The principles of tax policy

Written evidence submitted by ACCA

About ACCA

ACCA is the global body for professional accountants. We aim to offer business-relevant, first-choice qualifications 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 develop successful careers in accounting and business, with the skills required by employers. We work through a network of over 80 offices and centres and more than 8,000 Approved Employers worldwide, who provide high standards of employee learning and development. Through our public interest remit, we promote appropriate regulation of accounting and conduct relevant research to ensure accountancy continues to grow in reputation and influence.

The expertise of our senior members and in-house technical experts allows ACCA to provide informed opinion on a range of financial, regulatory, public sector and business areas, including: taxation (business and personal); 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 percentage of GDP as part of its economic management, and then be held to account via objective measurement and variance analysis.

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

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

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

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

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

8. Efficiency: Tax systems should be efficient for governments in terms of their ability to secure the revenue due and to prevent tax leakage and the development of a black economy. It should, however, also be efficient for 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 periodically overhauled 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 clarity in 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 subject to tax only once.

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

13. Tax shifting – Green Taxes: ACCA believes one of the most important examples of legitimate discriminatory 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 systems worldwide 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 taxation put down by Adam Smith, who is generally considered (certainly in the English-speaking world) to be the father of modern political economy. In The Wealth of Nations (1776) he argued that, ‘the evident justice and utility 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 as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy 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 of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor, and to 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 convenient for 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 little as 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 to argue for progressive taxation, where tax is levied according to the ability to pay. On fairness grounds it is hard to argue against this and most modern tax systems follow this principle, but whereas the huge inequalities of wealth in Smith’s day made such a position necessary, it is arguable that it is now a political position rather than a statement of fact.

21. The other maxims are less contentious. Canon II forms our 5th tenet. A society's tax system must be known and understood by all its adult members; otherwise, they cannot play their part to the full. Maxim III is hard to argue against though is not always adhered to in practice. Maxim IV forms our 7th tenet – though it could be argued this is the area where Smith’s theory is furthest from modern reality, given the costs of the state’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 to apply the tenets of even the greatest thinkers to contemporary tax systems. Unlike Smith, ACCA does not offer the following points as universal truths, but believes that if followed by governments these 12 policies would represent the basis of effective tax systems around the world.

What are the key principles which should underlie tax policy?

ACCA’s tenets are:

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

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

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

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

27. Openness, transparency and accountability: Tax policies should be transparent and non-discriminatory unless part of a declared discriminatory policy, such as one intended to encourage new enterprise. ACCA’s view is that this use of tax by elected governments is legitimate but such taxes should then meet the other principles such as being transparent, simple and effective. Governments should be wary of increasing the complexity 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 already been decided, and are carried out largely for appearances’ sake. On major issues of tax policy, there should be clear consultation where the different options are specified at the start, and properly considered with an audit trail including unambiguous minutes and written responses.

29. There should also be openness on the application of tax policy. So-called ‘stealth taxes’, such as the quiet reduction of tax exemptions, and the phenomenon of ‘fiscal drag’, whereby personal tax thresholds are not 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 outcomes or operations. It should always be possible for different taxpayers who look at legislation to come to the same interpretation 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. Taxpayers must have certainty over Revenue authorities’ interpretations. Authorities should establish a proper and efficient clearing mechanism for complex anti-avoidance provisions

31. Tax Competitiveness: The globalisation of business means that each country should ensure its tax rates are competitive and its regime user-friendly. Tax is a key factor in ensuring the overall attractiveness of a location to mobile capital (businesses and individuals). It is important to look at the underlying tax base of a country 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 flat tax systems can lead to ‘beggar thy neighbour’ approaches, in which inward investment can be lured from one country to another and which may undermine agreed international financial regulation initiatives. They can also 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 a global competitive environment, but governments must be wary of causing retaliatory action and trade wars by drastic business tax cuts.

34. Avoidance/evasion: There is a clear division between tax avoidance (or planning, or mitigation), which is legal, and tax evasion, which is not. It is not unethical to minimise one’s taxes. While most businesses try only to comply with the law, there have nonetheless been many cases of convoluted tax planning schemes that are designed not for any proper business purpose but to exploit loopholes in the law and avoid its spirit. ACCA does not support this artificial activity, which could be considered the equivalent of the creation of some of the extremely complex financial products, designed to get round banking regulations, which have had such a disastrous 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 revenue due and to prevent tax leakage and the development of a black economy. It should, however, also be efficient for taxpayers in terms of their ability to comply with its requirements. It should not be forgotten that small businesses represent the bulk of economic activity in most countries and regulation can have a disproportionate effect 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 periodically overhauled and consolidated to bring it up to date and make it easier to follow. Outdated laws should be removed.

