corporations can present additional challenges because theyare in a position to employ expert advice to help them avoid taxes. Some argue that because wealthier peoplehave become increasingly effective at avoiding tax, we should not bother to tax them so much, but we are incomplete disagreement with this view. We believe there has been a lack of will to focus on the closing of

loopholes, simplification and investment in enforcement that would ensure a greater level of revenue

is collected.

3.4 Some tax payers are able to speak louder than others in favour of their own interests. There are powerfullobbies for corporate tax payers and wealthy individuals with significant sums of money invested in persuadingthe government to decrease their tax liabilities. Lobbying can be conducted by traditional businessesrepresentatives, such as the Confederation of British Industry, or by front organisations set up by wealthy elites.Too often avoidance from wealthy elites has become a threat to government, whilst evasion and avoidance inthe cases of tax rises in other areas may receive too little consideration—for example the possible increase inblack market trading resulting from rises in VAT. We believe there has been a creeping tendency for

politicians to be too credulous in response to claims and threats from wealthy elites who seek policies

that limit their tax liability, or who threaten to avoid tax payment.

3.5 Announcements by the Chief Secretary to the Treasury suggest that the Government’s headline objectiveon tax avoidance is to reduce it by £7 billion per annum by the end of the current parliament. Even on thelowest and most conservative estimate of the tax gap (the HMRC estimate of £40 billion), this is less than afifth of the total; and it is just 4% of the top end estimate of the tax gap. There would be a public outcry if

the Government’s target on recovering funds lost to the taxpayer through benefit fraud and error was

limited to just below 20% recovery at best, or perhaps as low as 4% recovery. This is the limit of

government ambition on the tax gap, despite the fact that the sums lost to honest taxpayers because of

the tax gap far exceed those for benefit fraud and error.

3.6 It is crucial that HM Revenue and Customs have adequate human resources to collect tax and conductinvestigations. Employment of additional staff is likely to more than pay for itself at a very favourable ratio tothe outlay. It has been estimated by Richard Murphy, visiting fellow to the Tax Research Institute at theUniversity of Nottingham, that each additional officer could be expected to recover £252,000 of debt owed tothe Exchequer through unpaid revenue.iv

3.7 At a meeting in which Child Poverty Action Group participated last year at the conference of the Publicand Commercial Services Union, many officers from local tax offices complained that staff cuts would meanhigher levels of tax avoidance. One tax officer told the meeting that he knew exactly who the local businessesmen are in his area who will no longer pay as much tax to the Exchequer once the local office, scheduled forclosure, is shut. He suggested they will be laughing all the way to the bank. It is vital that investment is

made in local offices with staff who build up an ongoing knowledge base of local tax liabilities and are

have the knowledge necessary to quickly recognise and investigate cases of avoidance in their area.



3.8 We recommend an immediate review of cuts to HMRC staff involved in revenue collection, enforcementand investigation and a freeze on closure of local tax offices.

3.9 We further recommend that the Treasury reviews its objectives in regard to lost revenue and produces acomprehensive strategy with ambitious targets for maximising the role that closure of the tax gap can playin reducing the deficit, hence alleviating the need for public spending cuts that may lead to job loss andfiscal hindrance.

4. Policy Goals

4.1 Reversing the rise in economic inequality that has affected the UK over the last three decades is an aimshared by all three main Westminster parties. The Prime Minister, David Cameron, said while leader of theopposition: “The Conservative Party recognises, will measure and will act on relative poverty… Fightingrelative poverty [is] a central policy goal”v.

4.2 A further policy goal of the Government is the eradication of child poverty by 2020 in accordance withthe Chid Poverty Act 2010. Taxation policy impacts on levels of child poverty due to (a) its direct impact onfamily budgets, (b) its role in redistribution, and (c) its role in providing revenue for services that alleviateimmediate need and improve long term life chances. Decisions on taxation are therefore levers that can impacton levels of child poverty in both positive and negative ways. The Government must ensure that child

poverty impacts are considered so that taxation decisions contribute to the measurable impacts on child

poverty necessary meet the requirements and policy goals of the Child Poverty Act.

4.3 We recognise that some policy goals that demand taxation approaches have the potential to conflict withgoals on inequality and poverty, such as the growing need to tax carbon consumption. Where this is necessary,tax changes must be made in the round with other policies to address fairness for low income families. Forexample, increases over time to the rate at which domestic fuel has been taxed have not been sufficientlymatched by policies to redress the impact on low income families, such as tax free fuel allowances for sometypes of household, energy efficiency refits for low income households and requirements on energy companiesto introduce policies like social tariffs with sufficient reach. Greater use must be made of impact assessments

where there is potential for such conflicts. Policies to redress negative impacts for low income families

resulting from taxation approaches in areas like health and environmental protection must be timely and

of fully commensurate scale to protect families.

5. Tax Policy for Growth

5.1 There are important principles in regard to when it is right to use taxation rather than other fiscal levers.Rarely is the application of such principles more important than in situations like the present when the countryfaces a major deficit.

5.2 Different fiscal policies are associated with different economic multipliers and can have fiscal stimulus,or fiscal hindrance effects. Powerful voices from elite groups like corporations and wealthy individuals warnthat if they are taxed any higher, there will be negative economic consequences. We believe these claims areregularly given too much credence with too little scrutiny. The success that other wealthy countries have atoperating more redistributive tax systems than the UK suggests that the claims are overstated. If there arestructural problems such as loopholes and complexity that are responsible, then it is these which need tobe tackled.

5.3 Far too rarely are the economic impacts considered of those taxation and fiscal policies that areunfavourable to the lowest income households. A crucial feature of low income families is that they have thehighest marginal consumption rates. They go out and spend their meagre income immediately in their localbusinesses. Comparatively, the wealthiest households have lower marginal consumption rates and are muchmore likely to tie up income in offshore tax avoiding investments, spending on high capital and luxury goods,or make regular trips overseas during which they spend in other territories.

5.4 The decision to focus deficit reduction primarily on spending cuts rather than taxation for wealthyhouseholds, with an annual reduction to benefit payments of £18 billion by the end of the parliament, shouldtherefore be looked upon as a massive fiscal hindrance package. It should be expected to have negativeconsequences for economic growth. These will be particularly targeted to the poorest communities,exacerbating economic decline in areas of concentrated deprivation, high unemployment and low levels ofjob vacancies.

5.5 Positive economic multipliers and fiscal stimulus affects have been subjected to greater academic andempirical scrutiny than negative multipliers and fiscal hindrance.vi However, fiscal hindrance is of equalimportance generally, and of greater importance during periods of fiscal contraction in an economic cycle.Evidence of the strong positive multiplier effects for targeted income transfers to households with high marginalconsumption rates strongly suggest that, conversely, cuts to such income transfers will have significant fiscalhindrance impacts.



5.6 We recommend that the Office for Budgetary Responsibility be tasked with an independent study intoeconomic multipliers so that it is able to provide independent and transparent information to the governmentand the public on the expected multiplier effects—and the expected stimulus or hindrance impacts—of taxationpolicy decisions and other relevant fiscal policy decisions, such as income transfers through welfare benefits.This will improve decision making and increase public confidence in claims made by government in regard tothe economic objectives of such fiscal policies. In the meantime the Government should publish any economicmultiplier estimates it is already using in its own modelling.

January 2011

References

HMRC, Measuring Tax Gaps 2009 (http://www.hmrc.gov.uk/stats/measuring-tax-gaps.pdf)

Richard Murphy FCA, Tax Justice and Jobs: The business case for investing in staff at HM Revenue andCustoms, 2010 (www.pcs.org.uk/taxjusticedoc)

National Fraud Authority, Annual Fraud Indicator, January 2010 (http://www.attorneygeneral.gov.uk/nfa/GuidetoInformation/Documents/NFA_fraud_indicator.pdf)

Richard Murphy FCA, Tax Justice and Jobs: The business case for investing in staff at HM Revenue andCustoms, 2010 (www.pcs.org.uk/taxjusticedoc)

The Scarman Lecture, 24.12.06

See:

— Effects of Fiscal Stimulus in Structural Models, IMF Working Paper WP/10/73, March 2010 (inparticular section G, p. 18) (http://www.imf.org/external/pubs/ft/wp/2010/wp1073.pdf)

— D Elmendorf and J Furman, “If, When and How: A Primer for Fiscal Stimulus”, The BrookingsInstitution, 2008.

Written evidence submitted by the CBI

The CBI is the UK’s leading business organisation, speaking for some 240,000 businesses that together employaround a third of the private sector workforce. With offices across the UK as well as representation in Brussels,Washington, Beijing and Delhi the CBI communicates the British business voice around the world.


The primary purpose of taxation is to raise revenue to fund government expenditure programmes. Ultimately,different groups will have different ideas regarding the additional purposes of taxation. These will includeredistribution and changing behaviour.

It is up to governments to decide on the appropriate balance between these competing priorities, but, in allcases, the objectives should be achieved as efficiently as possible. From an aggregate welfare perspective, theideal tax system would be “neutral”, ie would not distort decisions in areas such as business investment andrecruitment. But policy priorities inevitably result in a non-neutral system.

Instances where the tax system works in the opposite direction to non-tax policy objectives should beminimised. This requires those responsible for setting tax policy to be aware of other Government policypriorities. In the current economic climate, it is particularly important that taxation policy is undertaken in away which supports, or, where possible, does not inhibit, economic growth. This means that tax competitivenessis also a critical principle.




UK Tax Competitiveness

0

1

2

3

4

5

6

Corporate tax revenue as % GDP (2009)

The competitiveness of corporate taxation influences not only the decisions of internationally mobilecompanies to locate and/or remain in the UK, but also the incremental investment choices made by internationalgroups with operations in the UK. As well as affecting the stability and breadth of the tax base, multinationalstend to have higher rates of productivity and produce positive spillover effects in the countries in which theyoperate. Therefore, an uncompetitive corporate tax system can have negative implications for both tax revenuesand economic growth.

The UK’s tax competitiveness has been slipping in recent years. The Coalition Agreement published in Mayannounced the government’s commitment to aim for the most competitive corporate tax regime in the G20.This is necessary for ensuring a stable and broad tax base as well as a more vibrant economy, generally. Manyelements will inform a company’s view of whether a country’s tax system is competitive.

All taxes create distortions through their effect on prices. Prices are used by producers to set the mostprofitable level of production and by consumers to maximise their utility. Taxes disrupt these signals by drivinga wedge between the price paid by the buyer and the price received by the seller. The taxation of corporateincome in the UK creates distortions over how firms raise funds (debt or equity finance), over investmentdecisions, and over decisions to incorporate. Recent research also shows a close correlation between corporatetaxation, wages and employment (put slightly differently, much of the incidence of corporate taxation falls onlabour56). An additional behavioural response for internationally mobile companies is to opt out of a particulartax system altogether. Where taxes are levied on bases which are particularly responsive to price changes, thepotential impact on behaviour and, therefore, growth is greater.

56 Arulampalam, W et al, “The direct incidence of corporate income tax on wages”, May 2008



Tax levels

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10

15

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25

30

35

40

45

Headline corporate tax rates in the G20

Source: KPMG’s Corporate and indirect tax survey 2010

Headline corporate tax rates are an important indicator of tax competitiveness, though not the only one. TheUK’s lead on corporation tax rates has been eroded in recent years, as other countries have cut their corporationtax rates further and faster. The UK currently has the 7th lowest rate of corporation tax in the G20 and the20th lowest rate in the EU27. In 1997 the UK had the 10th lowest main rate among the EU27 countries; bythis year it had slipped to 20th.

The introduction of the 50% personal tax rate has also affected the UK’s competitiveness. In particular,combined with the implications of other tax changes, such as the banking levy, “one-off” bonus taxes andrestriction of pension tax reliefs, the competitiveness of the UK as a financial centre has been affected. Researchhas shown a strong link between tax rates on high earners, and levels of FDI.57

Companies will tend to look at effective tax rates rather than marginal tax rates in their assessment ofwhether to invest and the costs of doing business in a particular tax jurisdiction. The effective average tax rate(EATR) is the proportionate difference of the net present value of a profitable investment project in the absenceof tax and the net present value of the same investment in the presence of tax. Effective rates are a moreaccurate reflection of the true burden of corporation tax on UK business. Our members confirm that this isborne out in practice. For discretionary “big ticket” investments, such as installations in the infrastructure orenergy sectors, the combined cash effect of the tax on project profits and the tax relief on the upfront investmentcan influence which country is the most deserving location when there is limited capital available.

According to analysis by the European Commission, the UK had an (EATR) for corporations of 29.3% in2007 compared with an EU27 unweighted average of 22.3%. The UK’s effective rate is somewhat below thatin, for example, the US (36.9%), Canada (36.0%), Germany (35.5%). Countries with lower effective ratesinclude Ireland (14.4%), Switzerland (18.8%) and Norway (24.5%).58

Tax Structure

The tax system as a whole can also be structured so as to support economic growth, minimising thedistortionary impact on economic decisions and maximising revenues. The OECD has done some valuablework in this area, culminating in its recent report on growth-oriented tax policy reform.59

Recurrent taxes on immobile property are consistently found to have the least distortive effects on long-runGDP per capita, followed by consumption taxes, other property taxes, environmental taxes, personal incometaxes and corporate taxes. However, the OECD acknowledges that it is politically difficult for governments toshift the tax base onto property, which tends to receive tax breaks.

An alternative is to shift towards consumption taxes and away from income taxes as has been occurring overthe past few decades since the Meade report. This has happened to some extent in the UK, following the57 Buettner, T and Wamser, G, “The impact of non-profit taxes on foreign direct investment: evidence from German multinationals”,

June 200658 Elschner, C and Vanborren, W, “Corporate effective tax rates in an enlarged European Union”, Taxation Papers, European

Commission, 200959 OECD Tax Policy Studies, “Tax Policy Reform and Economic Growth”, Tax Policy Study No. 20, 3 November 2010



increase in personal allowances for basic rate taxpayers and the recent increase in VAT. The recently publishedMirrlees review into the UK tax system looks comprehensively at the different options for optimal tax structure.Changes in income taxes will have implications for both the number of working hours undertaken by thosealready in work, and the labour market participation decision. The review notes that, taking into account theinteractions between the benefit and tax system, many of those with the lowest incomes face the highestmarginal tax rates. The sharp increase in tax rates for mobile higher earners, for example, is expected to affectthe choice of entrepreneurs to locate in the UK. The OECD finds that a reduction in the top marginal tax rateis found to raise productivity in industries with potentially high rates of enterprise creation.

Corporate income taxes are viewed as the most harmful for growth as they discourage the activities of firmsthat are most important for growth, namely productivity and profitability enhancing investment. The OECDfinds that lowering headline corporate tax rates can lead to particularly large productivity gains in firms whichare dynamic and profitable. However, lowering the corporate tax rate substantially below the top personalincome tax rate incentivises high-income individuals to shelter their savings within corporations, ie is counterto the principle of tax neutrality.

The Mirrlees review looks at the effect of the corporate tax system and the differential tax treatment of debtand equity and the effects on investment. Alternatives proposed include cash flow taxes, the Allowance forCorporate Equity (ACE) and the Comprehensive Business Income Tax (CBIT). Any of these would result inthe equalisation of the treatment of debt and equity finance (something similar to ACE was introduced inBelgium in 2008). The first two proposals essentially extend tax relief to equity-raising, while the thirdabolishes tax relief for debt finance. All would be difficult to implement as the first two would involvenarrowing the corporate tax base, while the last would put the UK out of kilter with international competitors.

