124.In Chapter 2 of this Report we presented an analysis of the widening long-term gap in the public finances between public spending commitments and current plans for taxation. The evidence submitted to this inquiry generally supports the proposition that the UK would be able to raise additional taxation to help fill this gap, should current and future Governments choose to do so. However, in addition to its function of raising revenue, there is a pressing case for reform of the tax system, in order to ensure that taxes are less distortionary and less damaging to growth.
125.The UK’s tax system encompasses a vast range of different taxes, reliefs and regulations. It is hugely complex: the reform of its every aspect would be beyond the scope of a select committee inquiry. In this Chapter, we have been selective and have drawn together the evidence we have received on what seem to be some of the most pressing areas in need of reform.
126.When launching the Self-Employed Income Support Scheme (SEISS) on 26 March 2020, in response to the coronavirus crisis, the Chancellor of the Exchequer (the Rt Hon. Rishi Sunak MP) said that “… in devising this scheme—in response to many calls for support—it is now much harder to justify the inconsistent contributions between people of different employment statuses. If we all want to benefit equally from state support, we must all pay in equally in future.”
127.Although the Chancellor was referring specifically to the self-employed and their lower rates of taxation relative to those who are employed directly and taxed entirely under PAYE, he might also be taken to be implying that the relative lack of support for those taking salary as dividends is due to the tax advantages that many of them are receiving. The different burden of taxation between the self-employed and employees is largely due to differing levels of national insurance contributions.
128.Over the past 40 years there has been a steady reduction in the basic rate of income tax but an increase in rates of national insurance contributions (NICs), which has reduced the benefits of income tax cuts. For example, in 1980–81 the basic rate of tax was 30%, the employee Class 1 NICs contribution was 6.75% and the employer NICs 10.2%. In 2020–21 the basic rate of tax is 10% lower than it was in 1980–81, at 20%, but the benefit of the reduction to employees is partially offset because the employee Class 1 contribution is now 12% and the employer contribution 13.8%. This shift towards NICs and away from income tax has occurred incrementally over many years. Coupled with reductions in the corporation tax rate, it has made alternative work structures to PAYE employment more attractive from a tax perspective and has contributed to more workers and employers seeking to avoid PAYE costs by working as self-employed or contracting through a limited company.
129.The self-employed pay Class 2 NICs at a flat £3.05 per week and Class 4 NICs of 9% (2% on profits over £50,000). In 2017 an increase in the self-employed Class 4 NICs by 1% was announced in the Budget but was abandoned. When announcing it, the then Chancellor of the Exchequer (the Rt Hon. Philip Hammond MP) said that “This change reduces the unfairness in the national insurance contributions system and reflects more accurately the current differences in benefits available from the state.”
Figure 8: Tax in different legal forms
Source: Institute for Fiscal Studies, Taxing work and investment across legal forms
131.The growth in self-employment and incorporation is one of the “Fiscal risks” that the Office of Budget Responsibility set out in its Fiscal risks report in 2019. The OBR takes the view that the increase in these forms of work is likely to be the result of differences in tax treatment.
Figure 9: Trends in self-employment and incorporation (% of the workforce)
Source: OBR, Fiscal Risks Report 2019, chart 4.7
132.We have received differing evidence on whether the self-employed should be taxed at the same rates as employees. Professor Judith Freedman, Professor of Taxation Law and Policy at the Faculty of Law at Oxford University, told us:
I do not think there is any principle at all on which the self-employed should be taxed at a lower rate than employees. There is some small difference in rights to benefits, which accounts for about a 1% difference, around parental leave and jobseeker’s allowance. Beyond that, there is no good rationale. The rationale usually used is to encourage entrepreneurship and so on, all of which is very important. We are going to need to encourage entrepreneurship after this pandemic. However, doing that through a blanket relief to all self-employed, some of whom are not particularly entrepreneurial, does not seem to be a good way of using scarce resources.
On the economic benefits of tax neutrality, she said:
As far as the tax system is concerned, the ideal is to be as neutral as possible between different legal forms of working, because that would then not distort the market. Both the engagers and the engaged would decide how best to organise their businesses without having to take tax into account. That would be far better commercially and would be good for the economy.
133.We asked Charlotte Barbour, Director of Taxation at the Institute of Chartered Accountants of Scotland (ICAS), whether reduced taxation of the self-employed was justified. She said:
“It is very difficult to justify different tax rates for what people call the three-person problem. If you have similar work, whether you are employed, self-employed or through a company, there does not seem to be a logical reason in terms of fairness as to why those different people should pay different amounts of tax.”
However, she went on to recognise that the self-employed face more risk, saying that “the self-employed do face more risk so maybe, arguably, they have to pay less”.
134.On the question of whether the additional risks taken on by the self-employed justify less taxation, Professor Freedman said:
“The tax system is a very poor vehicle for reflecting that risk, because some self-employed take on risk, but some take on very little or no risk. Therefore, if you use the risk argument, it does not work well. Some employees are in very risky and precarious employment. Risk is not related to the amount of tax being paid under the current system. It would be impossible to devise a system that would properly reflect risk within the tax system. There are other ways of assisting people to take risks. Tax is a pretty crude instrument for doing that.”
