UK Must Raise GBP8bn In Tax To Meet Fiscal Rules, IFS Warns

by Jason Gorringe, Tax-News.com, London

31 January 2008

UK Chancellor of the Exchequer Alistair Darling, would need to raise taxes by the equivalent of GBP8 billion in this year's Budget to keep public sector debt below the Government’s self-imposed ceiling, and to bring about significant improvement in the public finances over the next five years, according to a new report by the Institute of Fiscal Studies (IFS).

In its 2008 'Green Budget,' produced in collaboration with Morgan Stanley, and with financial support from the Economic and Social Research Centre, the IFS warns that the government is planning to increase the tax burden to a 24-year high and cut public spending to an 8-year low as shares of national income, as it struggles to comply with its own fiscal rules.This would involve the Government taking 48% of the “proceeds of growth” (the extra real income generated by the economy) in tax and other revenues over the next five years, up from 45% under Labour to date, and 30% under the previous Conservative government.

However, the IFS fears that tax revenues will not grow as strongly as the Treasury hopes, as the impact of the credit crunch and a weak outlook for profit growth depress corporation tax receipts, and as weaker share and property prices reduce Stamp Duty revenues.

Under existing policies, the IFS expects the government to have to borrow more than GBP40 billion this year, next year and in 2009-10, and anticipates that public sector net debt will hit the government’s ceiling of 40% of national income in 2009-10, and rise to 41.2% by 2012-13. The government would also break its 'golden rule' (to borrow only to pay for investment) over the new economic cycle, unless that cycle lasts at least a decade, the IFS predicts.

The think-tank's key conclusions on the tax front in this year’s Green Budget are as follows:

Capital gains tax:

"The Government’s proposal in the Pre-Budget Report to abolish taper relief was a welcome step in the direction of making capital gains tax simpler and less distortionary. CGT could be made even less distortionary by aligning CGT rates with the tax rates on earnings and dividend income, applying reduced rates to corporate equity to reflect corporation tax already paid, and perhaps reintroducing relief for inflation. Higher CGT rates might discourage saving, investment and entrepreneurship, but these could be encouraged in better-targeted ways.

The announcement on 24 January 2008 of a GBP200 million ‘entrepreneurs’ relief’ to be introduced in April 2008 will be a welcome reprieve for many owner-managers of small businesses, but reintroduces complexities and distortions similar to those inherent in taper relief, and the process by which the final proposals were arrived at was shambolic. It is hard to believe that they are the final word."

Tax and benefit changes taking effect in April 2008 and under Labour to date:

"Tax cuts and tax credit increases worth GBP14 billion are already due to take effect in April, offset by tax increases of roughly the same amount. In general, households at the top and bottom of the income distribution will gain most from the changes to personal taxes and tax credits, while those in the middle will see very little impact. However, some low income individuals ineligible or not claiming the working tax credit will be worse off. Cutting the marginal tax rate for basic-rate taxpayers will improve incentives to work and to save very slightly for many individuals, but the package will not reduce the very high marginal tax or deduction rates faced by those with the weakest work incentives.

Taking this April’s changes into account, the tax and benefit reforms since 1997 will have increased the incomes of the poorest tenth of the population by 12.4% (GBP1,300 a year) and reduced those at the top by 5.5% (GBP4,200 a year) on average. In spite of facing higher net taxes, a household in the middle of the top tenth of the income distribution has still enjoyed an increase in real post-tax income of around 20% between 1997 and 2006 due to growth in pre-tax incomes."

Aviation taxes:

"The government proposes putting a tax on flights from November 2009, replacing the current tax on passengers, air passenger duty (APD). This should allow it to target the level of emissions more effectively than APD does at the moment. To be targeted precisely on the environmental costs of aviation, the rates of a new aviation duty would have to vary by aircraft type, aircraft emissions and departure airport, as well as by distance travelled.

But the more sophisticated the tax is, the more complicated it will be to administer and comply with. The winners from a relatively sophisticated aviation duty would be those flying short distances on full, clean, quiet planes from airports away from residential areas."

Corporation tax and entrepreneurship:

"Labour has changed corporation tax rates in seven of its 11 years in office and plans to change them again next year and in 2009–10. Throughout Labour’s time in office, the tax and National Insurance system has provided incentives to be self-employed rather than employed, and incorporated rather than unincorporated. The removal of the starting rate of corporation tax (first introduced in 2000-01), together with the planned increase in the small companies’ rate over the next two years, suggests that the government has now acknowledged that creating tax incentives that favour one legal form over another may not be the most sensible way to encourage entrepreneurship.

But stemming the continued tide of incorporations may require further increases in – and perhaps even the abolition of – the small companies’ rate. This may be no bad thing, as the economic rationale for a distortion in the tax system in favour of companies with low profits is far from clear."

Taxation of companies’ foreign profits:

"In June 2007, the Treasury and HM Revenue & Customs published a package of proposals for taxing foreign income, including a move away from taxing foreign subsidiary dividends (with credit for any foreign taxes paid in respect of those dividends) to a system in which foreign dividends are exempt from UK taxation altogether. Moving to an exemption system would ordinarily increase the after-tax profitability of UK multinationals and be less likely to distort investment decisions unhelpfully. In principle, an exemption system should also be simpler and cheaper for companies to comply with. Other elements of the proposed package, however, may detract from these outcomes and produce a new system that is as complex as the old."

Tax simplification:

"The government has reaffirmed its commitment to simplify the tax system, but attempts by this and previous governments to deliver real and long-lasting reductions in complexity have usually come to nothing and the volume of tax legislation has grown inexorably.

The rewrite of direct tax legislation, initiated under the last Conservative government and still in progress, uses simpler language but at much greater length and without resolving any of the underlying complexity in the legislation. Real simplification is difficult to achieve without more fundamental consideration of what, who and how we tax. Tackling complexity requires that we recognise what is complex and why, and focus on what can sensibly be done about it."

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