In the latest HMT publication on Corporate Tax Reform,60 and in line with our Tax Task Force reportrecommendations, the Government has committed to maintaining the position of interest as a legitimatebusiness expense, and thus tax deductible, given that this is considered one of the more competitive featuresof the UK tax system.

Broad base-low rate

The OECD also looks at base broadening accompanied by rate lowering as a means of increasing theefficiency of the tax system.61 Benefits of a broad base-low rate combination include:

— Fewer distortions due to fewer exemptions.

— Higher tax compliance due to reduction in arbitrage opportunities and lower rates.

The Mirrlees review notes that the UK corporation tax rate has fallen from 52% in 1982–83 to 28% in2009–10 and is set to fall further to 24% by 2014–15. Despite this, corporate tax revenues have remainedstable at a little over 3.5% of GDP. This is at least in part because cuts in corporation tax main rate have beenaccompanied by reductions in reliefs and allowances or other extensions to the corporate tax base.

The Office for Tax Simplification (OTS) recently published a list of UK tax reliefs and exemptions. Theywill be making recommendations for action in the 2011 Budget on 23rd March.

Other Features of a Good Tax System

This section outlines the characteristics associated with a “good” tax system. In its 2008 Report on TaxReform, the CBI Tax Task Force identified the following key principles which should underlie tax reform:

— Neutrality (ie, tax should not distort business decisions).

— Simplicity and clarity.

— Certainty and stability.

— Flexibility in response to changing business practice and competitive pressures.

Tax policy making which takes these into account can help minimise the burden of tax compliance. However,some of these will trade off against each other. For example, a complex tax system would benefit fromsimplification to help reduce compliance costs. But, changes in the tax system create uncertainty and, therefore,impact on the longer term investment plans of companies.

Neutrality

Tax neutrality essentially means that the tax system should not distort choices and behaviour, i.e. thattaxpayers in similar situations and carrying out similar transactions should be subject to similar levels oftaxation. So, for example, the incomes of employees, the self-employed and small companies should be taxedat the same rate. A non-neutral system creates incentives to reduce tax payments by changing behaviour—thebehavioural response. This may be either a deliberate policy choice, such as in the case of taxing pollutingindustries more heavily, or incidental to the revenue collection objective. Revenue-reducing behavioural60 HM Treasury, HMRC, “Corporate Tax Reform: delivering a more competitive system”, November 201061 OECD Tax Policy Studies, “Choosing a Broad Base—Low Rate Approach to Taxation”, Tax Policy Study No. 19, 28 October

2010



responses may be countered by the government developing anti-avoidance legislation, which tends to increaselegislative complexity and compliance costs. It should also be noted that, in the cross-border context, theTreasury has explicitly abandoned Capital Export Neutrality, ie trying to exactly equalize the tax treatment offoreign and domestic investments.

Clarity and Simplicity

Legislative clarity is important as it enables companies to comply more easily as tax liabilities are easilyunderstood, and should reduce costly and time-consuming disagreements with the tax authorities. Taxcompliance should not require an excessive amount of company resource, which would divert energy frommore productive and profitable business activities. Tax complexity may be a particular issue for SMEs ascompliance costs represent an almost fixed cost and SMEs are also less able to afford to take the steps tominimise their tax liability. Unfortunately, there may be a trade-off between clarity and simplicity. To providegreater clarity on the scope of a tax, for example, legislation may need to be lengthy, which may be consideredto reduce simplicity.

Tax incidence is important when considering ways in which the tax system can be simplified. For example,both employers and employees pay national insurance contributions and employees also pay income tax. Butemployer contributions affect employer decisions about pay and employment levels which ultimately are borneby employees. Tax incidence is particularly important when considering changes to corporate taxation as taxesare ultimately paid by individuals, ie employees or customers. In general, corporate taxes lead to a lower levelof investment leading to lower capital per worker, which lowers wages.

Stability, certainty and predictability

Companies make long term investment decisions over substantial time periods and need to do so in a taxsystem which is stable in order to receive the expected return on investment (which may then, for example,encourage further investment). Stability in the tax system gives companies certainty about their ongoing taxliabilities and when they fall due. However, changes in the tax system that reduce complexity introduceinstability so an assessment needs to made about the relative importance of these factors. For example,businesses may have a preference for government flexibility in tax setting where it is an appropriate responseto tax developments in competitor jurisdictions. The government can work to minimise the adjustment costsassociated with changes in the tax system. An adequate notice period for tax changes, the involvement of taxprofessionals in the design of taxes and an avoidance of retroactive tax changes (including by grandfatheringprovisions) can all help companies adapt. An appropriate balance obviously needs to be struck betweengovernment having flexibility in policy making and the business need for stability.

Administration and collection

Changes in the way in which taxes are collected can be every bit as disruptive as changes in the underlyinglegislation. As well as bearing the economic burden of some taxes, companies also act as unpaid collector ofmany other taxes62 for government, and the systems costs and complexity to do so can be highly material. Achange in the interpretation of tax law by HMRC makes it difficult for businesses to predict the impact ofcomplying with tax legislation.

The Mirrlees review states that the tax system should be judged by its impact on the trend rate of economicgrowth. An appropriate tax policy, taking into account the issues raised above, will help support economicgrowth. Adherence to these tax principles will give companies the confidence to invest in the UK, helpingboost investment and productivity.


To reiterate, we believe that the tax system should be as non-distortive as possible. And, furthermore, evenif a policy aim is thought to be worth pursuing, the question should always be asked whether the tax systemis the most efficient method of delivery. The tax system is often a blunt and indirect tool, and, additionally,using the tax system in this way inevitably increases complexity. However, taxation is often chosen as the policyinstrument for changing behaviour to deliver a government policy objective, such as promoting innovation orto support environmental objectives that the market seems unable to deliver. In such cases, the importance ofthe behaviour change for increasing growth or addressing other policy objectives is believed to outweigh otherprinciples of tax design.

The haste with which some tax policies with a behavioural objective are developed, however, may meanthat insufficient consideration is given to the principles of good tax policy. A number of taxes have been, orare set to be, introduced to counter perceived market failures in the financial services sector, namely the bonustax, 50% higher tax rate and bank levy. These have a number of objectives, including countering excessiverisk taking by individuals and inadequate regulatory structures. The 50% personal tax rate, for example, wasimplemented partly with a revenue-raising objective and partly following the backlash against aspects of thefinancial system following the crisis. It was arguably aimed at correcting a market failure, namely that financial62 Eg PAYE, employee NIC, VAT, CCL



sector pay was inappropriately structured to encourage excessive risk-taking. But there are, arguably, muchbetter ways of approaching this issue, and many of the principles of good tax policy making were set aside inthe announcement of this policy. The way in which the 50% rate fitted with other policy announcements, suchas changes to NICs and pensions taxation, and the scaling back in the tax free allowances for particularly highearners, led to substantial distortions in the tax treatment of earnings above £100k. In particular, it failed thecompetitiveness test, making London less attractive relative to other jurisdictions for mobile high earners.


From the perspective of a neutral tax system, there are a number of taxes which are distortionary. Again,the ideal of a neutral tax system needs to be considered alongside other government policy objectives whichdistortionary taxes may be designed to address. There are some areas of the tax system, for example, whichare distorting but can be justified on other grounds.

— The tax treatment of foreign earnings.

— Taxation of financial services.

— Taxation of innovation.

— Tax treatment of those with non-domiciliary status.

— Zero tax relief for a significant part of the cost of investment in the UK’s infrastructure.

There are also, however, a number of areas within the the business tax system which definitely requirechanges to remove distortions. These include:

— Taxable profit to comprise all business income less all genuine business expenditure;

— Abolition of the schedular system;

— Elimination of tax nothings.


To be able to levy a tax, the tax authorities need to be able to identify the base on which the tax is to belevied. Changes in tax rates often lead to a behavioural response where the affected individual or firm workout the best way to organise their activities so as to minimise their tax liability. The government will then oftenrespond through tightening up anti-avoidance legislation. This leads to a steady escalation in complexity andcompliance costs.

Those taxes which are easiest and most efficient to collect are more likely to be supportive of economicgrowth. Such taxes would have lower compliance and administrative costs and be straightforward in theircoverage, minimising the uncertainty which undermines competitiveness. However, this should be consideredalongside other important characteristics for an efficient tax system.

The current source-based corporate income taxes have very high administrative and compliance costs, forexample, in the setting of intra-firm transfer prices. The generally favourable tax treatment of debt encouragesmultinationals to raise debt in high-tax jurisdictions to maximise the tax relief. This then leads to thedevelopment of complex anti-avoidance rules, such as thin capitalisation which seek to limit the taxdeductibility of interest. The worldwide debt cap also seeks to limit the amount of debt that multinationals canset against tax in the UK. The tax treatment of interest is a particularly good example of excessively complexand largely unworkable legislation aiming to set limits on reliefs.

Another example is the CFC regime, where the current rules make it difficult for UK headquarteredmultinationals to finance their non-UK operations in the most efficient way, for example using surplus cashfrom one foreign subsidiary to fund another foreign operation. The UK has become perceived as particularlyaggressive both in terms of the rules themselves and the way that they are interpreted. Any move into a lowtax jurisdiction is likely to be treated as tax avoidance regardless of the existence of commercial motives, andthe available exemptions are both restrictive and administratively burdensome.

CFC reform has been needed for many years, and the complexity of the rules and uncertainty over reformhas contributed to decisions of a number of high profile UK listed companies (eg Wolseley, WPP, Shire)moving their tax base offshore/inverting. While tax rate competition is an obvious factor, many of thesecompanies have cited the prolonged uncertainty over CFC reform as the main reason.

The CBI has, therefore, welcomed publication of the Government’s Roadmap for Corporate Tax reform,which includes major reform of the CFC rules. Complexity and uncertainty in the tax system has a majorimpact on the competitiveness of the UK as a place to do business, and it is essential that tax policy takes thisinto account.

January 2011



Written evidence submitted by the TUC

Introduction

It is noted that1 “The Treasury Committee has decided to launch its own inquiry into the principles whichshould underpin the tax system, and invites written evidence on the following points:

— What are the key principles that should underlie tax policy?

— How can tax policy best support growth?


— How much account should be taken of the ease and efficiency with which a particular tax can beimposed and collected?

— Are there aspects of the current tax system which are particularly distorting?”

This submission to the Treasury Committee is made by the Trades Union Congress. The TUC is happy toprovide oral evidence in support of this submission if requested to do so.

Part 1—The Principles of Tax

Five reasons to tax

There are five reasons for taxation. Tax is used to:

1. raise revenue ie to fund the activities of government;

2. reprice goods and services considered to be incorrectly priced by the market such as support forfamilies, tobacco, alcohol, carbon emissions etc;

3. redistribute income and wealth;

4. raise representation within the democratic process because it has been found that only when anelectorate and a government are bound by the common interest of tax does democratic accountabilityreally work (this being a key issue in UK local government at present); and

5. reorganise the economy through the operation of fiscal policy.

Any system that determines the key principles of tax must be take all these considerations into account.

The 10 attributes of a good tax system

An efficient taxation system has nine attributes with one over-riding characteristic to which they allcontribute. An efficient tax system is:

1. Comprehensive—in other words, it is broad based;

2. Complete—with as few loopholes as possible;

3. Comprehensible—it is as certain as is reasonably possible;

4. Compassionate—it takes into account the capacity to pay;

5. Compact—it is written as straightforwardly as possible;

6. Compliant with human rights;

7. Compensatory—it is perceived as fair and redistributes income and wealth as necessary to achievethis aim;

8. Complementary to social objectives;

9. Computable—the liability can be calculated with reasonable accuracy;

All of which facilitate the chance that it will be:

10. Competently managed.

In combination we believe that these are key attributes of a good tax system.

The six steps to managing taxation

The process of managing a tax system taking all the above into account is a six step process:

1. Define the tax base. This is the first essential step in creating progressive taxation and in promotingthe better use of resources within society.

2. Locate what is to be taxed. If the tax base cannot be accurately located then there is no point tryingto tax it.

3. Count the tax base. Unless the tax base can be quantified it cannot be taxed.

4. Tax the tax base at the right rates of tax. In the process making sure the inter-relationship betweenthe various tax bases is properly managed to ensure that the essential revenue raising, repricing andredistributive qualities of a just tax system is vital.



5. Allocate the resulting revenues efficiently and to best social effect. Tax is not just about revenueraising, but is part of a whole revenue cycle that must also be properly managed.

6. Report—governments must be accountable for what they do with tax revenues or the democraticprinciple fails.

We stress that we believe these three elements—having proper and justified reasons to tax, using soundsprinciples to design a tax system and having clear objectives in managing a tax system are all inter-related. Itis when that inter-relationship fails that problems arise in the tax system.

Part 2—Tax and the Economy

Tax and growth

Tax is not an option within a developed economy; it is an integral part of it. A developed economy is alwaysa mixed economy; the state and private sector do, without exception, interact in such economies to create theenvironment in which personal, social, political and societal goals are met. This point is stressed: economicgrowth is an element in achieving these goals, but it is not the sole way in which they are achieved. As suchany policy on growth has to respect other purposes for taxation as well. This is clear from the attributes of agood tax system, noted above.

It should also be noted that tax can only provide a part of the solution to any economic issues that the UKfaces: tax is only paid when economic income that can be located and assessed to tax is generated. Tax policyby itself cannot create an environment in which additional government income of the scale needed to resolvethe level of unemployment currently suffered in the UK will be generated. At best tax policy can only help indoing so. Other policies will be needed as well.

That said, there can be no doubt that growth in employment is vital to the recovery of the UK economy andto the raising of the revenues needed to clear the government’s deficit and if tax is to play a part in this processit must encourage the creation of the most jobs possible for the least government spending achievable. This,in our opinion, means three strategies need to be adopted.

Firstly, our research2 has shown that about £38 billion a year of subsidy was given to pension contributionsin the UK in 2007–08. We note that recent caps on pension contributions and the economic downturn mayhave changed this situation slightly but we do firstly question whether this level of subsidy can still be justifiedwhen other elements of government spending are subject to significant cuts and secondly question whether thegovernment might take more powers to direct the resulting use of the funds in question to enhance employmentopportunities and the prospects for growth. We believe that substantial resources might be redirected to activitythat would create employment if such intervention was considered.

Secondly, it has long been recognised that small business is the biggest engine for growth in the UKeconomy. This suggests that any tax advantage to be given to business to encourage growth should be focussedon encouraging the growth of small enterprises and the creation of new employment opportunities in thissector, which often have the lowest cost of job creation. This is not, however, assisted by current taxationpolicies where a number of trends are emerging as evidenced by research we have undertaken on effectivetax rates:

1. The effective tax rates of large companies in the UK have fallen to little more than 21% by 2009,with a trend reduction of 0.5% per annum.

2. It is stated government policy to reduce headline UK tax rates for large companies by 1% per annumfor the next four years.

3. Whilst changes in capital allowance rules may have marginal impact on effective rates of tax it ishighly likely that sometime during this period many large UK companies will see their tax rates fallto rates lower than those paid by a majority of small UK companies, whose rate of corporation tax isonly set to fall to 20%. This will mean that the very long established deliberate differential in rates infavour of small business will have effectively been eliminated and this does not appear to be a policyaimed at encouraging growth.

4. There remain significant administrative impediments within the tax system to running small limitedcompanies that do also, unfortunately, provide some with opportunity for abuse of the tax system onoccasion. It would seem that creation of a simpler style of corporate trading entity enjoying simplertax structures with regard to the relationship between an owner and the entity which does at the sametime eliminate opportunity for tax abuse is an issue worthy of further investigation so that impedimentsto growth of small businesses can be removed whilst protecting the tax base.