135.Derek Cribb, Interim CEO at the Association of Independent Professionals and the Self-Employed, (IPSE) disagreed:
“Unsurprisingly, I am going to disagree with Judith on a few of these points. Tax is a very blunt system and blunt implement for differentiating between types of risk, in terms of your business. Sadly, it is the only one we have. Yes, there is a differential that needs to be there. We do need to encourage the entrepreneurialism. There is also a premise here that the self-employed want the same support and safety nets as employed people have. I am not sure that is always the case. A large number of the self-employed are more independently-minded, risk-taking and entrepreneurial. That does not mean they never need support. Coming back to the coronavirus and support packages, we need to look outside the normal economic 10-year cycle, or whatever it might be, where I do not think most of the self-employed would look for support from the Government. Coronavirus is more of a one-in-100-year event, and with that everybody needs a bit of extra support. [… ].”
136.John Cullinane, Tax Policy Director of the Chartered Institute of Taxation, recognised the principle that the self-employed should be taxed the same as employees but also saw difficulties with removing the differences. He said:
“it is very hard to justify these differences. If you had a blank sheet of paper, you would probably design something where either they were somehow paying the same tax or, even if there were different taxes for different legal situations, the overall balance was better. The big problem with saying that [ … ] is that the differences are so huge that to adjust them would be massively painful for self-employed people.
People often talk about the few-percent differences on employees’ national insurance, or not having national insurance on dividends, as being what it is all about, but the elephant in the room is the employer’s national insurance of 13.8%, which is being taken out of the system by having somebody move off payroll, whether they are incorporated or not. The amount of money that self-employed people are able to charge in the market no doubt reflects the fact that they are less heavily taxed than if everything was run through an employed basis.
[ … ] The politics are much more difficult here, frankly, than with VAT on food or some other things we have been talking about, and for good reason. It would be a massive shock to people. [ … ]”
137.Bill Dodwell, Tax Director at the Office of Tax Simplification, said:
“ [ … ] A self-employed person pays self-employed national insurance, albeit at a lower rate, and income tax. Of course, a great many freelancers provide their services via a company. Work from the Institute for Fiscal Studies and others has demonstrated that people in that category can use the flexibility of a company to smooth out their tax rates and, over time, end up with substantially lower rates than everyone else through all that.
There is definitely a case for looking at evening up that burden of taxation, and you will have to find different ways of doing it. [ … ]”
138.Andrew Titchener, Head of Tax Policy at the Confederation of British Industry, suggested that tax was not the only reason why employers engage people as contractors instead of employees:
“ [… ] the differential in cost is taken into account when employers are making decisions, but there are a huge range of reasons why an employer would engage with someone as a contractor or as an employee, around the type of work you are doing, the sector you are in and the sort of project you are doing.
One of the other things is certainty. If employers are trying to decide what they need for their workforce, whether someone permanent or a contractor, the way that employment status is currently quite difficult to manage and come to a conclusion on is probably as big a thing, if not bigger, than the tax. There is a risk to the employer, in that they cannot be sure in certain cases whether they have got the status right for the person they are engaging with. The fact that they have to pay people to help them decide that adds to the overall cost of engaging somebody.
Mr Titchener also made a point about clarity of employment status:
[Employers] would welcome clarity … We mentioned earlier the certainty piece for employers … we have three different statuses for employment law and two for tax, each of which requires an independent determination. For every worker, you effectively need an employment, a tax lawyer and an HR professional to decide their status, which adds a lot of cost to the engagement
139.We strongly believe that a major reform of the tax treatment of the self-employed and employees is long overdue. The current system is confused, unfair and unsustainable. The review should incorporate the benefits which accrue upon payment of NICs and other taxes as well as the level, the incentives and the interaction of such taxes. It should look as far as is possible to eliminate the so-called ‘three person problem’ altogether.
140.Limited companies pay corporation tax at 19%. Profits distributed as dividends to shareholders are taxed at the dividend rates, which are 7.5% for basic rate taxpayers, 32.5% for higher rate and 38.1% for additional rate. As the chart in paragraph 130 above shows, owner-managers are taxed less overall than those in employment or self-employment.
141.The incentives to set up as a limited company are currently even stronger in Scotland, where income tax on employment is devolved but national insurance contributions, corporation tax and income tax on savings (including dividend taxation) are not. John Cullinane, Tax Policy Director at the Chartered Institute of Taxation, told us:
For an unincorporated business in Scotland, the business owner will be paying income tax under rates set entirely in Scotland but national insurance will be set in the UK. If they incorporate that business, you are thinking about corporation tax and income tax on dividends, all of which are at the UK level. You can have a mess entirely within the tax system.
142.We believe that if the tax advantages of self-employment were to be reduced, then the tax advantages of running a limited company should be considered for reduction relative to the taxation of employees under PAYE.
143.The differences in design and scope between tax and NICs have impacts beyond the taxation of employees, the self-employed and contractors discussed above. For example, NICs—unlike income tax—are not payable by employees or the self-employed when they are above the state retirement age; nor are they payable on pensions or investment income. Another difference is that NICs rates and thresholds are calculated on the amount of earnings received each month (or week for weekly-paid staff) and not, as in income tax, for the full year; so NICs are not cumulative in the same way.
144.These differences have led to calls for a merger of the two taxes. We heard evidence in support of this from Judith Freedman, Professor of Taxation Law and Policy at the Faculty of Law at the University of Oxford, although she also recognised the practical difficulties:
“I am on record as having proposed a merger. [ … ] but one has to recognise the practicalities. That would be an immediate jump of the headline rate of income tax, which politicians would find hard to deal with. We may have to take steps towards that, but eventually that should be the aim. I do not feel that the current national insurance system is any longer what it was intended to be. It is not a contributory system any more. We could move towards merger, in my view, and remove a lot of the structural problems that we are talking about.”