37. There needs to be a positive prompt for justifying the existence of legislation. All anti-avoidance legislation should have sunset clauses attached to it. This will ensure that it is regularly reviewed and the need for it to remain in place is actively considered. Governments and tax authorities should devise clear metrics to gauge 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 when taxpayers do not know why they are being taxed and where the revenue is being spent. It is of benefit to society, 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 has been spent on activities to help the environment.

39. Although we are not convinced that such ‘hypothecation’ of particular taxes to specific areas of spending is practical, we do believe that there should be greater clarity in the public finances showing expenditure projections and how these are to be financed.

40. Avoidance of double taxation: An essential principle of tax law must be that income should be subject to tax only once. This applies both to direct tax, where an individual or business should suffer tax once, and consumption taxes such as VAT, where input tax recovery should be available at each stage of the transaction chain 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 services everyone 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 taxpayers places 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 in certain circumstances in pursuance of agreed social policies. ACCA believes one of the most important examples is to change behaviour that can damage the environment. Accountants should play an active part in efforts to reduce global carbon dioxide emissions, and the concept of ‘tax shifting’ by increasing carbon taxes on the use of fossil fuels but reducing them for payroll, income or corporate taxes should be promoted.

How can tax policy best support growth?

44. Growth is best supported by simplicity and removing the drain on productive time imposed by unnecessary 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, principally underinvestment 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. Policy makers must then establish the level of tax incentive required to offset that inefficiency. The disconnect between problem 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 their investment, or indirectly by reducing the tax burden on the SMEs and thereby hopefully increasing the return on investment to the investor.

48. The former type of measure will generally be more effectively targeted than the second type which will tend to influence all SMEs, whether they are looking for further investment or not. Moreover, where the incentives 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 companies with small profits. The aim was apparently to induce a supply side boom driven by reinvestment of profits not paid in tax. Among the actual results were complex anti-avoidance measures and a rash of incorporations by small businesses which had operated perfectly well as sole traders and partnerships but now saw a financial advantage 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 the most effective remedy. Subsidised training for small businesses in how to keep records and present financial information will be more effective, and will have a positive impact on efficiency even in businesses with no wish to expand.

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

51. Tax systems in general are cumbersome instruments of policy implementation, so while use of tax as a policy instrument can be legitimate, it should be exercised with care and restraint. Once enshrined in law and relied upon by influential groups a distortion to the system can be remarkably enduring. Specific policy goals however can change far more rapidly. Use of the tax system by policy makers as a regular instrument of policy implementation results in constant change, complexity confusion and cost.

52. Tax as a policy instrument (rather than revenue raiser) broadly falls into redistributive and regulatory functions. Redistribution is usually best served through income taxes, although some academics argue that a properly formed consumption tax can have redistributive effects. Regulation of consumption meanwhile is most 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 decision making, and which cannot be addressed by other means – for example, green taxes, to reflect the environmental cost of given behaviours which might otherwise be ignored and where regulation would be ineffective. The tax can be closely linked to the desired behavioural outcome by seeking to monetise the impact of ie carbon consumption and increase the cost of consumption accordingly.

54. Other policy measures, seeking to encourage particular types of activity rather than consumption of a particular good or service are, for the reasons outlined above, more difficult to form. Adjustments to consumption tax on a particular good or service essential to the desired activity are unlikely to be sufficiently specific to be effective, particularly where it is just one sector of the economy that is the target of the proposed stimulus but the goods are widely consumed. The most effective method will generally be the income taxes paid by the businesses or individuals concerned. If the population can be identified and defined an adjustment can be made to the income taxes of that population in isolation. An example is R&D tax credits, where the labour and consumable goods subjected to tax relief could be consumed in any number of ways. The tax incentive is given based on the behaviour of the specific consumer, rather than the goods and services consumed.

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

55. The extent to which costs of administration are relevant depends on how focussed the particular tax is on being "profitable". Revenue raising is all about the money; costs need to be kept to a minimum. International experience 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. Wastage on administrative costs reduces the amount of money which can be transferred from rich to poor, directly reducing the efficiency of the tax.

57. Regulatory taxes are not necessarily about the money at all, eg carbon taxes. The important goal is reduction 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 the costs of collection outweighed the revenue raised. The alternative cost to the economy in lost income tax were the gains tax removed was however considered to be even greater.

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

58. Any level of differential taxation introduces distortion. Some cases (redistribution for example) are deliberate. Often however the differential treatment of otherwise equivalent behaviours (ie the differing tax cost of Debt finance v Equity finance, or the proliferation of zero rated goods for VAT) exists for primarily historic reasons, often with little objective economic justification. The question of whether any specific distortion is justified on policy grounds can is one for policy makers themselves.

January 2011