Thirdly, and perhaps most importantly, since we believe that government spending will be the instrumentfor the growth we need to break us out of the current economic situation in which we find ourselves, webelieve that measures to tackle the tax gap are vital if we are to raise the funds needed to promote the growththe UK economy now needs. The tax gap is defined by both H M Revenue & Customs and the TUC as thetotal of the tax avoided, evaded and unpaid despite being declared as owing in a period. It is, we believe, onlywhen the government spends more money into the UK economy through new engagement with the privatesector leading in turn to new employment that the multiplier effect can fully function in the way that is desired



to drive the UK economy back towards full employment and, in turn, government finances back towardsbalance. The most obvious means by which this cycle can be financed is through spending financed by thethreefold process of tackling tax evasion, tax avoidance and overdue tax debt. This can be done through arange of measures. In particular:

1. HM Revenue & Customs should recruit a substantial number of new staff to tackle these three issuesof evasion, avoidance and debt: we do not see how they can be properly addressed otherwise.

2. Local tax offices need to be re-opened. We believe that this would make HM Revenue & Customsmore effective. We also think it important that tax is managed from within the communities in whichpeople live in the UK. This, we think is part of the democratic process of taxation to which we referin the first part of this submission.

3. We support the introduction of a General Anti-Avoidance Principle into UK taxation law and changesin the legal process of interpretation with regard to tax law to make this purposive.

4. We believe that changes in accounting regulation to make it easier to identify what tax is paid bymultinational companies in each country in which they operate (“country-by-country reporting”) wouldbe of real benefit to identifying the UK Tax Gap and drawing attention to the issues that arise withregard to recovery of the right amount of tax from multinational corporations trading in the UK.

By adoption of these and similar measures we believe that important tax revenues needed to firstly preventcuts and secondly stimulate growth can be raised from within and beyond the UK economy.

Tax and other policy goals

As noted above, the goals for a good tax system are much broader than the promotion of economic growth,however important that might be.

Within the constraints of space we note that a number of vital social goals are not currently being promotedby the UK tax system:

1. The need for a tax on financial transactions to ensure that a) banks make their fair contribution tosociety; b) that they are taxed on an equal footing to other services which is not the case at presentas VAT does not apply to their charges, and c) to limit speculation has not been met by any measureso far proposed for taxing banks. We believe that such a tax—popularly known as the Robin Hoodtax—is an essential component of a just tax system.

2. The UK tax system is not progressive at present. Effective tax rates by income decile have beencalculated as follows:

Source: Byrne and Ruane, 2008; The dotted line refers to the average for the first ten years of the Labourgovernment (until 2006/07). The continuous line refers to 2006–07 only.

The 50% tax rate may have helped change this profile slightly, as has restriction on the pension tax reliefavailable to those on that tax rate, but it remains true that tax in the UK remains far too penal on the poorestand those on middle income and is overall beneficial in its structure and operation to those on high incomes.



Reforms to council tax, where higher tax bands and a complete overhaul are essential, to national insurancecontribution rates (which are regressive) and to the amounts of tax relief available to those on higher incomesto introduce overall caps on other reliefs similar to that now applied to pensions, are essential if this situationis to be addressed.

3. There is no tax incentive to reduce pay disparity in the UK. The banker’s bonus tax did this, and waseffective in raising revenue but was discriminatory in application, not least because it only applied to bonusesand to the finance sector. We note that Will Hutton believes that a pay differential of 20 times the lowestearnings paid by an organisation is the maximum pay differential that should be allowed in the public sector.Assuming that low pay is defined as the minimum wage and that 40 hours is an average working week thenthis would suggest that there is at present a potential public policy issue with pay of above approximately£250,000 per annum. Whilst limits on pay can be imposed in the public sector this is hard in the private sectorbut tax differentials to discourage such pay can be created, for example either by the payment of increasednational insurance contributions by an employer on high levels of pay or by removing tax relief for salarycosts for businesses making payment of remuneration above this level. We believe that these are issues wheremore work needs to be undertaken to reduce income disparities in the UK.

4. It is clear that carbon taxation is an issue that has not been properly addressed by any government, andwhere little progress is being made. If it is accepted that global warming is a reality—and that is the positionof the TUC and the UK government—then finding appropriate measures to firstly encourage green technologyand secondly to discourage carbon use (with necessary protection for those on lower earnings levels) areessential. We believe that green technology is best encouraged through direct government intervention, forexample through expanded industrial support. We do however think that tax has a potential to reduce carbonusage that has not as yet been properly explored, subject to the protections for those on low income noted.

5. Wealth disparities in the UK remain high, and as the work of Richard Wilkinson and Kate Pickett hasshown, contribute to a loss of well being for all in society and not just the poor.3 Wealth taxes in the UK arewidely avoidable and are avoided. A review of wealth taxation and its reform is essential. This is particularlytrue of Inheritance Tax which has relatively little impact on those with significant wealth.

6. Access to housing is a key issue for many people in the UK economy. Despite this very large numbers ofhouses stand empty in the UK, often for extended periods. Allowing reduced rates of council tax on vacantproperties encourages this practice. We have proposed that instead of allowing reduced rates of council tax onsuch properties that they should instead be subject to a substantial uplift in the council tax charge after areasonable period of vacancy (and with due allowance made for those absent through ill health). We believethis would achieve three goals. The first is additional tax revenue. The second is that properties would be madeavailable to the market place for sale or rent. The third is that the blight of empty properties will be removedfrom communities that suffer this problem.

7. Effective local taxation is essential if local government is to be truly accountable to those who elect it. Inview of the government’s plan to devolve more powers to local authorities a review of the out-dated andregressive structure of Council Tax is long overdue.

The ease of collection of tax

As noted above (The six steps to managing taxation) unless a tax base can be defined, located, counted andtaxed (or collected) then a tax is inefficient.

If HM Revenue & Customs data on the UK tax gap is to be believed then income tax and national insuranceare the least avoided and evaded taxes in the UK, proportionately. Their rate of loss, according to HMRCdata,4 is £15.8 million out of £253 billion, or an error rate according to HMRC of 6%. In contrast H MRevenue & Customs estimate the VAT gap is 12% and the corporation tax gap is 16%.

This very clearly implies that indirect taxes are a much less efficient way of collecting tax in the UK thandirect taxes for the vast majority of sources of income, the exception clearly being with regard to incomegenerated from business activities. Since VAT loss is also related to business activities it is readily apparentthat to promote more dependence on indirect taxation is inappropriate until better mechanisms for locating thecorporate and business tax base can be established. This does relate in part to issues already noted with regardto corporate reporting but it also suggests substantially enhanced regulation and control of the UK smallbusiness sector by the Department for Business Innovation and Skills is required through the operation ofCompanies House so that tax losses through what are, in effect, “missing traders” are mitigated. It seems to usthat this is an issue of the highest priority at this point in time and until it is then the generally accepted ideathat indirect taxes are somehow more efficient than direct taxes cannot be accepted and is not a basis for actionin the UK economy.

Distortions in the UK tax system

There are a number of very significant distortions in the UK tax system. Some that are of concern to us are:

1. The regressive nature of the overall tax system, as noted above.

2. The regressive nature of local taxation already noted.



3. The bias in favour of large companies now being built into the tax system, already noted.

4. The continuation of the availability of the domicile rule, which we believe wholly inappropriate as itallows discrimination on the basis of national origin within the tax system.

5. The relative ease with which those with sufficient means can abuse the UK tax residence rules remainsa matter of considerable concern.

6. The tax system still heavily favours capital gains over income, an anomaly that only Nigel Lawsonsuccessfully addressed.

7. The taxation of labour income remains at much higher rates than the taxation of income from capitaldue to the impact of national insurance charges on the former but not on the latter: this is an anomalythat appears long overdue to be addressed.

8. Consumption is now taxed at the same rate as income—and consumption taxes will for manyhouseholds now form a greater part of their tax burden than do direct taxes. This denies those in thissituation the chance to save, invest and create opportunity that is available to those with wealth whodo not need to spend all they earn on the basic needs of modern living. This impairment to equalityof access to the realisation of the potential all people in our society latently enjoy is a matter of seriousconcern and should be addressed in a fair tax system.

9. Small businesses run as limited companies are still being provided with opportunities to both save taxand avoid national insurance when compared to those run on a self employed, partnership or limitedliability partnership basis. This distorts business behaviour and provides an incentive for tax abuse.This distortion needs to be addressed to encourage a level playing field for all small businesses inthe UK.

10. Tax relief on pension and other tax reliefs is still worth considerably more for each pound expendedby those on higher rates of tax than it is to those on the basic rate, meaning that the cost of pensionsaving is higher for those on low income that it is for those on high income, an anomaly that appearsto make no sense in the current UK economic environment. The creation of a level playing field wherethe amount of tax relief granted for each pound expended by a taxpayer is equalised would appear tomake sense within the current economic climate and to ensure that the goals of an efficient tax systemare met. In addition, the tax free lump sum allowed on retirement is always worth more to higher ratetaxpayers than to those on basic rates of tax and this is another anomaly that makes no sense in thecurrent economic environment, where relief might appropriately be restricted at higher rates.

January 2011

References1 http://www.parliament.uk/business/committees/committees-a-z/commons-select/treasury-committee/news/committee-launches-inquiry-into-the-fundamental-principles-of-tax-policy/

2 http://www.tuc.org.uk/economy/tuc-16929-f0.cfm

3 http://www.equalitytrust.org.uk/

4 http://www.hmrc.gov.uk/stats/measuring-tax-gaps.pdf

Written evidence submitted by Catherine Fromant

I am a solicitor in private practice and through my membership of the Society of Trust and EstatePractitioners I have received details of the above inquiry.

I specialise in advising elderly clients and through my dealings with them I would like to mention thefollowing in relation to your inquiry.

1. I have had several probate cases where following the death of the first spouse, the surviving spouse sellsa second property that was held by both spouses jointly for many years eg a holiday home or an investmentproperty. The sale triggers a capital gains tax charge on the surviving spouse's half share. Very often in thesecases the surviving spouse has never had to complete a tax return—their pension is taxed under PAYE andtheir interest on savings has tax deducted at source. Trying to deal with a one off CGT assessment in thesecases is very difficult and I am sure there must be many cases when taxpayers either are not aware of theirliability or because of the difficulties in reporting the one off gain do not in fact inform the Revenue.

2. The benefits and tax allowances given to the retired generation are a burden on public funds anddisproportionate to the tax liability of the working population.

Many retired people bought homes for around £5,000 in the 1960s and are able to sell the same propertyfor between £500,000 and £1,000,000 now, depending on the area. There is no CGT on sale (principle privateresidence exemption) and no CGT if it is sold after they die. There might be inheritance tax on death, althoughfor many if their estates are under £650,000 this does not apply for married couples with the transferablespouse IHT allowance.



In the meantime they are entitled to winter fuel allowance, free prescriptions, free travel, free TV licencesetc. For those retired people whose incomes are within the personal age tax allowance this is understandable.However, many retired people have very good incomes and do not need these benefits—they do not havemortgages to pay or children to support, their food bills are lower than in their younger days as they do noteat as much, they do not travel as much as when they were younger and many are not mobile enough to haveweekends away or holidays and so do not contribute much into the economy. As people live longer, a sizeableproportion of that generation have high demands on the NHS over many years, free at the point of delivery.

Many have benefitted from a generous tax and benefit system for retired people, aimed at those on modestincomes but benefitting many who have seen a massive transfer of wealth in the values of their properties andthere now seems to be a disproportionate burden of tax on the working population, particularly young people,many of whom cannot earn enough to pay for the basics of housing, food and travel to work etc but meanwhileare paying a relatively high percentage in income tax, national insurance, VAT and Council Tax.

Because of the generous IHT allowances, money is now passed to a proportion of fortunate beneficiaries inthe next generation in large amounts creating an unfair distribution of wealth between the next generationwhich leads to other difficulties in society. The generation dying often have not had the use of their wealthbecause it has been tied up in their property, but when they die this is released and passed on as untaxed moneyto the next generation who have not had to work for it.

3. The IHT exemption given to charitable bequests often means that well off people, particularly thosewithout children, leave their estates to charities and therefore pay nothing back into the system for the benefitsthey have received from the National Health Service, a well resourced society eg the police, teachers,government departments etc. Perhaps instead of a 100% IHT exemption for charities this could be a 50%exemption.

January 2011

Written evidence submitted by EEF

About EEF

1. EEF is the representative voice of manufacturing, engineering and technology-based businesses with amembership of 6,000 companies employing around 800,000 people. A large part of its representational workfocuses on the issues that make a difference to the productivity and competitiveness of UK manufacturing,including investment, innovation and tax issues.

Summary

2. To build a better balanced economy, the UK needs the right type of growth, built on long-term investmentsin innovation, technology and exports. Consequently, the UK needs a competitive and predictable tax regimethat gives the private sector—including fast growing manufacturers—the long-term confidence it needs toinvest in the UK.

3. At the start of 2010, however, the UK had a business tax regime—including corporate, personal,environmental and indirect taxes—that stood in the way of growing a better balanced economy through long-term investments in innovation, technology and exports.

4. The government’s commitment to reforming the corporate tax system has been commendable in that ithas sought to provide stability and reduce the corporate tax burden on business. In practice, however, itsreforms have yet to deliver the improvements to the business tax system needed to drive growth.

5. For example, its “New Approach” represents a much needed change in how tax policy is developed, yetthe government has got off to a rocky start in implementing it. In addition, the government has put reforms insilos, focusing narrowly on individual aspects of corporation tax rather than looking holistically at businesstaxation and how tax reform should support growth.

6. EEF are therefore concerned that the government’s current approach to tax reform risks leaving businessfacing a patchwork of reforms in which the whole is significantly less than the sum of the parts.

7. Consequently, EEF believe that the government’s tax reform agenda is in danger of falling short of thegovernment’s own priorities, and most importantly, what businesses—including manufacturers—need from thetax system to invest in growth.

8. Government, however, can ensure its tax reforms support growth through the following actions:

— Commit to the “New Approach to Tax Policy Making”. Businesses will begin to question thegovernment’s credibility on tax reform if its implementation does not improve.

— Revisit reforms that are neither neutral nor efficient. This includes rethinking planned reforms forcapital allowances and environmental taxes.



— Take a more holistic approach to business tax reform. Doing so would help government in itsefforts to reduce the cumulative burden of business taxation and ensure its proposals—such as onthe R&D tax credit and the patent box—make the best use of Exchequer revenues in terms ofsupporting broad-based investments in innovation.

Introduction

9. The Select Committee’s inquiry provides the ideal opportunity to assess how this government’s tax policyis affecting investment and growth.

10. Private sector growth in 2011 and beyond will be driven by investments in innovation and newtechnology in the UK (see Chart 1). But despite the recovery, many businesses still perceive too many unduerisks around making long-term investments in the UK.

Chart 1

INNOVATION & CAPITAL INVESTMENT IN UK IS KEY TO SUCCESS

% of companies citing how strategic priorities will be met

8

25

25

32

36

69

76

0 20 40 60 80

Investment in marketing

Increase capex elsewhere

Increase innovation elsewhere

Acquistion

Joint venture

Increase capex in UK

Increase innovation in UK

%

Source: EEF Shape of British Industry Survey

11. At the start of 2010, the UK had a business tax regime—including corporate, personal, environmentaland indirect taxes—that was tilted against manufacturing and stood in the way of growing a better balancedeconomy through long-term investments in innovation, technology and exports.

12. The government’s commitment to reforming the corporate tax system has been commendable in that ithas sought to provide stability and reduce the tax burden on business. In practice, however, its reforms haveyet to deliver the improvements to the business tax system needed to drive growth.