145.Bill Dodwell, Tax Director at the Office of Tax Simplification (OTS), told us that the OTS had looked at the idea of merger in 2016. He said:
“The Office of Tax Simplification did some work in 2016, looking at merging the base for national insurance and income tax in relation to employment income only. That is important, because national insurance does not apply to pension income or investment income. Moving to extend it to that would mean a substantially higher burden for pensioners. There are about 12 million pensioners in the UK. About 6 million of them actually pay income tax, a little bit. It is a group that has benefited over the decades from the increase in national insurance, borne by them when they were employed, but not borne by them as pensioners. Simply looking at merging the base for the two of them, the Office of Tax Simplification, working with HMRC’s economics unit, estimated that there would be about 7 million winners and about 7 million losers from that merger”.
146.Evidence to this inquiry is clear that differences between income tax and national insurance contributions create distortions and unfairness. While we have not heard enough evidence to recommend a wholescale merger of national insurance contributions and income tax, the Government should consider what can be done to remove the distortions gradually through time.
147.Paul Johnson, Director of the IFS, commented on the effects of taxation of pensions in payment resulting from the long term increases in national insurance contributions and reductions in income tax discussed at paragraph 128 above:
“There has, of course, been no increase in the tax on pensions in payment. In that sense, as in many other senses, those who have already reached pension age have been protected from tax rises, so there is a case for at least a modest increase in tax on occupational pensions in payment, given that they will have not have had national insurance paid at any point in the past and have been extremely well tax relieved.”
However, he noted that “this is not something that would raise you very large amounts of money.”
148.We believe that when reviewing the burdens of taxation for the employed and self-employed and limited companies, the Government should also review the taxation of pensions and the tax relief applicable to pension payments.
149.The OECD’s Base Erosion and Profit Shifting (BEPS) project aims to reach international agreement to put an end to tax avoidance strategies that exploit gaps and mismatches in tax rules to avoid paying tax. These gaps and mismatches have been used by multinational enterprises—including large multinational digital companies—to move profits to low or no-tax jurisdictions. The UK has played a leading role in the development and implementation of BEPS.
150.The UK is also one of a number of countries which have introduced unilateral taxes on digital services aimed at capturing more of the profit made in their territories by large overseas digital concerns such as Google, Amazon and Facebook. The digital services tax was announced by then Chancellor of the Exchequer, the Rt Hon. Philip Hammond MP, in the 2018 Budget statement. It is charged at 2% on the revenues of certain digital businesses. The tax came into force on 1 April 2020. The UK Government has said it will abolish the tax when international agreement is reached to share the profits of the companies more fairly across the territories in which they operate.
151.When introducing the tax, Mr Hammond said:
We will continue to work at the OECD and G20 to seek a globally agreed solution, and if one emerges, we will consider adopting it in place of the UK digital services tax, but this step shows that we are serious about this reform, because it is only right that these global giants with profitable businesses in the UK pay their fair share towards supporting our public services.”
152.The current Chancellor of the Exchequer, the Rt. Hon Rishi Sunak MP, signed a joint letter from finance ministers of the UK, Spain, Italy and France to US Treasury Secretary Mnuchin in June 2020, restating the governments’ commitment to the principle of a digital services tax. The letter stated that
Digital giants, no matter where they are headquartered, will emerge from the current crisis more powerful and more profitable. These companies benefit from free access to the European market. It is fair and legitimate to expect that they pay their fair share of tax within countries where they create value and profit.
153.Whilst recognising that the digital services tax is well designed and is expected to raise about £400m per year, Chris Sanger, Global Government Leader at Ernst and Young and Chair of the Tax Professionals Forum, said:
It will increase the price, effectively, of those businesses acting here in the UK. That then will determine whether that is a price that they can either bear themselves and therefore it will not affect the consumer or whether they pass it on. At the margin, it will deter investment.
154.Tom Clougherty also thought that the tax had faults:
“The fact that it is levied on turnover is a problem. The fact that we are just targeting a specific industry and specific businesses within a specific industry is a problem. It sets a bad precedent for good tax policy in general. The real danger is not so much with the UK levying a relatively marginal minor tax unilaterally. The problem would come if lots of other countries follow in our footsteps and if the US continues to put in place retaliatory tariffs because it sees this as a move against American business interests.”
155.We recognise that the digital services tax is a useful step towards capturing some of the profits made in the UK by digital companies. We strongly approve of the Government’s approach in seeking international agreement on taxation of companies providing digital services and, where international agreement is reached, maintaining its commitment to abolishing the digital services tax in favour of any such agreement.
156.We recommend that the Government provide this Committee with an annual report on progress towards reaching international agreement on the taxation of digital services, the yield of the digital services tax and the effects of the tax on digital companies and the wider economy.
157.The Government has recognised that there are problems with two of the main capital taxes, inheritance tax (IHT) and capital gains tax (CGT). Capital gains tax is paid on gains made on the disposal of capital assets. Inheritance tax is payable on the value of the estate of a deceased person. Both taxes are subject to extensive reliefs and exemptions.
