British Tax System In Need Of Reform

17th September 2023

"There are few corners of the British tax system that are not in urgent need of repair." Isaac Delestre writes for Taxation.

A better aligned set of tax rates across all legal forms would be a welcome development. Better still, income tax and NICs could be combined into a single, unified tax on income - a reform that would leave the tax system both more rational and less opaque.

Key points
Council tax should be reformed and stamp duty land tax should be abolished.

The role of National Insurance contributions (NICs) has almost been fully eroded and in effect the UK now simply has two separate income taxes.

NICs drive a wedge between the tax liability of employees and the self-employed - generating serious biases in the labour market.
Reduced and zero rates of VAT cost the Treasury £64bn in foregone revenue in 2022-23.

The cost of reaching net zero will be higher than it needs to be due to the unsuitability of environmental taxes.

The Palace of Westminster has seen better days. Wayward masonry falls with ever greater regularity, forgotten corridors moulder, and decades' worth of antiquated wiring threatens to at any moment burst into flame. It is hard to imagine a more appropriate building for the UK's tax system to have been devised in.

From council tax to National Insurance, from VAT to environmental levies there are few corners of the British tax system that are not in urgent need of repair. With what is likely to be an election year on the horizon now is the time to look beneath the floorboards of that ramshackle structure and take stock of some of the horrors that lie beneath.

A good place to start is housing taxation. Alarmingly, council tax (which raises the considerable sum of £44 billion a year) is still based on property values as they were in 1991 - an era when a terraced house in Islington would cost you around £90,000 (you can expect to pay £1.1 million today). That means council tax bands have become increasingly arbitrary, often bearing little relation to the present value of housing.

As Figure 1 shows, house prices have grown at very different rates in different parts of the country. In conjunction with the mechanism for allocating funding to local councils, outdated valuations mean that regions where property values have grown most strongly since 1991 (like London and the South East) are treated increasingly favourably when it comes to council tax compared to those where they have grown more slowly (like the Midlands and the North).

The best that can be said for council tax is that, were it to be seriously reformed, there would at least be a case for its continued existence. Stamp duty, on the other hand, deserves no similar praise. Taxing housing transactions means that those who move house more often pay more tax (not something that adheres to any obvious principle of fairness). The result is to throw an almighty spanner into the gears of the housing market. Everything from downsizing in retirement (freeing up unused housing) to moving house to find a better job is discouraged. A tax that does so much damage is beyond repair. It should be abolished entirely.

So much for housing taxation, what about personal taxes? Income tax and National Insurance are, at least, not levied on people's incomes as they were in the early 1990s. That, however, is about as far as praise can extend. The first question to ask is why National Insurance contributions (NICS), which are the UK's second largest revenue raiser after income tax, exist at all. While it was once the case that NICs played a significant role in determining benefit entitlements, this relationship has been eroded almost to the point of non-existence. In effect the UK now simply has two separate income taxes.

That inheritance is a damaging one. For a start, NICs is levied only on earnings from employment and (at lower rates) self-employment. Other forms of income (like dividends or rent) incur no liability. Then there are employer contributions, which are charged on the wages paid out to employees but for which no equivalent exists for the self-employed. One consequence of that is to create a tax system in which employment is heavily penalised.

Figure 2 sets out these tax differences explicitly for an example person generating £40,000 of income per year. If our example person is an employee then the total tax liability incurred will be a little over £11,300. As a self-employed sole-trader or partner, on the other hand, that tax bill would be just over £8,100. This more than £3,000 gap is almost entirely a result of employer NICs.

Read the full article HERE