The Fundamentals of Tax Policy

13. If tax policy is to support growth, government needs to refocus on competitiveness and predictability,two principles which provide a real-world context for academic concepts like neutrality and efficiency.

14. According to academic literature on tax, a truly neutral tax regime would treat all taxpayers, regardlessof size or sector, the same, while an efficient tax regime should not artificially distort investment decisions.

15. As noted above, the private sector recovery and sustainable growth needs to be driven by long-terminvestments in new technologies, innovation and exporting. In a global economy, manufacturers—even smallones—can choose to invest in growth outside the UK if the tax system remains uncompetitive.

16. Consequently a neutral and efficient tax regime would be competitive if it reflected modern businesses’investment cycles and payback periods, recognised the costs and risks inherent to developing innovationsquickly and to scale, and it provided the stability and predictability needed to confidently make long-termcommitments to the UK.

17. EEF believe that it is possible for the government, through simple reforms, to create a competitive taxregime for growth without resorting to special carve outs and tax breaks that distort investment decision acrossthe economy. Maintaining neutrality and efficiency across the tax system is essential for broad-based growthin the UK. Doing so, however, requires the government to shift from its narrow focus on individual aspects ofcorporate tax reform to take a holistic view of how to improve the competiveness of the business tax system.



18. Consequently, it is important to understand that the current tax system and the government’s proposalsfor reform are far from neutral or efficient for businesses planning for growth, including manufacturers. In factthe tax system is becoming increasingly tilted against the investments in technology and innovation that thegovernment believes are critical to private sector growth.

Tax Policy and the Right Type of Growth

19. The tax system, through its various rates, reliefs and allowances, creates incentives and barriers forbusinesses planning for growth. However, the financial crisis and the painful recession have shown that not allgrowth is equal. To build a better balanced economy, the UK needs the right type of growth, built on long-term investments in innovation, technology and exports. Consequently, the UK needs a competitive andpredictable business environment—including tax—that gives manufacturers the long-term confidence to investin the UK.

20. Manufacturers’, however, have concerns about the UK’s business tax regime (as shown in Chart 2below). Given this negative view, the government’s early commitment to tax reform has been commendable.The 4p cut in the headline rate of corporation tax over the next four years sends a strong signal that the UKwants to create a competitive corporate tax regime. The government’s “New Approach to Tax Policy Making”,which is based on more effective consultation and scrutiny of tax reform proposals, could improve the qualityof legislation and reduce the likelihood of unintended consequences. Similarly, the government’s broad roadmap for reforming corporation taxes underscores its commitment to improving predictability for businessesmaking long-term investment decisions.

Chart 2

UK MANUFACTURERS CONCERNED ABOUT BUSINESS ENVIRONMENT

% citing business environment as bad or challenging

0% 10% 20% 30% 40%

Supplier quality

Infrastructure

Supplier quantity

Skills

Tax

Regulation

Source: EEF Shape of British Industry Survey

21. However, these positive improvements to the tax system have been more than offset by the government’sother reforms and proposals. For example, the cut in corporation tax rates was financed by lowering the levelof capital allowances (from 20% to 18%) and by lowering the threshold of the Annual Investment Allowance(from £100,000 to £25,000). The result was a tax rise and a significant cashflow loss for growing, capitalintensive companies. EEF is also concerned that future cuts to the headline rate of corporation tax will befinanced by higher and inefficient environmental taxes placed on manufacturers. The government’s reforms ofthe Carbon Reduction Commitment and Controlled Foreign Companies tax rules were not in keeping with thespirit of its the “New Approach to tax policy making”. And by focusing too narrowly on individual aspects ofcorporate tax reform, the government may miss opportunities to think strategically on how tax reforms canstimulate growth and investment. Each of these issues is discussed in detail below.

22. Consequently, EEF are concerned that the government’s current approach to tax reform risks leavingbusiness facing a patchwork of reforms in which the whole is significantly less than the sum of the parts.

Taxing Growth?

23. A modern, competitive and predictable tax system would not only recognise the significant costs ofinvesting in modern machinery. It would enable small businesses to invest in growth. It would attract mobile



multinational investment to the UK. And it would provide the predictability needed to minimise the tax risksto returns on those investments.

24. However, EEF believe that the government’s tax reform agenda is in danger of falling short of thegovernment’s own priorities, and most importantly, what the private sector need from the tax system to investin growth.

Predictability

25. While the “New Approach” represents a much needed change in how tax policy is developed, thegovernment has got off to a rocky start in implementing it. For example, the Spending Review included anunexpected and costly reform to the Carbon Reduction Commitment. The £1bn reform of environmentaltaxation removed tax incentives for companies to reduce carbon emissions, even though thousands ofcompanies had made significant investments in complying with the scheme. Far from the government’scommitment to consult on changes in advance, the £1bn tax change came as a surprise in the fine print of theSpending Review announcements.

26. Recent announcements on changes to Controlled Foreign Company tax rules have also increaseduncertainty that the “New Approach” was designed to tackle. In November, the government published wide-ranging road map for reforming the corporate tax system. The initial reaction from manufacturers was positive.But their confidence in the government’s ability to deliver on the important and otherwise well receivedproposals was dented by aggressive new anti-avoidance legislation announced on the 6th of December—daysafter the road map was launched—via a written Ministerial Statement from David Gauke, Exchequer Secretaryto the Treasury. One of the measures that was introduced in the statement with immediate effect, effectivelyblocked what the road map indicated government would allow from 2012.

27. These departures from the “New Approach” have fostered uncertainty and left manufacturers questioningits patchy implementation: there is little clarity on which tax reforms would use the “New Approach” andwhich reforms would not. The resulting loss in predictability adds unnecessary uncertainty to firms makinglong-term business decisions.

Competitiveness

28. Given that their growth is driven by investment and innovation, the UK's headline corporate tax rate isunlikely to be the only consideration for firms debating whether to make long-term investments in the UK orabroad. Changes to environmental taxes, capital gains taxes, pensions relief, personal allowances and the toprate of income tax, are also crucial to determining whether the serial entrepreneurs and multinationals thatcould invest in growth and jobs choose to invest in the UK. Apart from changes to capital gains taxes in theJune Budget, businesses have heard very little on how the government plans to address the cumulative drag ongrowth from the breadth of business taxation.

29. Instead, government has put reforms in silos, focusing narrowly on individual aspects of corporation taxrather than looking holistically at business taxation and how tax reform should be support growth.

30. Taxation and innovation provides one such example. Rather than look in the round at the best way tosupport innovation and growth, the government’s proposals for the Patent Box (a 10% rate on profits earnedfrom patented products) and R&D tax credit unnecessarily split into two the singular process of innovation.The R&D tax credit offsets costs at the front-end of innovation, where market failures limit firms’ ability tofinance the expensive and relatively risky development of new technologies, processes and services. The patent-box, by contrast, provides a very narrow tax break to patent-reliant sectors (such as biotech and pharmacompanies) at the back-end of innovation after the profit has been made.

31. The economic and policy rationale for such the patent box as currently defined is weak. Patents are onlya small proportion of intellectual property, which is only a small proportion of innovation. By narrowly focusingon patents, the proposal erodes the tax base in favour of patent-reliant sectors, to the detriment of sectors that,for commercial reasons, choose not to use patents to protect their intellectual property. Nor is the proposallikely to resolve the thorny issue of firms shifting their IP to low tax countries. As Table 1 shows, the proposedUK scheme is not internationally competitive—other countries either offer a lower rate of tax, or includeincome from R&D activity as well.

32. By treating each separately, the UK could potentially be left with a narrow, inefficient and uncompetitivepatent box and limited reforms to the R&D tax credit. The preferred option would have been to use the £2bnin combined costs of the two to design reforms that would provide significant incentives to the breadth ofbusiness to invest in innovation in the UK.



Table 1

IP TAX INCENTIVES IN THE EU

Can work be ObjectivesCounty ETR Qualifying IP Cap performed abroad? policymakers

Netherlands 0%–5% Patented IP or IP for which No Yes for patent IP. Attract more R&an R&D declaration is For R&D IP D activitiesobtained (R&D IP) stricter condns

Luxembourg 0%–5.72% Software, subject to No Yes Attract IPcopyright, patents ownershiptrademarks, domain names,designs and models

Belgium 0%–6.8% Patents and extended patent No Yes, if qualifying Retain andcertificates R&D centre attract R&D +

stimulateBelgian patents

Hungary 0%–9.5% All IPR (guidelines) No Yes EU R&D policy/strategy

Ireland 0%–12.5% Patent=0%. Other defined IP € 5 Yes, relevant for Retain andfor amortization Mio for R&D tax credit attract R&D

0%?? UK somewhere in here ??

France 15.92% Patents and extended patent No Yes Retain andcertificates attract R&D

Source: IBM

33. The government’s narrow focus on the headline rate also ignores other aspects of the UK tax systemwhich are particularly distorting and leaves the UK in the damaging position of taxing growth. Two such areasare capital allowances and environmental taxation.

— Capital allowances—The UK’s regime is inefficient and internationally uncompetitive. In the JuneBudget, the Chancellor reduced the rate on capital allowances from 20% to 18% and lowered thethreshold on the Annual Investment Allowance from £100,000 to £25,000, effective April 2012.

— However, the cost of capital investment is rising and investment cycles are shortening as newtechnologies render existing equipment obsolete. The faster the rate of this depreciation, the earliermanufacturers are forced to reinvest in new, more productive equipment. A report by StatisticsCanada estimated that, from 1995–2001, the average depreciation rate for machinery andequipment, based on the declining balance method, was 27%.

— In the intervening decade, modern machinery has become more productive by increasinglyincorporating the latest technologies and software. Empirical and anecdotal evidence suggests thatmanufacturers are replacing their machinery and equipment, on average, every seven to eight years.Yet the UK’s current rate of 20% means that manufacturers are only able to recoup their costsafter 30 years, adding a premium to investing in the UK.

— The new 18% rate from 2012 will widen the gap between the UK and our closest competitors anddampen down the capital investment and growth our economy needs.

Table 2

AVERAGE RATE OF ECONOMIC DEPRECATION

1971–1990(1) 1985–2001(2) 1995–2001(2) UK tax regime(3)

Industrial Sector 12.3 - - -Machinery and equipment - 23.0 26.8 18.0Manufacturing buildings - 8.7 9.9 0.0

Source: (1) Institute of Fiscal Studies, (2) Statistics Canada and (3) HM Treasury—figure for 2012

Table 3

AVERAGE SERVICE LIFE OF MACHINERY AND EQUIPMENT, YEARS

1985–1989(1) 1995–2001(1) 2005–2011(2)

Machinery and equipment 12.3 9.8 7.3–7.8Manufacturing buildings 35.6 27.9 20.2–21.8

Source: (1) Statistics Canada and (2) Statistics Canada & EEF



Table 4

INTERNATIONAL TREATMENT OF USEFUL ECONOMIC LIVES IN 2011

Country Recovery period

US 2011: Immediate2012: 7 years

Ireland 5–10 yearsGermany 10–16 yearsFrance Plant, machinery, equipment &

tools: 10–20 yearsCanada 20 yearsUK 2011: 30 years

2012: 33 yearsSingapore 30 years

Source: US Congressional Research Service, PWC & EEF

— The UK’s proposed triple taxation of carbon inefficiently saddles manufacturers with additionalcosts not faced by other UK sectors or competitors abroad. The Carbon Price Floor (CPF)Consultation sets out how government intends to encourage investment in low-carbon electricitygeneration by providing a clear, long-term price for carbon, by taxing input fuels for electricitygeneration.

— The government’s concern is that the EU-wide carbon price set by the EU Emissions TradingScheme may not provide sufficient certainty over returns to encourage the required level ofinvestment in low-carbon technologies. The CPF would thus be an additional, UK-specific tax paidby power generators on their use of fossil fuels. The current proposals will undoubtedly increasecosts to all electricity consumers, as generating companies pass on costs arising from this new tax.

— This carbon price would sit alongside the Climate Change Levy, which taxes businesses’ energyconsumption and the £1bn Carbon Reduction Commitment. This triple taxation of carboninefficiently imposes costs on energy-intensive sectors, including manufacturing.

— EEF’s previous support for a carbon price floor was conditional on countervailing measuresensuring that the overall cost burden on manufacturers did not increase. For example, imposing acarbon tax on electricity generation would imply that the Climate Change Levy on electricityconsumption is inefficient. In order to decarbonise the energy supply, the government should taxcarbon either during generation or consumption, but not both.

— Consequently the government should substantially lower the CCL on electricity from the current£4.85 per MWh rate to the EU-mandated minimum of £0.42 per MWh and scrap the CarbonReduction Commitment, which represents a third layer of carbon taxation for 5,000 businesses.

Conclusion

34. The UK’s business tax regime will, in part, determine the pace and sustainability of growth and the long-term competitiveness of the economy. Despite making tax reform central to its plans for deficit reduction andgrowth, the government’s current approach is unlikely to address the cumulative burden that business taxesplace on growing businesses. Moreover, the government’s plans for reform fall short of its own principles oftax reform it set in November 2010, as Table 6 shows.

Table 6

Government Government action Resultprinciple

The 4p cut in the headline rate provides a strong boost to competitiveness.Lower tax rates But the patent box—as currently defined—provides an unnecessarywhile maintaining distortion in the tax base without a corresponding benefit to the UK’s xthe tax base competitiveness. The government has not yet signalled its intentions on the

50p rate.The government’s “New approach to tax policy making” provides a strongfoundation for introducing predictability in the tax regime. However, theMaintaining government’s reforms to the CRC and the Controlled Foreign Companies xstability rules are not in keeping with the “New Approach”. The resulting instabilityin taxes has eroded government’s credibility with business.By lowering the level of capital allowances, the UK’s regime will becomeBeing aligned with increasingly antiquated. Manufacturers replace their machines, on average,modern business xevery seven to eight years. The tax system will only reflect that cost after 30practices years.



Government Government action Resultprinciple

Although the Office of Tax Simplification will have an important role toplay in simplifying the tax regime, the government has given it an overlynarrow objective. The OTS should be free to analyse the structural reforms

Avoiding that would deliver significant simplification for UK businesses. ↔complexity The government has also struggled to avoid introducing complexity in to thetax regime. For example, days after announcing its road map for corporatetax reform, the government implemented legislation that effectively blockedcommercial activity that the road map proposes to allow in 2012.

Maintaining a Given recent changes to capital allowances and environmental taxes, andlevel playing field relative to other sectors in the UK and to their competitors abroad, UK xfor taxpayers manufacturers face a playing field increasingly tilted against them.

January 2011

Written evidence submitted by the British Bankers’ Association

1. The British Bankers’ Association (BBA) is the leading association for the UK banking and financialservices sector, speaking for over 200 banking members from 60 countries on the full range of UK andinternational banking issues. In addition, 40 professional firms are also associated with us. Our members, whilstpredominately banks, engage in activities which range widely across the financial spectrum, encompassingservices and products as diverse as primary and secondary securities trading, insurance, investment advice andwealth management, custody, as well as conventional and non conventional forms of banking.

2. The BBA welcomes the opportunity to provide written evidence to the Treasury Committee on thefundamental principles of tax policy.

Executive Summary

3. The BBA considers that the key principles which should underlie tax policy are that the system shouldbe: statutory; certain; simple; easy to collect and to calculate; properly targeted; constant; subject to properconsultation; regularly reviewed; fair and reasonable; competitive; predictable; and consistent.

4. The BBA is concerned that increased taxation on the banking sector will inhibit growth.

5. The BBA considers that the Government should, as far as possible, minimise costs on businesses and theburden of complying with the tax system.