158.The Government commissioned the Office of Tax Simplification (OTS) to examine both taxes and to make proposals for reform. The OTS published reports on inheritance tax on 5 July 2019 and on capital gains tax on 11 November 2020. On inheritance tax, its recommendations included simplifying the lifetime gifts allowance, shortening from seven years to five years the period before death during which lifetime gifts are chargeable, and restrictions to the capital gains uplift on death. The capital gains tax report recommendations included a closer alignment between capital gains tax rates and income tax rates, and it also called for restrictions to the capital gains uplift on death. The Government has yet to respond to either report.
159.Speaking in favour of reform of CGT and IHT, and against the idea of a wealth tax, Sir Edward Troup, Former First Permanent Secretary at HMRC, told us:
There is real risk that we are looking at putting something new, difficult and probably pretty inefficient on top of some already non-working taxes. We should actually go back and look at inheritance tax and capital gains tax. If this commission and your Committee’s work do one thing, I would like it to expose some of the defects of the existing capital taxes while expressing some view on what you think about this as an additional capital tax.”
160.It was also suggested to us that there would need to be an indexation allowance to avoid taxing inflationary gains. Emma Chamberlain, barrister at Pump Court Chambers and visiting Professor at Oxford University, cautioned against alignment, based on her professional experience:
“I am old enough to have been in practice in 1998, when Labour reduced the rates. They had a differential rate between long-term and short-term gains, which is what some other countries, like France and the USA, do. I remember that people just stopped going abroad, doing avoidance schemes like selling their shares and taking loan notes. The rate is absolutely critical to behaviour. If you raise CGT rates, I am sceptical about whether you will get more revenue. If you are going to align the rates, you are probably going to need an exit tax, because otherwise before people sell their business they will go abroad, stay abroad for six years, sell while they are abroad, and then you will not get anything”
161.Sir Edward Troup was also cautious about alignment, saying:
“Capital gains tax is a bit like Churchill’s description of democracy. It is the worst way of taxing capital gains except every other one that has been tried. It is very much a minority sport. We did not have it until 1965. It is only really here to protect the bigger base of income tax, to try to stop people turning income into capital gains. There is no right way to do it. You can actually say that what was done in 1965 was not a bad way, just taxing gains at about half the rate of income tax and be done with it, because some gains represent income that is already taxed—your shares in a company, which has already paid the full amount of tax, for instance—and some represent gains that are completely untaxed, like your holding of gold bullion or whatever else”.
162.But in contrast to other witnesses he thought there was a case against indexation:
“It is extraordinary that the Office of Tax Simplification should be advocating inflation relief in capital gains tax, when if I go out and buy a Government gilt, in normal days when there is normal interest rates and normal inflation, I get no relief against income tax for the inflationary element of my interest. They are now suggesting that we have all the complexity of inflation relief on capital gains.”
163.There are problems with the existing capital taxes, and we await with interest the Government response to the OTS reports on inheritance tax and capital gains tax.
165.VAT was introduced in the UK when it joined the European Economic Community in 1973 and was one of the requirements of joining. The overall structure of the tax, including what could and could not be charged to VAT, was set in an EU VAT Directive. Now that the UK is no longer a member of the EU, this Directive does not apply. The UK Government now has more scope to tailor the VAT system to suit the UK economy or to go further and replace VAT with a retail sales tax.
166.A sales tax is incurred by the buyer at the point of sale of goods, and the retailer accounts to the tax authority. VAT, by contrast, is incurred by all buyers in the production chain. VAT allows businesses to recover the VAT they pay (their “input tax”) by setting it against the VAT they receive (“output tax”). It is not necessary to define the final retail purchaser: that will be anyone who cannot recover the VAT. Businesses only account to HMRC for the difference between output and input and can claim a refund from HMRC. VAT is favoured by economists because, by accounting for inputs and outputs, it distorts transactions less than a retail sales tax does, and because it applies only to the “Value Added” at each stage of production.
167.We took evidence on whether a sales tax should replace VAT. Stuart Adam told us that:
If you were starting from scratch, either [VAT or a sales tax] would be potentially a reasonable option, thinking specifically about a retail sales tax, not a turnover tax. Either would in principle be reasonable. I would probably still lean towards VAT, but, given that we have a VAT system up and running, I would not go near the upheaval of scrapping one and introducing the other with a bargepole.”
168.Alan McLintock, Chair of the Indirect Taxes Committee at the Chartered Institute of Taxation, agreed. He said: “If you look over the last 20 to 25 years, almost every country in the world has implemented a VAT system. None of them is implementing sales at purchase tax systems. The US is pretty much a standalone. I would not look at that as a model of good tax.”
169.We did not hear or receive any evidence in favour of replacing VAT with a retail sales tax. Any contemplation of such a change must be accompanied by more evidence as to the effects it would have, not least on our trade with the EU, which would continue to levy VAT.
170.The VAT rate of 20% applies to most goods and services, but there are a number of zero rates, including food, children’s clothes and books. In addition, there are reduced rates on domestic energy, energy saving materials and protective and safety equipment such as children’s car seats. There are also a number of exemptions from VAT. A seller can recover input VAT where goods or services are zero-rated but cannot where the goods are exempt. The Government also introduced reduced rates for hospitality and certain attractions on 15 July 2020, as a measure to help businesses affected by the pandemic.