Treasury Select Committee Questions


6. In the BBA’s response to HM Treasury (HMT) and HM Revenue and Customs’ (HMRC) paper “Taxpolicy making: a new approach”, we stressed that predictability and consistency are critically important featuresof a stable and attractive tax regime.

7. The increasing politicization of aspects of the fiscal regime has created a tax policy that is sometimespopulist, reactive and lacking a principled basis. Tax reform proposals should rather be underpinned by solidresearch and analysis, culminating in an evidence-based and analytically sound case for reform. The rapidchange and volatility in bank taxation over the last three years has caused significant concern about thepredictability of the UK’s tax policy. Indeed, predictability was flagged in a report63 prepared for the City ofLondon Corporation by CRA International as “the most important factor in judging competitiveness, but alsothe one on which the UK got its worst score and fared the worst in comparison to other countries”.

8. Consistency has also been an issue in UK tax policy, with policy statements being made indicating adesire to make the UK more attractive internationally whilst unilateral action is taken imposing uncompetitivenew measures. Such inconsistency sends a very mixed and confused message and betrays the incoherence ofcertain aspects of the UK’s tax policy.

9. More generally, the BBA concurs with the views outlined by the Tax Faculty of the Institute of CharteredAccountants in England and Wales in its discussion paper, Towards a Better Tax System,64 that the tax systemshould be:63 Taxation of the Financial Services Sector in the UK Predictability and Competitiveness, City of London Economic Development,

October 2010,http://217.154.230.218/NR/rdonlyres/E3CEF4F7–479B-46B4-AB93–29DF5F673B53/0/TaxationofFinancialServices.pdf

64 Taxguide 4/99, Towards a Better Tax System, A discussion paper by the Tax Faculty of the Institute of Chartered Accountantsin England and Wales published in October 1999, http://www.icaew.com/index.cfm/route/118111/icaew_ga/doc



(a) Statutory: tax legislation should be enacted by statute and subject to proper democratic scrutiny byParliament.

(b) Certain: in virtually all circumstances the application of the tax rules should be certain. It should notnormally be necessary for anyone to resort to the courts in order to resolve how the rules operate inrelation to his or her tax affairs.

(c) Simple: the tax rules should aim to be simple, understandable and clear in their objectives.

(d) Easy to collect and to calculate: a person’s tax liability should be easy to calculate and straightforwardand cheap to collect.

(e) Properly targeted: when anti-avoidance legislation is passed, due regard should be had to maintainingthe simplicity and certainty of the tax system by targeting it to close specific loopholes.

(f) Constant: Changes to the underlying rules should be kept to a minimum. There should be a justifiableeconomic and/or social basis for any change to the tax rules and this justification should be madepublic and the underlying policy made clear.

(g) Subject to proper consultation: other than in exceptional circumstances, the Government should allowadequate time for both the drafting of tax legislation and full consultation on it.

(h) Regularly reviewed: the tax rules should be subject to a regular public review to determine theircontinuing relevance and whether their original justification has been realised. If a tax rule is no longerrelevant, then it should be repealed.

(i) Fair and reasonable: the revenue authorities have a duty to exercise their powers reasonably. Thereshould be a right of appeal to an independent tribunal against all their decisions.

(j) Competitive: tax rules and rates should be framed so as to encourage investment, capital and trade inand with the UK.

10. It is disappointing that such little progress has been made in taking the UK tax system further towardsthe objectives set by the ICAEW over a decade ago. The BBA would urge the Government, HMT and HMRCto make a categorical statement of support for these principles.


11. New taxes, such as the Bank Levy or a Financial Activities Tax, add to the incremental costs currentlybeing faced by banking groups, such as increased capital and liquidity requirements. Measures that imposenew costs on financial institutions need to be borne between shareholders, employees and customers and placepressure on the flow of credit to businesses and households. Such outcomes are not generally supportiveof growth.

12. The OECD in its November 2010 Tax Policy Study No. 20, “Tax Policy Reform and EconomicGrowth”,65 analysed factors contributing towards or impinging on economic growth. It noted that:

“A country’s rate of economic growth depends on many factors including the rate of economic growth ofits main trading partners, the country’s innovative capacity, the availability of venture capital, the amountand type of investment, the degree of entrepreneurship, the skills level and the mobility of the workforce,the flexibility of the labour market, the degree to which individuals have an incentive as well as anopportunity to participate in the labour market, the labour costs for employers of hiring workers, theavailability of qualified workers, the administrative burden on businesses, product market regulations, theeconomic infrastructure as well as the legal certainty and the confidence level of consumers andbusinesses.

The tax system plays a crucial role as it is likely to impinge on many of these factors. The level of thetaxes that are raised, the tax mix, the quality of the tax administration, the complexity of the tax rules andthe tax compliance costs, the certainty and predictability for households and businesses of the taxes thathave to be paid, the network of tax treaties as well as the specific design characteristics of individualtaxes including the availability of tax incentives and the broadness of the different tax bases can have animpact on the country’s rate of economic growth.”

13. Finally, the report also concluded that “In general, a growth-oriented tax system may want to create aslittle obstacles as possible to the growth of economic activities. This implies also that tax systems may notwant to discourage … the possible inflow of high-skilled and other foreign workers”. We do not find thegovernment’s imposition of a permanent immigration quota constructive in this regard.

14. The immigration cap will have a direct effect on UK trade and business, not only limiting the supply ofavailable, skilled labour that UK businesses can access but also limiting the number of migrant investors andentrepreneurs coming to the UK.65 Tax Policy Study No. 20—Tax Policy Reform and Economic Growth, November 2010, http://www.oecd.org/dataoecd/34/49/

46617652.pdf




15. The tax system should not be structured to support specific policy goals other than economic growth andsound public finances.

16. The BBA considers that fiscal policy is too imprecise a lever to successfully or predictably drive aparticular behavioural response. Furthermore, the use of tax incentives and disincentives may result inunintentional consequences, such as an adverse effect on economic growth.


17. The BBA supports the Government’s commitment, in “Tax policy making: a new approach”,66 to “asimpler tax system” which would “ensure that, as far as possible, reforms minimise transitional costs onbusiness and the burden of complying with the tax system.”

18. Both the Bank Levy and Bank Payroll Tax required extensive consultation and discussion, necessitatedby the complexity and confusion, within industry but also within government, surrounding both measures.Complexity adds to the costs of existing taxpayers and acts as a disincentive to prospective investors to the UK.

19. The costs of compliance with the tax regime, for both the tax administration and the taxpayer, should beproportionate to the amounts collected. The same also holds for costs incurred by intermediaries includingbanks whether in terms of their acting as collecting agents or the providers of information. Where possible theGovernment should seek to utilise established mechanisms and channels to avoid creating additional burdenswith concomitant costs.


20. The BBA has consistently flagged the different treatment between foreign branches and subsidiaries asa particularly distortive effect of the current tax system. We are pleased to see that this anomaly is nowbeing addressed.

21. While we welcome the consultation on branch taxation, we remain concerned that the proposals, as theystand, may well end up being useful only to structured arrangements rather that to genuine business as a resultof a move away from the expected exemption with loss relief and clawback. Therefore, rather than creating aworld class competitive regime for the UK we risk ending up with something that is rather less useful.

22. The BBA is also pleased that the distortive effects of the Controlled Foreign Companies regime arebeing addressed through the CFC review, although we note that this workstream has been problematic and asatisfactory conclusion is not assured.

January 2011

Written evidence submitted by RSPB

Executive Summary— For general, revenue raising, taxation we believe in the principle of fairness in taxation as it relates

to the ability to pay and accept the other basic principles that they should be understandable,should be designed to minimize collection costs and to minimize harmful distortions.

— However given that fairness may mean a move towards wealth and land type taxes, the deliveryof valued ecosystem services from both land and marine space should be addressed. Werecommend further research into this important issue.

— Taxes are levied not only to finance government expenditure but also for purposes of stabilization,distribution and resource allocation. With regard to allocation, one of the most important roles isin addressing environmental externalities.

— The RSPB believe green taxation and fiscal reform should be seen as a fundamental part of anoverall package of measures designed to promote more sustainable patterns of production andconsumption not growth per se.

— Taxation should be a principal means of realigning market incentives by internalising the externalcosts private actors impose on society.

Introduction

1. The RSPB is Europe’s largest wildlife conservation charity. We have over a million members, the supportof over 12,200 volunteers and manage 200 nature reserves covering almost 130,000 hectares, home to 80% ofour rarest or most threatened bird species. Internationally, the RSPB is part of the Birdlife Partnership and areinvolved in numerous conservation projects including three large scale tropical forest and peatland restorationprojects.66 “Tax policy making: a new approach”, BBA, September 2010 http://www.bba.org.uk/download/5633



Question 1. What are the key principles which should underlie tax policy?

2. Historically, tax considerations have centered on the need for them to be efficient, economical andequitable but not environmentally friendly. For general, revenue raising, taxation we believe in the principle offairness in taxation as it relates to the ability to pay. We also accept the other basic principles that they shouldbe understandable, should be designed to minimize collection costs and to minimize harmful distortions.

3. Recent advances in the fields of ecology and economics have highlighted the existence of a vast array ofecosystem services—benefits nature fortuitously provides humanity (flooding risks mitigated by saltmarsh,carbon sequestered in peat soils etc). These provide an, as yet, unaddressed consideration when exploring whata fair tax system might look like. Essentially, if fairness means a move towards wealth and land type taxes,what role should the delivery of public goods play in determining the wealth basis for the tax ? We recommendfurther research into this important issue.

4. In addressing the principles of taxation, it must be noted that taxes are levied not only to financegovernment expenditure but also for purposes of stabilization, distribution and resource allocation. With regardto allocation, one of the most important advances in the taxation literature and practice has been anacknowledgement of the role it can play in addressing environmental externalities. We believe the issue ofenvironmental taxation is sufficiently novel and important for the Committee to devote some time toconsidering what an appropriate tax regime would look like if we are to succeed in meeting the twin challengesof climate change and biodiversity loss.

5. All UK Political parties recognize a main failing of many markets is that they fail to account for the harmdone to the environment through damaging economic activity. When the potential damage is catastrophicclimate change, the issue is clearly a serious one. In recent years “green” taxes have begun to be adopted asmeans of internalising such external environmental costs ensuring that polluters pay for the damage they do.As for any issue, the appropriate choice of fiscal instrument will depend on the objective in question but greentaxes are often the most efficient means for achieving an environmental objective at the lowest cost to society.A distinguishing feature of green taxes is that, unlike most regulation, they encourage polluters to mitigatetheir environmental impacts and provide an incentive to research and develop more environmentally sustainableproducts, processes and services. We provide an illustration of how a green tax on peat extraction could beused to address environmental damage in the appendix to this response.

6. The RSPB believe green taxation and fiscal reform should be seen as a fundamental part of an overallpackage of measures designed to promote more sustainable patterns of production and consumption. Thepurpose of environmental tax reform must be to change behaviour, protect the environment and ensureeconomic actors pay for the damage they do. The rationale is not therefore to raise revenue. The RSPB alsoadvocates hypothecation of green taxes. This can take the form of offsetting the increase in tax on things thatdamage the environment by a corresponding reduction in taxes on good things, like employment, leaving theoverall tax burden unchanged. Hypothecation can also entail using the proceeds of taxes on environmentallydamaging activities to support environmentally beneficial ones. We believe there is scope for increasing theamount of environmental tax revenue recycled specifically for environmental purposes. The RSPB alsoadvocates the introduction of new taxes on empirical grounds, where alternative approaches, such as voluntaryagreements, have proven to be ineffectual.


7. Taxation is not a tool designed to support growth but the impact of taxation on economic activity andcompetitiveness is clearly important. We think this question is somewhat misspecified. A concern we havewith the recent OECD Report (excellent in many other respects) is that it is rooted in a conventional view ofmacroeconomic policy making which fails to take into consideration a dynamic view of what measures willenable us to achieve a sustainable path for the UK economy. In terms of growth, it is broadly accepted thatguagin performance by measures of aggregate income or activity (like GDP) which fail to take intoconsideration the depletion of natural capital, will be hazardous. We also know from the Stern Review and theMillennium Ecosystem Assessment that we are depleting natural capital at ever accelerating rates. Allenvironmental assessments, at virtually all scales, whether it be fisheries, soil productivity or forests, underlinethis trend. If we are to remain within ecological limits, then these limits must then inform decision making atall levels and taxation can be one of the most effective, and appropriate means to address environmentalexternalities. We think a more pertinent question to address is how taxation can support sustainabledevelopment.


8. As noted above, the answer to this is to a very large extent. Taxation should be a principal means ofrealigning market incentives by internalising the external costs private actors impose on society. It is entirelylegitimate to use them to change behaviour even if the outcome is a reduction in growth. For example, if afactory enhances it profits by polluting a river, taxing their emissions may well reduce GDP but will increasesocietal wellbeing—the proper metric for assessing taxation.




9. For revenue raising taxes it is broadly correct that certainty and cost and ease of collection should be keyconsiderations. But there are two interesting aspects of environmental taxation which traditional tax theory hasyet to incorporate fully. The first is dealing with uncertainty. When using taxes to change behaviour orinternalise externalities, uncertainty must be addressed. To date, uncertainty is generally an excuse for inaction.There is a large literature on decision making under uncertainty in economics but I am not aware of muchwhich addresses taxation. This is an issue we believe should be researched further.

10. The second issue relates to the preceding answer. Traditionally, economic management focuses on staticefficiency and stability. Questions of sustainability are naturally more dynamic. Growth can only be sustainableif activity today does not undermine the prospects for growth in future. There is overwhelming evidence that,on current trajectories, it will. If that is accepted, the question becomes what do we need to be doing now toensure we can sustain the economy. Knowing the scale of CO2 emission cuts required by 2020, for example,should be informing present tax policy as much as the static efficiency of different tax options (in a costbenefit sense).


11. Yes, a fairer tax structure would be one based on wealth and one that truly accounts for all public goods.We overexploit and undervalue natural resources (beyond the marketable ones) because of their public goodscharacteristics. As we grow ever more aware of the looming ecological disasters business as usual will entail,far greater attention should be given to this issue.

APPENDIX 1

CASE STUDY—PEAT USE IN HORTICULTURE

This appendix looks at the example of a tax on the use of peat in horticulture, based on the principlesidentified above. The arguments for government intervention will be assessed, with a brief assessment of therelative merits of the policy tools available for governments to deal with peat. Finally a fiscal policy will beproposed, with an evaluation of the revenue raising potential, environmental effectiveness, and industry effects.The RSPB proposes that in the 2011 budget, the UK Government introduces legislation, in the form of a salestax on peat based growing media at the point of retail, to offer greater incentives for the growing media industryto switch to peat alternatives, stimulate investment in these greener alternatives, and raise much needed revenuefor the public purse.

Environmental Externalities

— Carbon emissions: Over 630,000 tonnes of CO2 is emitted per year from horticultural peat use inthe UK at a cost to society of £32.5 million.67

— Damage to biodiversity: 94% of lowland raised bog habitat, which is rare and slow-forming, hasbeen lost in the UK, putting a significant number of species at risk.68

— Damage to other ecosystem services delivered by Peatlands that ensure benefits such as regulationof the water cycle, and recreational enjoyment of the landscape.

These externalities, which have been well documented for some time, illustrate the market failures in theindustry, tangibly impacting upon the welfare of UK citizens, and working against UK Government objectives.Almost all of the peat extracted in the UK is used for the production of growing media (compost).Acknowledging this, the UK Biodiversity Action Plan set a target for 90% of the materials used in growingmedia and soil improver markets to be peat alternatives by 2010. However, this voluntary initiative failed toensure that the social damages were properly internalised into firms’ decision making processes, and the targetwas missed by a significant 32%.

Post 2010 Policy

Defra has recently launched a consultation on phasing out peat in the horticulture industry, which will discussthe setting of new voluntary targets for a phase out of peat use by amateur gardeners by 2020 and forcommercial growers by 2030. However, the recent levels of decline in UK peat use (just 1.63% between 2007and 2009), and the industry’s failure to meet the 2010 UKBAP target, suggest that a voluntary approach willbe insufficient to bring about the necessary change.

The Defra Impact Assessment for the 2030 phase out proposal estimates that the annual costs to theprofessional horticultural and growing media manufacturing industries would be 1% of their combined annualrevenue. Such a policy is not giving great enough weight to the extent of the environmental damages associatedwith peat use, or the economic opportunities from investing in alternatives.67 Comerford et. al., 2010, Financing Nature in an Age of Austerity.68 Lindsay and Immirzi, Scottish Natural Heritage Research, 1996, An inventory of lowland raised bogs in Great Britain.



There is a role for the businesses to play in protecting our natural environment and the efficient use of UKresources. However the two key motivations for the private sector will always be financial incentives andregulatory risk. A 10–20 year voluntary initiative following on from the unpunished failure to meet UKBAPtargets does not constitute a significant enough level of regulatory threat for firms to engage at the requiredlevel.

Comparing Policy Tools: Taxation, Regulatory, or Voluntary Approach

Regulatory—There have been a number of cases where the UK Government, to implement the EU HabitatsDirective, has enforced a ban on peat extraction. In these cases, the UK Government has been required tocompensate firms who hold property rights over the land. Earlier in the decade, sites at Thorne Moors,Wedholme Flow, and Hatfield Moor were designated as Special Areas of Conservation (SACs), at a cost to theUK Government of £17 million. Compensation to a firm operating at Bolton Fell Moss, where a new SAC isbeing designated, is ongoing but will be at least £9 million. This illustrates the costs associated with over-riding property rights through outright bans on extraction. This approach does not seem viable at present, whenpublic funds are under strain across the board.

Voluntary—A voluntary scheme, as proposed by Defra, is at the other extreme of the policy scale, with noguarantee that the policy objective will be achieved and insufficient pressure being placed upon firms andconsumers who are responsible for the damages. Voluntary targets regarding peat have failed in the recent past,and with increasing marginal costs of abatement for the peat industry, further voluntary schemes risk not givingadequate incentive for firms to transition to alternatives. Based on this policy approach, environmental targetsmay be missed, and the externalities will not be addressed at great social cost to society. In addition, businesseswill be sluggish in their innovation and investment, and may consequently lose out on significant revenuesfrom having a competitive advantage in the future.

Taxation—A levy on peat use could create the right price signals to ensure that a peat free policy objectiveis met, whilst allowing for a gradual transition away from peat. There are numerous merits to using a taxpolicy over a regulatory policy. Primarily, it allows for the most efficient abatement of environmental damages,because decisions are left to the market. Those firms who can stop using peat the most cheaply will do so themost, and so the transition towards alternatives will occur at the lowest overall cost.

These static efficiency gains over a regulatory approach are accompanied by dynamic efficiency gains overa voluntary approach, with concrete, cost-related incentives being given to firms to invest in alternatives.

Taxation, unlike peat policy, is not devolved in the UK, meaning a taxation policy would allow for a uniformand coherent approach across all countries. In contrast regulatory or voluntary approaches, which would be setby each devolved administration, would risk unnecessary bureaucracy, higher costs, and could even result in arace to the bottom in standards between UK countries.

In terms of the costs and ease of administration, a tax would be far lower than a regulatory approach, makingit the cheapest way of actually intervening in the market to achieve the policy objective. A voluntary initiativewould be the cheapest and easiest policy tool to administer, however, lower administration costs will count fornothing if the industry fails to act.

In addition, taxation has the potential to raise revenue. The amount of revenue would depend on the levelof behavioural change that occurred, which in turn would depend on the level of a tax and the elasticities ofthe products. In the case of peat, it is possible to ensure behavioural change in line with government objectives,whilst raising significant amounts of money.

Options

The RSPB has examined the opportunities for policy based around inclusion of peat into the aggregates levy,to tax peat extraction, and a tax on peat grown potted plants, to tax the downstream consumption of peat.However, difficulties of addressing international trade and the costs associated with monitoring were amongthe reasons that these options did not ultimately seem viable.

A sales tax on bags of peat based growing media has emerged as a viable policy option for raising revenue,and giving the correct market signals to facilitate a move away from peat consumption and towards the useof alternatives.

Sales Tax on Peat Based Growing Media

What?

The tax would be directed at retail sales of any peat based growing media in the UK. All growing mediaproducts would be required to report whether they contained any peat, and all content levels would be chargedat one uniform level (to lower administration/monitoring costs and in line with the zero peat content policyobjective).



Who?

This tax would target amateur gardeners, who it is assumed, (based on transport costs, administrative barriersto trade, and habit) will continue to rely on retailers for all or almost all supply of domestic use (ie 80litrebags and under) composts. This tax would not target commercial growers, who it is assumed obtain all of theirgrowing media directly from the manufacturers (bypassing retailers). Therefore this tax targets the 69% of peatconsumption that is leisure or recreation related, making it a progressive tax that is sensitive to UK business,overcoming a criticism of previous voluntary initiatives where industry could not pass increased costs on tothe consumer.69 The industry would only be impacted by falling demand that occurred due to the tax, but ifthe policy was appropriately designed, it need not mean any quicker transition towards alternatives than is laidout in Defra’s voluntary scheme proposal, if that is the timeline the UK Government decides upon.

Trade effects?

Based on this option, the UK industry would have no added incentive to import peat from overseas, as thetax targets the final sale of peat composts for amateur consumption. Retailers, commercial growers, andmanufacturer/extractors would all face the same input costs for using peat, meaning that there would be noadvantage to sourcing peat from foreign suppliers for peat products. Horticultural products other than peatcomposts such as plants and vegetables would also be exempt from the tax at the retail level, meaning therewould be no change in prices.

The sales tax targets the final consumption level. It is assumed that there is unlikely to be much, if any,demand for direct purchase of foreign products at this level from recreational gardeners, who tend to buylocally, and in small quantities. The levels of tax being assessed (around 10%) are unlikely to be higher thanany transport costs for imports, meaning that individual bags of peat composts should stay competitive at thislevel. Even in the event that a foreign supplier set up a means to import individual orders of compost cheaplyto individual consumers, habitual factors may mean that gardeners continue to buy from their local retailers.Some trade effects are considered later in the calculations of revenue, but they are likely to be small.

A lack of trade effects ensures that the tax is effective in targeting consumption, giving market incentives tofirms to phase out peat, and ensuring the environmental effectiveness of the policy.

How much?

Given the lack of information about the price elasticity of demand (PED) for peat products, and variabilityof prices for peat based growing media, some assumptions are necessary to calculate the total revenue of thepolicy. It is estimated that a 10% tax on peat composts (roughly 1p per litre on bags of 25–80 litres), wouldraise between £25–28 million, and cause between a 3 and 12% fall in peat growing media consumption in theyear of introduction.

These figures imply that a tax does not need to force industry away from peat use at a faster rate than hasbeen set out by the voluntary objectives, but that it can facilitate the transition, raising money in the processfrom consumers who are unwilling to change their behaviour.

Introducing a tax on an escalator basis would allow it to map with the gradual transition of gardeners awayfrom peat by 2020. For example, a 10% rate in 2012, followed by a 20% in 2015, and subsequently gettinghigher based on consumption patterns (the optimal tax rates would become clearer once the initial tax allowedfor an assessment of the PED of peat composts).

Capacity of peat alternatives?

This will not be a consideration for a tax policy in particular. A well designed tax system would simplyencourage transition away from peat at the rates laid out by Defra’s voluntary proposals. A brief look at thisissue shows that successful alternative materials suppliers report that there is room for significant expansionbased on current levels of supply. In addition a tax would incentivise firms to innovate and expand theavailability of materials, by making the industry more competitive with peat.

Directly targeting environmental damages?

Different peat composts have different levels of peat content. Peat bogs around the UK also have differentproperties regarding the wetness and consequent carbon emissions of the peat extracted. Therefore within theindustry there is a diversity of environmental damages. Ideally a tax policy would always set a levy based ondamages, to ensure static efficiency. However, the administration costs associated with measuring differentgrowing media peat contents, and damage levels would diminish the practicality of a tax. Consequently a taxshould be equally levelled at any growing media product using peat, to ensure a relatively transparent, cheap,and simple way of working towards a “zero peat” policy objective.69 Defra, 2009, Costs to the horticultural sector of meeting the UKBAP target on peat use in horticulture—SP0577.



Jobs supported by alternatives market?

There are opportunities for significant employment gains from encouraging investment in alternatives. Forexample, processing domestic waste for green compost is relatively labour intensive, compared to peatprocessing. In addition, there will also be a smaller number of jobs created in researching and developing newavenues for the cheap supply of green alternatives, which will yield current and future benefits for UKbusinesses.

January 2011

Written evidence submitted by The Chartered Institute of Taxation (CIOT)

1. Introduction

1.1 The Chartered Institute of Taxation (CIOT) is pleased to have the opportunity to submit comments tothe Treasury Committee inquiry into the fundamental principles of tax policy. Our comments are intended tocover the whole range of UK tax policy making, though we have not commented specifically on mattersrelating to the unrepresented and tax credits. These are dealt with in the response from our Low Income TaxReform Group (LITRG), whose submission has our support.

1.2 How a country’s tax revenues are designated and collected are clearly fundamental to the well-being ofall aspects of the country. A modern tax system touches all areas of society and all individuals and businessescontribute to some extent. The CIOT has regularly commented on aspects of tax policy in the past, particularlyon the way tax changes are effected. We have often called for improvements to that process and to the principlesthat underlie the tax system that we have in the UK. There are real signs that the calls we and others havebeen making are being heeded and we welcome the Treasury Committee’s focus on this crucial issue.

1.3 We will address each of the Committee’s five questions in turn and conclude with some further generalobservations on aspects that do not fit easily into the five headings.


2.1 The primary reason for raising taxes is to raise money to fund government expenditure. That is hopefullyan obvious initial point to make but it is a necessary one. Governments must be prepared to ensure thattaxpayers appreciate this rationale; allowing taxpayers to understand why taxes are being raised contributesmaterially to their acceptance and so has a positive impact on their collection.

2.2 Having decided that taxes are needed, we think the most important principle is Certainty. In this we echoAdam Smith. The point is that taxpayers need to be sure of what taxes are to be levied and at what level; thosein business can plan their investment knowing what taxes will be charged. The Certainty principle then hassome subsidiary points:

— There should be long term frameworks in which taxes can operate, so that if there are changes,then the main principles continue.

— Taxes should as far as possible be simple, so that they can be understood and operate under clearly-expressed rules enshrined in statute; the system must be easy to operate.

— As most taxes will inevitably not be simple, there must be scope for the taxpayer to confirm theirposition. This is a key issue for businesses planning investment: we need to have moreopportunities for rulings where there is genuine uncertainty.

— Taxes should be applied consistently: the same actions should achieve the same taxing results yearon year and should not be dependent on the tax authority’s way of interpreting the rules; thereshould be no retrospective changes70.

— Where changes are made to tax rules, these should flow from proper consultation. By this we meanopen consultation, over a proper timeframe, with the changes developed in stages and withappropriate feedback throughout the process. Those changes should then be subject to properParliamentary scrutiny.

— Fiscal neutrality must be borne in mind (we return to this issue in section 4).

2.3 The Government’s paper on “Tax Policy Making—a new approach” does, we think, offer a muchimproved way of effecting tax policy and we have welcomed it71. It endorses the need for properconsultation—something we have long campaigned for and on which we have commented separately72. Themain shortcoming in the document is the way it stops short of addressing the issue of Parliamentary scrutiny,which our paper “The Making of Tax Law”73 seeks to address; we think there is a need to utilise the expertise70 The CIOT recently published a paper analysing the issue of retrospection and retroaction: see http://www.tax.org.uk/NR/

rdonlyres/6E03C65F-8F28–4F09-B89C-AF6E7642F5C4/0/RetrospectivetaxationandtaxpolicymakingCIOTNov10.pdf71 See http://www.tax.org.uk/NR/rdonlyres/661F4FEC-4A51–4894-B302-C8D56BE2CD58/0/TaxPolicyMakingCondoc.pdf72 See http://www.tax.org.uk/NR/rdonlyres/69DA4A3E-3521–4600-ACD6–8C7CEDBC3947/0/CIOTTaxPolicyMakingresponse

200910.pdf73 Available at http://www.tax.org.uk/NR/rdonlyres/9265C21D-2CE8–445C-9EC8–590657401327/0/themakingoftaxlaw.pdf



available in the House of Lords, which can be done without interfering with the primacy of the House ofCommons in matters of tax rates.

2.4 We also welcome the Government’s commitment to developing a framework for corporate taxes, whichis much needed. There is a similar need to develop a framework for environmental taxes, so that these developin accordance with the principles set out above rather than on an ad hoc basis.

2.5 The possibility of a GAAR is an interesting one in terms of these key principles. The challenge will beto deliver certainty, consistency of application and simplicity—though it does, we accept the offer of thepossibility of simplifying anti-avoidance rules74.


3.1 This should follow from the key principles and can be summarised as “commit to a stable tax system”.Stability will encourage business confidence and encourage businesses of all sizes to plan on a long term basis.

3.2 Simple, low taxes will naturally be more attractive that complex, higher taxes that try to compensatewith a range of reliefs. We do not say that there should not be specific reliefs in a tax system, just that theseneed to be thought through, properly designed and carefully targeted. Reliefs also needs to be simple to claim,otherwise they become ineffective. Research & Development: the additional relief is clearly welcome to thosewho claim it and the possibility of a tax repayment is particularly valuable to smaller companies. But for along time claiming the relief was seen as too complex (though HMRC have certainly improved the process)and arguably it still concentrates too much on the “R” rather than the “D”.

3.3 We accept that changes will need to be made to the tax system and in particular to its rates. However,such changes should follow from consultation (at least on systemic changes) and should always have regard tothe impact on stability and confidence. Whether or not the withdrawal of industrial buildings allowances wasnecessary, doing so over a four year period when investors had anticipated a 25 year writing down period didnot enhance the UK’s business tax environment. Constant detail change also damages growth prospects:businesses have to devote resource to dealing with change and have no confidence that future change will notdamage their plans.

3.4 As the UK is an open, international economy, we must have a tax regime that is internationallycompetitive. This means far more than tax rates that are comparable (or lower) than our competitors. It meansthat the system must deliver the certainty referred to above and operate in a business-friendly way. In recentyears there has been a growing perception that the UK’s tax system has become less competitive withuncertainty probably being at least as important a factor than simple tax rates. Again, there are welcome signsthat this issue has been recognised with initiatives such as the Patent Box.


4.1 Taxes will inevitably distort behaviour. This can lead to unintended consequences. The example of the0% corporation tax rate is a classic example of where an attempt to give a relief went badly awry, much aspredicted by the CIOT and others.

4.2 Ideally the tax system would be fiscally neutral. That is impossible in its purest sense but the principleof fiscal neutrality needs to be borne in mind when considering the use or amendment of the tax system.

4.3 We accept that the tax system can legitimately be used to address market failures. It can be used toencourage (or discourage) particular behaviours. However, as this takes the tax system into non-fiscal areas,such moves need to be undertaken with care. It should always be part of policy development to questionwhether the behaviour modification would be better achieved through non-tax mechanisms. Using the taxsystem will inevitably increase complexity; all too often a new relief or incentive has had to be regularlymodified to better target it or for perceived anti-avoidance reasons. It also increases volatility of tax revenues:the London congestion charge is a good case study of how the success of the charge in its early days (inreducing traffic) led to problems (it did not generate as much money as was hoped).