171.We asked witnesses about the impact of the UK’s departure from the EU and the freedom to change the scope of VAT. Stuart Adam, Senior Research Economist at the Institute for Fiscal Studies, said:
“The obvious danger is [ … ] it opens up scope for every sector of the economy to lobby for preferential VAT treatment. So far, the Government have been able to say, “The EU ties our hands”. If they cannot say that, lobbying pressure may grow. That is particularly in the context of a weak economy. Lots of sectors can make reasonable arguments for saying, “Look, we are struggling. We need support”. Every sector can make a good case for why it is particularly deserving. I am not convinced that preferential VAT treatments are a good way to support particular industries.
172.We received evidence putting the case for new zero rates.
Some witnesses spoke about the desirability of zero rates. Paul Johnson, Director of the Institute for Fiscal Studies, suggested extension of the VAT base as a revenue raiser after the pandemic. He said: “Politically difficult, but good for the efficiency of the tax system, would be to extend the VAT base somewhat—not necessarily by charging 20% on everything that is currently charged at zero per cent … “.
173.Dr Gemma Tetlow, Chief Economist, Institute for Government, agreed. She said:
“I would support Paul’s call for thinking about broadening the base of some of these taxes rather than just increasing the rates, which has tended to be what Governments have liked to do in the past. I agree with Paul’s statement that it is hard to do politically but, for example, things like charging VAT on all goods rather than having many products zero rated would be one way of doing that. It would stop the current behaviour, which is that the producers of goods try to ensure that their goods get classified as being zero rated and not 20% rated.
174.Philip Booth, Professor of Finance, Public Policy and Ethics and St Marys University and Senior Academic Fellow at the Institute of Economic Affairs, was opposed to tax increases, but he pointed out that other countries have a broader VAT base and suggested that expanding the VAT base would be a way of raising additional tax without damaging growth:
“if you are looking for the least anti-growth taxes, one thing you could do is look at tax systems in other northern European countries where they raise a somewhat higher proportion of national income through tax. [ … ] they [have] a much broader VAT base, for example by charging VAT on domestic fuel and transport and very often food as well. They [ have] [ … ] people starting to pay tax at lower levels of income and higher rates of tax come lower down the scale. [ … ]. Broadening the VAT base and potentially some kind of tax on user services and cost of housing—a complex issue that we might come back to and that I know the IFS has written about—would be another non-anti-growth way of raising taxes significantly.”
He also said “ … I would extend the VAT base to at least include domestic fuel and transport.”
175.We asked Alan McLintock about changing the VAT base. He said:
“The VAT exemptions and zero rating are very significant. Food is about £19 billion. Construction and sale of new dwellings is about £15 billion. Domestic passenger transport is about £5.5 billion. There are obviously large amounts of tax being relieved there so you could look at increasing the tax base and taxing these. As we have just seen with the retail export scheme, there are lots of people and businesses that would be negatively impacted and would be lobbying hard against such a move. Extending the tax base or increasing the tax rate is probably where your choices are. For things like healthcare and particularly financial services, it feels far more difficult technically to apply a rate of VAT. It would get very complex. You would probably have to do very narrow things, such as applying VAT to motor or contents insurance, rather than taxing it as a generality. Technically, food and passenger transport are the easy ones because you just apply VAT rate.”
176.Our witnesses mentioned the political difficulties in changing the scope of VAT. Dr Gemma Tetlow, Chief Economist, Institute for Government, reminded us of the difficulty that the Government encountered in its attempt to charge VAT on “pasties” in 2012 when she said “ … if you look back to the attempt in 2012 to charge VAT on a slightly broader range of products, including pasties, that obviously created serious difficulties.”
177.Another example of difficulty was the attempt by the Chancellor of the Exchequer in 1993 (the Rt Hon. Norman Lamont MP) to remove the zero rate on domestic gas and electricity that had been in place since 1973 and charge the full rate of VAT, partly to raise revenue but also to encourage energy efficiency. The new policy was announced in the Budget in March 1993, but the Government was defeated on a Budget resolution in December 1994 and the reduced VAT rate applied instead of the full rate.
178.We asked Charles Seaford what his research of public opinion on VAT showed about attitude to changing the VAT base. He told us:
“If we turn to exemptions, the ones like food are the easy ones technically, but they are the most difficult in terms of politics and what people think. In the groups, we got very strong objections to increasing on what are perceived to be essentials and eliminating exemptions on essentials.
We got some support for extending the tax base to what people thought of as luxuries or those goods and services that are bought by people who are thought to be able to afford it. In the poll, we got strong support for levying VAT on private school fees—not nurseries but private schools. We got a net positive of 49%, which is one of the most popular proposals we put forward. That would raise about £2.5 billion. We got a net positive of 57% for applying VAT to gambling stakes. We got a net positive of 26% for applying VAT to private medical fees. All those were strong net positives, but there was a total opposition to extending it to food or those things that people thought of as essential.”
179.There was also agreement amongst tax professionals that the VAT regime is complicated, and that reliefs and exemptions need reform. John Cullinane said that “ … the whole area of exemptions, zero ratings and reduced ratings costs a great deal of money and, at the same time, is a source of complexity, compliance issues in the system and ongoing disputes.” Anita Monteith, representing the Institute of Chartered Accountants of England and Wales (ICAEW), said about VAT: “We need simplification, but I would go further and suggest that we examine the whole principle of exemption.”
180.We welcome the increased flexibility that the UK Government has to set VAT rates–for example we welcome the abolition of the “tampon tax”. We recognise that the VAT system is complicated and that the zero and reduced rates, together with the exemptions, create economic distortions. We also recognise, however, that in political terms simplification through removing exemptions and zero rates is likely to be very hard to deliver. We do not recommend any significant changes to the scope of VAT.
181.The Government should, following consultation, set out principles and objectives for the VAT system now that VAT is free from EU law. This should include a framework within which new reliefs can be assessed or existing ones withdrawn. The Government should ensure that the principles balance revenue raising, economic growth and other objectives, such as improving the quality of the environment and “levelling up”.
182.Parliament legislated in 2019 for a reduction in the target for net greenhouse gas emissions to zero (or negative) by 2050, measured against the 1990 baseline. The UK will host the COP26 summit in Glasgow in November 2021, and the Government recognises that it will be expected to take a clear lead in addressing climate change. It also recognises that the environment will play a key part in the UK domestic economy’s recovery from the effects of the pandemic. In his Summer Statement on 8 July 2020, the Chancellor of the Exchequer said: “This is going to be a green recovery with concern for our environment at its heart.”
183.Green taxes currently raise around 4½ per cent of the tax yield. These and new green taxes may need to play a greater role in the short to medium term as part of incentivising the transition to net zero, while in the long term, a successful transition to net zero seems likely to result in a loss of environmental tax revenue.
184.An Institute for Government report published in September 2020 concluded that after more than a year the UK was still off track to meet not only net zero by 2050 but also its previous less ambitious target, which was to reduce emissions by 80% from the 1990 levels by 2050. It called for the Treasury, in co-operation with a new unit in the Cabinet Office leading on net zero, to “produce a tax strategy to support the move to net zero, which will need to address the substantial loss of revenue from fuel duty as the vehicle fleet is electrified.”
185.During our Decarbonisation and Green Finance inquiry we asked about the role of the Treasury in decarbonisation. Baroness Worthington, an environmental campaigner, told us that “the Treasury is central to all of this and we are delighted that it has now set up a dedicated team to look at net zero and make recommendations on how we get there.” Lord Turner of Ecchinswell, Chairman of the Energy Transitions Council and the founding Chairman of the Committee on Climate Change, agreed. He told us:
It is obvious what the core role of Treasury is in this. Treasury is in charge of taxes and Treasury is in charge of public expenditure. Although there are many other tools of policy required to build a zero-carbon economy, what the tax regime is and what the public expenditure regime is are crucially important, so that needs to be integrated with the overall strategy [ … ]
Expanding the point about tax, Lord Turner said:
[You] have to use the power of the price mechanism to incentivise companies to search for the cost-efficient solution [to decarbonisation], and that means a tax regime. The Treasury is in charge of taxes in other sectors of the economy, some of which we are not currently differentiating by high carbon or low carbon. We already have a non-trivial tax on air traffic … but at the moment there is no differentiation in that levy according to whether the airline is using a zero-carbon fuel or a high carbon fuel. There are major opportunities to introduce a differentiation, which would create incentives to develop low-carbon fuels.
186.In this inquiry we asked about the challenges of green taxes. Alex Cobham, CEO at the Tax Justice Network, pointed out that they are not always progressive. He said:
[ … ] A lot of these taxes on consumption or emission end up being passed through in pretty regressive ways. That not only worsens the inequalities in our societies, but it imperils the political support, as we see with things like the gilets jaunes movement in France. [ … ]
187.He suggested that this difficulty might be overcome with a hypothecated payment to households:
One idea that is worth looking at is the carbon dividend, where you would say, “We will capture the revenue that comes in from taxes on carbon and pass that back out to people”. Even if you are paying a bit more for your petrol, say, because you as a poor household do not have a choice about using the car, you will get more than that back in the dividend … You get both elements of addressing inequality and reducing carbon emissions.
188.Annie Gascoyne, Director of Economic Policy at the Confederation of British Industry, was concerned about complexity that could arise from multiple carbon taxes:
One thing that probably needs to be done first on carbon taxes is to decide exactly what kind of tax we want and where we are going to tax it because, at the moment, there is a risk of lots of taxes trying to price carbon in different ways. There is a simplification thing that we can do there.
189.Tom Clougherty, Head of Tax at the Centre for Policy Studies, agreed with the need for simplification:
There is scope for huge simplification because we have lots of different taxes on environmental ills at the moment. Replacing them with a comprehensive carbon tax would be a great move.
Mr Clougherty also emphasised that carbon taxes could not be regarded as a lasting source of public revenue by their very design, since “if you change behaviour, you get less revenue in the long run.”
190.We recognise the challenge of net zero and agree with witnesses to our Decarbonisation and Green Finance inquiry that tax has a part to play in achieving this goal. However, carbon taxes are unlikely to form a major part of the long-term tax base or stabilisation of the public finances, as they are designed to complete the transition to net zero.
191.The Government should develop a tax strategy to meet net zero. This should include tax measures to incentivise the behavioural changes needed to achieve net zero while at the same time providing short term support in the tax system for pump-priming green innovation and balancing the need to protect those on low incomes.
192.Stamp duty land tax is a tax on property transactions. It was introduced in 2003 as an administrative modernisation of stamp duty which removed the need to physically stamp documents. The OBR estimates the total yield for property transaction taxes for 2019–20 to be £12.5 billion. The tax has been devolved in Scotland and Wales.
193.In 2014 the structure of the tax was reformed so that instead of tax being payable at one rate on the entire value of the property, tax is calculated by applying different rates to different bands of the total value. For 98% of home buyers this led to a cut in liability. One consequence of this reform was that the marginal rate of tax on the most expensive home purchases rose considerably, and the top rate which applies in all four nations of the UK is now 12%. There is also a second home surcharge of 3%.