4.4 The tax system will always need to be reviewed to make sure it does not work against wider policyobjectives. An example of this is how attempts to encourage people back into employment has to contend withthe income tax and NICs imposed from quite low starting points; tax credits and moves to increase the incometax personal allowance attempt to address this.

4.5 To succeed, these incentives and behaviour modifiers need to be carefully designed and explained—andthen monitored for effectiveness. There will always be risks that tax incentives can drive behaviours in waysother than those desired. Some examples where the tax system has not necessarily achieved its objective are:

— Financing incentives: the Business Expansion Scheme started well but was taken away from itstarget. The current VCT/EIS reliefs have been successively modified so that their application isnarrower and narrower.

74 The CIOT’s paper on a GAAR is at http://www.tax.org.uk/NR/rdonlyres/3E24A2EB-D618–4D04-B078-E2EFB3B6AC95/0/CIOTGAARresponsefinal150910.pdf



— Film tax reliefs: the tax reliefs available were, inevitably, exploited and led to constant tinkeringwith the rules to try and get back to the original purpose.

— Green investment incentives: the 100% capital allowances for some investments are complex withboundary issues and can be difficult to achieve with certainty.

— High tobacco taxes aimed at discouraging smoking have boosted the attractiveness of smuggling.

4.6 This emphasises the need for tax incentives to be reviewed for their effectiveness after a proper period.We do not seem to have in the UK’s tax system the sort of approach a business would have of systematicallyreviewing initiatives to see whether they are proving effective. What has often happened, as we have alludedto in para 4.3, is constant tinkering, often argued as necessary for anti-avoidance reasons, but without a properoverall review or testing against properly-expressed objectives for the whole scheme.


5.1 This is surely axiomatic. All taxes impose administrative burdens on businesses and/or individuals.Taxpayers generally accept that they have to pay their taxes but governments must not add to the financialburden any more than they have to when it comes to the administration of those taxes.

5.2 Employers always cite the burdens of the tax system as a significant issue (although it is accepted thatsome of the burden relates to matters beyond taxation). The default attitude of government in recent years hasseemed to be that employers can absorb ever-increasing burdens: student loan repayments, attachment ofearnings, and maternity pay all add to the employer’s workload. Addressing the remaining differences betweenPAYE and NICs would help: this should include structural features such as the non-cumulative nature of NICs.

5.3 There is another more subtle burden the employer has to shoulder—that of being the first port of callfor an employee’s problems with tax. Recent PAYE problems have emphasised this and it is a matter of concernthat HMRC’s own resources are so reduced, leading to more of those who have difficulties with their tax affairsto turn instead to their employer (or the voluntary sector).

5.4 Some other examples of burdens:

— VAT is usually cited as a cheap tax to administer—but it needs to be borne in mind that theregistered trader does most of the work. Boundary issues over zero-rating cause problems fortraders: any evaluation of whether a particular zero rate should continue should take this aspectinto account, as well as fairness for consumers.

— Online filing is a sensible way forward—but mandating it in ways that seem to be driven byHMRC’s needs rather than with proper regard to taxpayers’ situations is inappropriate. We haveregularly highlighted concerns over the move to iXBRL, especially whether software will be readyin time, and requiring online VAT filing by all when some businesses simply do not have properaccess to IT or broadband is unfair.

— The controlled foreign company (CFC) legislation has become administratively burdensome whilstraising little real money. It has arguably lost sight of its real rationale and has been a factor in theperception of the UK’s tax system as uncompetitive. It is good to see this being addressed, thoughwhether true simplification can be achieved is far from certain.

— Tax exemptions and thresholds play an important part in reducing burdens—but they need to bekept up to date or they risk creating further burdens. The “Christmas party exemption” has beenraised sensibly in recent years to £150, but the tax-free amount for moving costs has remainedstuck at £8,000.

5.5 One indicator of problems in this area can be a need for extensive HMRC guidance. We are not opposedto HMRC guidance and generally welcome it, but it should not be a substitute for proper legislation. Ifsignificant amounts of guidance are needed, that is surely a signal that the rules need to be reviewed. Taxpayersand their agents must also be able to rely on HMRC’s guidance.

5.6 A facet of “ease of collection” is that where disputes do occur between HMRC and the taxpayer, theremust be proper mechanisms for achieving resolution in a good timescale. We have a good Tax Tribunal systemin the UK and the recently-developed HMRC review process is also proving valuable.

5.7 The administration of the tax system must also allow for taxpayers to take professional advice and forHMRC to deal with advisers on taxpayers’ behalf. HMRC have historically not valued professionally-qualifiedagents’ contributions as they should. There are some current initiatives that may change this to the benefit ofall concerned: the CIOT is participating fully in the discussions and is keen to move forward appropriately.

6. Are there aspects of the current tax system that are particularly distortive?

6.1 Arguably the tax system’s main contribution to encouraging growth would be to make sure it does notget in the way of, nor penalise, legitimate behaviours. Nor should it distort or contort actions. That said,taxpayers will always have regard to the tax consequences of their actions and are likely to choose a route thatdelivers a lower tax bill. This is something that needs to be accepted by the tax authorities.



6.2 Some examples of taxpayers exercising legitimate choice include:

— A small business will always want to assess whether it should operate on an incorporated orunincorporated basis (nowadays LLP is another option).

— Investment in equipment by purchase or leasing—though the way allowances for leasing havebeen changed does mean that this is not a simple decision.

6.3 Where the tax system distorts behaviour can be because of the uncertainty in the system as well asinherently disadvantageous consequences. Some examples:

— The incorporation decision—while this will always be an issue, ideally the decision should betaken based on what works best for the business.

— Share incentive schemes—complexity and overlap mean these are less easy to operate and maynot be encouraging all the preferred behaviours.

— Debt/equity—the tax system undoubtedly encourages debt finance.

— Residence and domicile—the difficulty of getting certainty causes individuals to take more extremeactions than are perhaps necessary.

6.4 It is accepted that sometimes the tax system will legitimately distort behaviour. This must be for clearpolicy reasons and needs to be carefully monitored for effectiveness. Landfill tax is a good example: it hasbecome increasingly expensive so as to encourage recycling rather than dumping (though there are alwaysconcerns that it results in fly-tipping).

7. Further points

7.1 The impact of tax changes driven by the devolved governments in the UK needs to be considered in thisinquiry. There is, for example, an inevitable additional burden for employers with employees in both Scotlandand the rest of the UK with Scottish rate of taxation.

14 January 2011

APPENDIX

THE CHARTERED INSTITUTE OF TAXATION

The Chartered Institute of Taxation (CIOT) is a charity and the leading professional body in the UnitedKingdom concerned solely with taxation. The CIOT’s primary purpose is to promote education and study ofthe administration and practice of taxation. One of the key aims is to achieve a better, more efficient, taxsystem for all affected by it—taxpayers, advisers and the authorities.

The CIOT’s comments and recommendations on tax issues are made solely in order to achieve its primarypurpose: it is politically neutral in its work. The CIOT will seek to draw on its members’ experience in privatepractice, Government, commerce and industry and academia to argue and explain how public policy objectives(to the extent that these are clearly stated or can be discerned) can most effectively be achieved.

The CIOT’s 15,000 members have the practising title of “Chartered Tax Adviser” and the designatoryletters “CTA”.

January 2011

Written evidence submitted by Christopher J Wales

Submission by Christopher J Wales, Senior Managing Director, FTI Consulting and former member of theCouncil of Economic Advisers at HM Treasury

Executive Summary

This note welcomes the Committee’s initiative and the recent reports of the Mirrlees Review team and theOECD on taxation policy. Taxation policy outcomes can be significantly influenced, not just by principles andobjectives, but by the structures, processes and governance arrangements that surround the policy process itself.The author is currently engaged on a multi-country study that examines, on a comparative basis, the way intax policy is made and the influence that the process exerts on policy outcomes. The initial findings of thatwork are reported here.

1. Introduction

1.1 I welcome the inquiry launched by the Treasury Committee into the fundamental principles of tax policy.As the Announcement notes, the inquiry follows closely on from the publication of the Mirrlees Review andthe OECD report on Tax Policy Reform and Economic Growth. Each of these publications makes a significantcontribution to the discussion of policy substance. They provide a reminder that good tax policy requires acomplex marrying together of political, economic and legal considerations and give some sense of the depth



of thinking and analysis that is required to develop effective policy. They also add valuable evidence of theinfluence exerted on policy outcomes by the way in which tax policy is made.

2. The Role of Taxation Policy

2.1 The growth trajectory of the UK economy has been significantly affected as a result of the internationalfinancial crisis. Monetary policy was used successfully by the Government and the Bank of England duringand immediately after the crisis to protect both individuals and businesses. However I believe that there is nowscope and indeed a need for taxation policy to be used more fully to put the UK economy back on a path ofsustainable growth.

2.2 Taxation is primarily a method of raising money to fund government expenditure but it can have aprofound effect on behaviour. The imposition, variation, reduction or elimination of taxes, whether of a generalor specific nature can and does have consequences for economic activity: consumption, investment, saving, jobcreation etc. I believe that, in principle, the broad thrust of taxation policy should be towards neutrality but Iaccept that, where a taxation instrument is likely to be the most effective in dealing with a particular marketfailure, an exception to this general rule should be made.

2.3 Governments can, of course, choose to use the tax system to influence behaviour or not but in eithercase, effective tax policy requires the consequences of both action and inaction in the tax policy sphere to beproperly understood.

3. The Problem with Principles

3.1 This note starts from the premise that there are, in fact, relatively few absolutes in terms of principlesthat should underpin the tax system; and that it is easy to confuse principles with features. For example, theGovernment might have an objective of creating a tax environment in which business can prosper and in doingso, might set a target of imposing a lower effective rate of tax on businesses operating in the UK than thosein the rest of the EU. Thus competitiveness might become a goal for policy-makers and ultimately a feature ofthe UK business taxation but this does not make it a principle underpinning the tax system.

3.2 Fairness might be a good principle to underpin the system but what does it mean? It is a loose concept,to which we all might subscribe, but capable of many different interpretations.

3.3 We can, of course, give more precision to the principle of fairness. We can develop and use the moreprecise concepts of horizontal equity and vertical equity that have been widely explored in the relevantliterature. We can broaden its scope to include the newer concept of intergenerational fairness. But essentially,even these concepts are only guides to the outer limits of where policy should go rather than active principleswith which to drive the development of policy.

3.4 The UK tax system, as it stands today, reflects the economic, social and legal history of our country. Iflegislators were to start afresh, it would be constructed somewhat differently. Society changes and the economychanges. Even principles and their relative importance can change.

3.5 Largely because of its origins and history, the tax system today is riddled with instances where principlesare in conflict. Anyone seeking to derive the principles that underpin the system today from the legislationwould struggle to establish any principle from what we have on the statute book that is not contradictedsomewhere in another piece of legislation.

3.6 The Committee’s inquiry is potential deeply philosophical. There is a place for that; but theAnnouncement suggests that the Committee is more interested in the active translation of philosophy intopolicy than in the passive pursuit of philosophical principles for its own sake; and that is where the substanceof this submission will focus.

3.7 I take the view that it is ultimately for the government of the day to determine the principles that shouldunderpin tax policy, on the basis of a mandate, properly sought and given by the people through the electionprocess. The principles may vary because both the wishes of the people and the economic circumstancesmay vary.

4. The Influence of Policy Process on Policy Outcomes

4.1 I do not intend, in this short note, to comment in detail on all the questions posed by the Committee inrelation to this inquiry but I should like to comment in some detail on the way in which tax policy outcomesmight be influenced by changes in the policy-making process itself. Good process cannot guarantee goodoutcomes but it can make their achievement more likely.

4.2 I am currently engaged with others in a major project to examine, on a comparative basis, the structures,processes and governance arrangements for tax policy-making in a number of countries and the influence thatthe process has on policy outcomes. I should like to draw the attention of the Committee to the ongoing workon this issue and to highlight the early findings of the project that may be relevant to its inquiry, even thoughthese are tentative at this stage.



4.3 The project is being carried out under the auspices of the Oxford University Centre for Business Taxation(OUCBT) and will provide the basis for a report for a ministerial-level meeting of the OECD.

4.4 The scope of the project is to examine:

— the functioning of the Executive in relation to the development of tax policy, including theinstitutional framework within Government through which tax policy is developed;

— the influence and role of external institutions, both formal and informal;

— the role of the Legislature in scrutinizing tax policy proposals emanating from the Executive andthe rights of the Legislature to initiate tax law changes; and

— the process through which taxpayer consent is sought for changes in tax law, including the natureand extent of any consultation with the public or with business on tax policy proposals.

4.5 The work is being carried out mainly through face-to-face interviews with ministers, advisers, high-levelofficials and policy experts, other commentators, business groups and financial journalists.

4.6 The study should enable good practice to be identified in each of the four areas identified above and aninitial assessment to be made of the relative significance of its contribution to good policy outcomes.

4.7 The “good practice” approach should allow Governments of both developed and developing countries tobenchmark their own structures, processes and governance arrangements. It is hoped that this will, in turn,make the achievement of better policy outcomes more likely.

4.8 There is still a considerable amount of work to be done but the meetings and discussions that have takenplace so far have allowed some tentative initial conclusions to be drawn.

5. The UK Tax Policy-making Process

5.1 It may be helpful to the Committee to provide some early thoughts from the project in each of thespecific areas of work.

The role of internal institutions

Concentration of power

5.2 The policy making process in the UK is highly centralised. Analysis is concentrated in the hands of theTreasury and the Chancellor’s departments and all of the main decision-making process takes place within theTreasury itself. There is little involvement by other government departments although the role of BIS has, Iunderstand, become more significant in relation to business taxation issues in recent years. Some degree ofconcentration is evident in the tax policy-making process in other countries but the UK is at the extreme edgeamong the countries examined to date.

5.3 The involvement of a wider group of Cabinet ministers in government decisions about taxation policyappears to be better established in continental Europe than in the UK. Similarly, the involvement of the PrimeMinister’s office in decisions on tax policy appears to be more common elsewhere.

Politically-appointed advisers and officials

5.4 Taxation is a highly technical area and ministers are rarely tax policy experts. Practice differs fromcountry to country in relation to the appointment and use of politically-appointed ministerial advisers withspecialist knowledge of taxation. In Germany, ministers do not have advisers per se within the department butthe appointment of some senior tax policy officials is effectively in the gift of the Finance Minister. In France,by contrast, the Finance Minister and the Prime Minister will typically each employ advisers with a specialisttax background. The appointment of some senior officials may be considered to reflect the politics of the day.In the UK, the practice has varied over time, with mixed results.

Departmental structures and a system-wide approach

5.5 The Mirrlees Review suggests that, to be most effective, taxation policy needs to be addressed on asystem-wide level. This does not negate the need for detailed work on individual taxes but the whole-systemreview should provide a framework within which that work is carried out.

5.6 Within the UK Treasury, taxation issues tend not to be addressed at a whole system level. This could beseen as a reflection of the departmental structure, which is organised more by themes and by individual taxes;or alternatively, the departmental structure could be seen as a reflection of an approach that puts emphasis onindividual taxes and groups of taxes rather than the coherence of the system as a whole. It is difficult to becertain which is correct. The situation is nevertheless better than it was 10 years ago, in the sense that seniorresponsibilities are now organised across a range of taxes but there is little to encourage a true system-wideapproach and an absence of senior economists with whole system responsibility. This may be considered tolead to the more piecemeal approach to tax reform in the UK.



5.7 More broadly-based reform has also been held back on a number of occasions by perceived difficultiesin modelling the revenue outcomes of complex change. Fundamental tax reform will remain challenging unlessoutcomes can be understood and modelled with confidence.

The role of external institutions

Influence on policy development

5.8 External institutions appear to figure relatively little in the tax policy-making process in any of thecountries we have examined to date. It is, of course, always a matter of debate as to whether policy is influencedby one institution or another and influence over policy may be exerted in a number of different ways. Forexample, although the idea for a tax change may initially come from one source that has the ear of the minister,it may be another institution whose analysis is particularly influential in shaping the development of a proposal.

5.9 In the UK, there are a number of institutions that actively seek to influence policy thinking. Some ofthese are think-tanks, with a point of view that reflects a broad political positioning. Others are more academicin their approach. In their respective areas of expertise, among the latter group, the Institute for Fiscal Studiesand the OUCBT appear to exert some influence through the analysis that they provide.

5.10 The UK is regarded by other countries as particularly well supported by external institutions but it maybe questionable how far the influence goes. In principle, governments can benefit significantly from strongexternal institutions in this area as in others. But a key issue in the taxation area is availability of data to thoseexternal institutions. There are issues around taxpayer confidentiality, but the value of external contributionscan only be fully realised if a way is found to overcome the concerns. There has been some recent progress inthis area and it is to be welcomed.

5.11 Also important to the strengthening of external contributions to the policy process would be to allowmuch wider publication of aggregate numbers. Researchers outside government often struggle to develop evenbroad estimates of the costs or revenue yield of potential tax changes and this can inhibit the development ofideas and the process of sensible debate around the tax system.

Post implementation reviews

5.12 One of the ways in which external institutions could be brought closer to the policy-making processand their formal role strengthened would be for the government to use them to carry out independent post-implementation reviews of significant changes in tax policy.

5.13 Independent reviews of this nature have not been widely used either in the UK or indeed in manycountries. This is perhaps surprising because a proper process of review to establish whether a particular taxreform has met its objective can potential provide invaluable information to policy-makers, particularly onbehavioural responses. But they are potentially challenging for both political leaders and civil servants. Theycan highlight outcomes from tax changes that are different in practice from those sought or claimed at the timeof their introduction. It would nevertheless impose a good discipline on the tax policy-making process if thegeneral practice was that the legislation that introduced substantial new measures contained a requirement foran independent post-implementation review. For certain changes, this could be coupled with a sunset clausefor the measure in question.

The role of the legislature

There are features of the UK parliamentary system that tend to weaken the role of Parliament in the taxpolicy-making process.

Access to expert support

5.14 Members of Parliament in the UK and, in particular, members of the Standing Committee dealing withthe Finance Bill have, by international standards, relatively limited access either to government officials or toother experts who might assist them in scrutinising proposals made by Treasury ministers. It is relativelycommon for other parliaments to call as witnesses, senior government officials and groups of experts who canrespectively explain and opine on legislative proposals.

5.15 There is no professionally qualified group of officials whose role is entirely to support committeemembers on taxation issues. Such support is not widespread in Europe but it exists, for example, in theUnited States.

Powers of initiation

5.16 Powers of initiation on taxation issues do exist in theory in many parliaments but, as in the UK, thereare few examples among the countries that we have investigated, where such powers are widely used. The USis the most obvious exception.



The role of the second chamber

5.17 Constitutional traditions similar to those around the House of Lords and its role in relation to taxationmatters are not widely found elsewhere. The absence of an effective second chamber review or policy initiationprocess is a relative weakness of the UK model as it stands today.

Taxpayer consent and consultation

5.18 In most democracies, tax policy is set by the few for the many and serious policy debate is held amongthe few. The many are not equipped by the education system to participate effectively. Public debate throughthe media is frequently led by misinformation of one sort or another, whether intentionally or not.

5.19 Consultation on business taxes

5.20 There is much admiration in some countries for the way that consultation on business tax issues hasbecome established in the UK, particularly over the last 10–15 years. There is, for example, a strong feelingin France that their tax-making process and with it, tax policy outcomes, could be enhanced significantly bygreater involvement from the business community.

5.21 However, the UK is not unique in involving outside parties in consultation on tax reform. TheScandinavian countries have well-established practices of examining legislative proposals long before they arebrought into law, some of them more broadly-based than our own. Other countries such as Luxembourg, haveencouraged the discussion of proposals among tri-partite committees of government, employers and unions.

5.22 In the UK, individual businesses and trade and employers organisations are regular contributors to taxpolicy debate and their involvement in the process has had positive benefits. It has benefitted policy-makersby providing an opportunity to understand more directly than was previously the case, the impact of particularproposals on both a conceptual and a detailed level. It has also strengthened the contributing organisations bygiving them a focus that goes beyond their direct work with the statute as it stands and it has given them agreater understanding of the issues and constraints on tax policy. Most important of all, it has contributed tobetter policy outcomes.

5.23 There is an argument that organised labour could also be encouraged more formally to participate inthe tax policy-making process in the UK. This would potentially have similar benefits. As noted above, it isan established feature of some other democracies.

Democracy and tax policy

5.24 By contrast to the business taxation area, broader issues of taxation generally appear to be discussedmore widely and openly in many countries than they are in the UK. There is elsewhere a greater spirit ofopenness about taxation policy issues in the run-up to national elections than has often been the case in theUK in recent years.

5.25 For democracy to function effectively in the UK, it would be helpful if the level of debate could beraised. A number of factors influence the current situation, including the education system, the media and theapproach to political debate itself. It would be beneficial if there was a better understanding of the link betweentaxes and government spending. Governments of all persuasions have failed adequately to explain that, in thelong term, everything that the government spends is the proceeds of taxation. It is a simple mechanism thatallows government to pay for the goods and services that we accept, democratically, should be providedcollectively through government rather than individually.

5.26 One of the issues that affects the taxation debate in the UK is that it tends to be somewhat remote.Taxation is essentially a national issue in the UK, whereas the decentralising of tax-raising powers makes it atleast partially an issue for local or regional government as well in many other countries. The UK is highlyunusual in its concentration of taxation rights at the national level. This weakens choice for citizens and maybe a factor in participation levels in local government elections. It is an issue that needs to be addressed.

5.27 A fuller and more open debate with the electorate on taxation policy issues can potentially pave theway for modernising policy reforms that will be of broad benefit to the economy.

January 2011



Written evidence submitted by the City of London Corporation

1. This memorandum is submitted on behalf of the City Corporation in the context of its role in promotingand reinforcing the competitiveness of the UK-based international financial services sector, for which “theCity” is now commonly used as shorthand. The City has a wide variety of consultation mechanisms by whichthe views of business are sought and incorporated into the policy-making process. The consultation processextends beyond the boundaries of the historic City—the “Square Mile”—to include companies and trade bodieslocated elsewhere in London and in important regional centres.

2. The central assumption of the City Corporation’s work on attracting and retaining business, and onfacilitating the optimum business environment, is that the City brand is internationally-owned, internationally-managed and internationally-staffed. Much of the business done could be undertaken in other centres wherethe two key factors, capital and expertise, are present. Nevertheless the fact that it is done in London haspositive benefits in terms of corporate profits, tax receipts and export earnings.

3. A study recently commissioned by the City of London75 showed that in 2009–10 the financial servicesindustry contributed £53.4 billion to the Exchequer in corporate and employment taxes, representing 11.2% ofthe total UK tax take. In broad terms, however, the City is less concerned with the absolute rates at which taxis charged, and more with the stability and predictability of the system by which tax is assessed, levied andcollected. In recent years there has been little such stability. In contrast, other countries, some of them attractivelocations for financial services business, have offered a stable environment in which companies have been ableto plan strategically.

4. As a consequence of this, some internationally-owned companies, which carry out business worldwide,recruit their workforce globally and which have no particular corporate loyalty to the UK, are looking at otherjurisdictions as locations for some areas of business. Several insurance companies for example have alreadychanged their domicile and there is speculation that some major UK-based banks are assessing the benefits orotherwise of being domiciled in the UK. Furthermore, some other institutions, including US investment banks,have already moved away from their previous settled view that London is the best placed centre for theiroperations in Europe, the Middle East, Africa and in some cases Asia as well.

5. Taxation is not of course the only factor in location decisions made by financial services businesses.International tax competitiveness does however become especially important when other key business factorssuch as regulation, access to skills and effective infrastructure—are also themselves in a state of flux andunder scrutiny.

6. In order to meet its aims of reducing the deficit and keeping the United Kingdom “open for business”, itis in the Government’s best interests to widenthe tax base, by attracting and retaining business activity whichmight otherwise be undertaken elsewhere, and by encouraging entrepreneurs to establish new businesses.

7. A phased reduction in rates of taxation and, over time, the abolition of special measures introduced inresponse to the financial crisis, including the bonus tax and the banking levy, will be likely to encourageinternational business to locate here and to build up their capacity rather than eroding it. In the medium tolong term this will generate more revenue, directly through corporate tax and indirectly through income andother taxes and national Insurance charges on employees.

January 2011

Written evidence submitted by Richard Brooks

1. I am a journalist with Private Eye magazine. I write on a number of issues including tax and was amember of the Guardian’s “Tax Gap” team that ran a series on corporate tax avoidance two years ago. Until2005 I was a tax inspector at HMRC specialising in international and corporate taxation.

2. This is a short submission on a basic flaw I have observed in UK tax policy making and the tax policiesthat emerge as a result.

Introduction

3. Tax policy is strongly distorted in favour of the very largest corporations. Among the harmfulconsequences of this are the shifting of the tax burden onto other businesses and individuals and the competitivedisadvantage suffered by smaller businesses. This distortion stems from a growing capture of the corporate taxpolicy-making process by the largest companies.

4. This trend appears to be accelerating, especially with HM Treasury’s current proposals for corporate taxreforms to be enacted in 2011 and 2012. Together with other recent changes (notably the 2009 exemption ofoverseas dividends) these mark the most fundamental shift in the corporate tax base since residence-basedtaxation, under which a UK resident is taxed on worldwide income, was introduced in 1914. Indeed, they arenot far off a reversal of this development. (There may be a history lesson in the fact that the economic demands75 The Total Tax Contribution of UK Financial Services—Third Edition, Report prepared for the City of London Corporation by

PwC, December 2010



of war then necessitated a greater contribution from large business, whereas fiscal troubles a century onapparently demand the opposite response).

5. HMT’s proposals make the UK corporate tax system a largely territorial one under which UK income istaxed, whilst tax allowances are still given for costs, including funding costs, that might support non-taxableoverseas operations. This is an extremely lenient arrangement that will see large multinationals’ effective taxrates fall drastically. In adopting the most generous features of two contrasting systems of taxation (a territorialview of income, and a residence-based view for allowances) it is unique. And even without this move the UKwas set to have the lightest corporate tax regime among major western economies, according to ExchequerSecretary David Gauke.76

6. The benefits of this system are not, however, equally available to smaller businesses that do not havelarge international operations since it would be prohibitively expensive for them to establish the requiredoffshore networks.

Imminent Corporation Tax Reforms

7. Changes planned for the “controlled foreign companies” legislation over the next two years include:exempting profits diverted into tax havens from third countries (a beggar-thy-neighbour policy with seriousconsequences for developing countries), taxing financial income parked in tax haven subsidiaries at 8% andexempting profits of foreign branches including tax haven branches.

8. These are self-evidently very generous moves that encourage tax haven activity in the face of globalpronouncements against offshore activity in the wake of the recent financial crisis. The important question ishow they were developed.

9. CFC reform has been led by a “CFC Liaison Committee” comprising HMT and HMRC officials alongwith the tax directors of BP, AstraZeneca, International Power, RSA (Royal Sun Alliance) and HSBC. Allstand to benefit substantially from relaxation of the CFC laws.

10. Reforms to be introduced in Finance Bill 2011, including the exemption for third country incomedescribed above, were developed by a working group comprising HMT and HMRC officials (four in total)plus tax directors from Anglo American plc, British American Tobacco plc, Xerox, IBM, Intercontinental HotelGroup plc, C&W plc, Rolls-Royce plc and Aviva plc. Again, all will benefit greatly from the changes developedby their group.

11. The same companies, plus others including Tesco, Diageo, Rio Tinto, Glaxosmithkline and many othersare currently taking forward wider reforms under a further six working groups.77 The group considering“monetary assets” includes the tax director of Vodafone, whose multi-billion pound tax avoidance usingtransactions covered by this very aspect of CFC law has been extensively reported by Private Eye.

12. The whole process has been overseen by a “tax and competitiveness group” comprising the finance orother directors of Vodafone Group plc, Diageo plc, RSA Insurance Group plc, GlaxoSmithKline plc, Rolls-Royce plc, General Electric Company, Ford Motor Company, Amey plc, Royal Dutch Shell plc plus the directorof the business-funded Oxford University Centre for Business Taxation and the Director-General of the CBI.Again, the companies mentioned stand to gain significantly from the changes proposed.

13. Of course such “stakeholders” should be heard, but the structure of corporate tax policy making has leftthem far too influential. Rather than listening to business’s concerns and opinions and then making policyrecommendations taking into account their and others’ views, policy-makers are writing the rules in conjunctionwith the very vested interests that stand to gain most from their decisions. The result is policy developmentreduced to not much more than giving the largest corporations the tax breaks they want in the name of“competitiveness” (with the words “whilst protecting the UK tax base” usually tacked on for form’s sake).

14. So in announcing its proposals on tax haven-based financing companies HMT reports: “Discussions withbusiness suggested that a debt:equity ratio of under 1:1 [related to the mechanics of the rules] would becompetitive if it delivered an effective tax rate of around and ideally less than 10%”.78 The tax rate proposedby HMT is 9%, falling to 8% by 2014. Multinationals operating in tax havens will thus be taxed more lightlythan a cleaner earning £7,500 a year.

15. On exempting profits of foreign branches, a crucial question was whether this would apply to branchesin all countries and territories, including tax havens, or just those with which the UK has a tax treaty and canbe considered not to be tax havens. Exempting tax haven branches opens big tax avoidance opportunities, butHMT’s response to consultation on the point reports: “There was a strong message from many respondentsthat extending exemption to all countries and territories is important for the competitiveness of the newregime”.79 So this is exactly what HMT proposes.76 In a speech to tax advisers Deloitte in November 2010 Gauke said that when corporation tax rates fall to 24% in 2014 the UK

rate “will be the lowest of any major Western economy”. Many other tax allowances legitimately reduce this rate yet further.77 See http://www.hm-treasury.gov.uk/consult_cfc_reform.htm78 http://www.hm-treasury.gov.uk/d/corporate_tax_reform_part2a_cfc_reform.pdf79 http://www.hm-treasury.gov.uk/d/corporate_tax_reform_part3b_foreign_branch_taxation.pdf



Conclusion

16. Surrendering policy-making to the group most affected by the policies in question to this degree wouldnot be accepted in any other area. The nearest policy field is probably the regulation of banking and financialservices, in which such “regulatory capture” over recent years has been widely reported. So have thedisastrous results.

17. A similar pattern is emerging in tax policy, as economies “race to the bottom” to offer the laxestcorporate tax regime. In 2005–06 28% of multinationals dealt with by HMRC’s Large Business Service paidno corporation tax. More than half paid less then £10 million.80 The latest changes are likely to see theseproportions rise.

18. With government revenues more stretched than ever, this amounts to a dangerous narrowing of the taxbase. Or to put it simply, everybody else will have to pay.

21 January 2011

80 National Audit Office report, Management of Large Business Corporation Tax, 25 July 2007

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