194.Many economists have argued that stamp duty is a poorly designed tax as it increases the cost of transactions and can be avoided simply by not moving home. The Mirrlees review, published in 2011 and before the 2014 reform, stated that “there is no sound case for maintaining stamp duty and we believe that it should be abolished”. However, recognising the difficulty of abolition, it said:
Simply removing it would create windfall gains for existing owners, as it will largely have been capitalized into property values; so a reasonable quid pro quo for its abolition is that a similar level of revenue should be raised from other, more sensible, property taxes.
195.House price inflation and increased stamp duty rates have increased the revenues from stamp duty over the last 25 years, as this chart shows:
Figure 10: UK Property transactions, tax receipts
196.Research by the London School of Economics for the Family Building Society, published in 2017, examined the impacts of stamp duty land tax (SDLT) on the housing market. In its conclusion it said:
SDLT contributes to reduced household mobility. Having bought a home, people are unwilling to move again soon and ‘waste money’ by paying SDLT twice over. This is costly for individual households as they are less likely to take up new job opportunities (or, if they do, may need to commute long distances); it is costly for the economy because it inhibits the efficient allocation of labour, and both consumer expenditure and housing investment are lower than they otherwise would be.
197.In his summer Statement on 8 July 2020, the Chancellor announced a temporary cut in stamp duty, under which house transactions where the agreed purchase price was under £500,000 would be exempt from the tax. The exemption is due to end on 31 March 2021. Announcing the cut in the House, he said:
One of the most important sectors for job creation is housing. The construction sector adds £39 billion a year to the UK economy. House building alone supports nearly three quarters of a million jobs, with millions more relying on the availability of housing to find work. But property transactions fell by 50% in May. House prices have fallen for the first time in eight years and uncertainty abounds in the market—a market we need to be thriving. We need people feeling confident—confident to buy, sell, renovate, move and improve. That will drive growth. That will create jobs. So to catalyse the housing market and boost confidence, I have decided today to cut stamp duty.
198.During our inquiry, witnesses commented on the inefficiency of stamp duty. Paul Johnson said that:
“The current structure of stamp duty for housing is extraordinarily damaging to the housing market and the economy more generally, and that reflects the very high tax rate. There are bits of the tax system where we need to reduce taxes, but if you are going to cut stamp duty on more expensive properties, there will potentially be an opportunity to increase council tax on more expensive properties, which we know is an extremely inefficient and inequitable part of the system.”
199.Others were similarly critical, and Dr Arun Advani, Assistant Professor at the Department of Economics at the University of Warwick, said “I agree with what has been said by essentially everybody at this point, which is that stamp duty does not really make any sense as a transactions tax.”
200.There was widespread agreement among witnesses that stamp duty land tax is economically inefficient, causing damage to the economy by affecting when and how often people buy homes. This in turn has implications for the flexibility of labour markets and for economic activity: a reduction in the volume of house transactions leads to a corresponding reduction in associated economic activity, such as home renovation and refurbishment. The Government should treat stamp duty land tax as a priority for reform and should set the tax at a level that optimises revenue while encouraging home ownership. Any review should take into account the impact of any UK changes on equivalent devolved taxes.
201.There have been recent reports that the Government is considering reform of council tax. The current council tax system is based on the same 1991 valuations that were used when the tax was introduced in 1992. A revaluation in Wales in 2003 led to many properties moving up council tax bands and was unpopular. A planned revaluation in England was cancelled in 2005, and governments since then have not revalued. In Scotland the system was reformed in 2017, following recommendations by the Scottish Government Commission on Local Tax Reform, but there has been no revaluation.
202.Council tax is devolved to Scotland and Wales and has never been introduced in Northern Ireland, where domestic rates still apply. Any reform of council tax by the Westminster Government would only apply to England.
203.Written evidence to the inquiry from the Local Government Association set out the problems with council tax:
In England, council tax is based on 1991 property values and has not been revalued since. The only circumstance in which a property is revalued is if it is improved and subsequently sold, in which case it may be re-banded if the new valuation (still based on 1991 property values) would place the property in a different band. Any change in relative values otherwise, between properties or between areas, will not be reflected.
The banding structure is regressive. The eight-band structure has a spread of 1 to 3 (where Band H pays three times as much as a Band A). It is flat at the top of the range, in other words a property worth £320,001 in 1991 will pay the same as one worth much more at that date. The band structure is fixed nationally so there is no ability to vary locally, for example by adding more bands or by changing the relativities within bands.
204.We asked Robert Palmer, Executive Director at Tax Justice UK, whether there should be a revaluation of council tax in England. He said:
“It is almost universally agreed that our current property taxes in England, Scotland and Wales do not work. We have a regressive system where poorer people proportionately pay more of their income and more of the value of their property in tax than richer people, and there are also geographic variations. People in the north of England and the midlands are paying higher rates of council tax than people in London. There is quite a lot of consensus that we should think about revaluation.”
He went on to say:
“I would argue that we should scrap stamp duty and council tax, and bring in a property tax based on the value of the property. If you cannot do those big changes, there are things such as revaluation, which I think would be important. You could do things like adding bands, which has been done elsewhere.”
205.Paul Johnson, Director of the Institute for Fiscal Studies, told us that “council tax [ … ] is absurdly generous to people towards the top.” We asked Mr Johnson about the merits of the idea of replacing stamp duty and council tax with an annual housing levy. He said:
Yes, it would be a much better situation from an economic and an equity point of view. From an economic point of view, it would get rid of what has become a really significant housing market problem. It is just very expensive to move house. There has been a downward trend in the number of people moving and people, frankly, are stuck in places they would be better off swapping with their neighbours, because it is just an expensive thing to do. It also has potentially negative effects on labour market flexibility, though it is hard to determine how big that is. Of course, at the moment council tax is extraordinarily out of date and regressive.
Recognising the political difficulties with reform, Mr Johnson said:
“ I am not expecting it to happen any time soon. To make that move would create some very big losers, and those losers will not all have the ready cash to make the additional payments, even if they have very valuable properties
206.Other witnesses also found fault with council tax. Dr Advani, Assistant Professor, Department of Economics, University of Warwick, said that “we would much rather have something that is a property tax. Council tax looks a bit like that but is fairly ineffective at this point.” Philip Booth, Professor of Finance, Public Policy and Ethics and St Marys University and Senior Academic Fellow, Institute of Economic Affairs, said that he “would replace all existing property taxes with a tax on user services on owner-occupied and other property and rents, or a tax on imputed income as it is sometimes known.”
207.A recent report by the Housing, Communities and Local Government Committee on Local government finance and the 2019 Spending Review concluded that council tax was a regressive tax which had become disconnected from property values. It recommended a review of council tax to include new bands at the top and bottom of the scale and a review of how a revaluation could be implemented.
208.We have heard strong arguments in favour of reform of council tax. We encourage the Government to consider how best to reform local taxation, taking account of recommendations from the Housing, Communities and Local Government Committee and we draw the Government’s attention to evidence submitted to this inquiry.
209.Our predecessor committee held an inquiry in 2019 into business rates, and a review of business rates was announced in the Government’s response to our inquiry. The review issued a call for evidence in 2020, and further details are expected at Budget 2021. Since 2019 the pandemic has highlighted problems with business rates, as retailers and hospitality businesses have been unable to trade for long periods due to coronavirus restrictions. The Government has provided relief from business rates for businesses forced to close, but businesses may struggle to pay business rates based on historic valuations if the relief is lifted.
210.Business rates remain problematic for many businesses. Annie Gascoyne, Director of Economic Policy, Confederation of British Industry told us: “[ … ] when we talk about a sustainable tax base, business rates is evidently not one.” Commenting on the need for reform, Tom Clougherty said that “it would be a mistake, or at least a big missed opportunity, to simply cut business rates without reforming the way tax works in an underlying fashion.”
211.As the previous Treasury Committee concluded in 2019, we believe that the business rates system needs reform. We welcome the current Government review and encourage it to make significant reforms to improve the overall functioning of the business rates system for the long term.
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146 HM Treasury, , accessed 18 February 2021
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148 HMRC GOV.UK
149 See , page 2 for the original announcement. The Chancellor announced the change in policy (and the reasons for it) in the House of Commons on 15 March 2017. See HC Deb 15 March 2017, , [Commons Chamber]
150 . Col 814
151 Helen Miller and Stuart Adam, Institute for Fiscal Studies, , 26 January 2021. See page 8
152 Office for Budget Responsibility, Fiscal Risks, , July 2019, p78, para 4.19
153 See paragraph 4.17 on page 78 of 2019.
167 HMRC, , www.gov.uk
168 Office of Tax Simplification . 7 March 2016. This report discussed the issues in detail and made recommendations for change.
170 Office of Tax Simplification , first report (7 March 2016) and (14 November 2016)
172 Term used to describe a pension payment received by a pensioner
175 Action 1 is “Tax Challenges Arising from Digitalisation”
176 HC Deb, 29 October 2018, [Commons Chamber]. HM Treasury , HC 1629, 29 October 2018, paragraph 3.4 page 41
177 HMRC, “” guidance
178 HC 121, March 2020 . see also, PQ61662, 24 June 2020; HC Deb 15 September 2020 ; , 7 October 2020
179 HC Deb 29 October 2018 [Commons Chamber]
180 HM Treasury, .
181 Also this as the estimate of yield at Budget 2018, see HM Treasury . 29 October 2018, HC 1629 table 2.1 line 53 page 38
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186 Office of Tax Simplification, Inheritance tax Review—second report: Simplifying the design of Inheritance Tax, July 2019, p7
187 Office of Tax Simplification, Inheritance tax Review—second report: Simplifying the design of Inheritance Tax, July 2019, p10
188 Office Of Tax Simplification, , November 2020, p18–19
190 For example see Dr Arun Advani
194 which updated previous directives on turnover taxes
195 For a detailed discussion of the economics see Mirrlees report, Dimensions of Tax Design, chapter 4
199 HMRC , 9 July 2020
211 HC Deb 24 June 2019, [Commons Chamber]; HL Deb 26 June 2019, col 1083 [Lords Chamber]
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213 Institute for Government, , 7 September 2020. p8
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216 Oral Evidence taken on 10 March 2020 Q3 [Chair]
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223 HMRC, , 3 December 2014
224 Rates and Bands and and . Northern Ireland has SDLT.
226 Institute for Fiscal studies, , p404
227 Stamp duty land tax on residential property, Standard Note , 29 January 2021. p94
228 London School of Economics, , November 2017, p31–32
230 HC Deb 8 July 2020 [Commons Chamber]
232 Qq [Professor Philip Booth], [Robert Palmer],
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