Examination of Witnesses (Questions 243-259)
Mr Michael P Devereux and Ms Judith Freedman
12 MAY 2008
Q243 Chairman: Welcome to our two
witnesses from the Oxford University Centre for Business Taxation.
Thank you very much for your written evidence, which we have of
course read. Do you want to make any introductory statement or
shall we just go straight into questions?
Mr Devereux: As you like. I think we can just
go straight in.
Lord Powell of Bayswater: I am chairman of the
trustees of the Said Business School Foundation, not that I intend
to give them a particularly easy time as a result, but I ought
to declare it.
Q244 Chairman: As you know, there
are two particular topics that you have been concerned with and
that we are looking at. They are capital gains tax and entrepreneurs'
relief on the one hand and encouraging enterprise on the other.
If I can start off with CGT, the October 2007 Pre-Budget Report
said, "The Government is committed to ensuring that the UK
has an internationally competitive capital gains tax system that
promotes flexibility and competition and responds to the changing
needs of investors. ... [The reform] will put the CGT regime on
a more sustainable footing and help investors plan for the long
term." In your paper you set out a framework for approaching
tax where you said that you were looking for a simple system that
may not be perfect but which is reasonably fair and which does
not create too many economic distortions. How far do you think
it would have been possible to achieve what you are seeking within
the government's aims as they have set them out?
Mr Devereux: We have not done an international
comparison here so we should be quite open about that in the first
place. We were approaching this from the point of UK citizens
and residents as to what an appropriate way of taxing them is,
also bearing in mind the effects of capital gains tax on the kinds
of investment decisions they would make. In that light, we look
at evidence as to the ways in which capital gains tax affects
the amount and type of investment individuals may do. We also
wanted to take into account the links with other forms of taxation,
as we point out in the note, and to income tax in particular.
That is the kind of framework that we had in mind.
Q245 Chairman: Do you believe the
government is right to seek a tax regime which is internationally
competitive?
Mr Devereux: It depends to some extent on how
it is being competitive and the nature of the tax. If it is a
tax on UK residents who stay in the UK, this is going to affect
the investment decisions of those UK residents. It is rather different
from something like corporation tax for example where we are taxing
the profits which arise in the UK. Having a high tax there may
induce companies to move abroad. The comparator here would be
whether it induces individuals to move abroad because of high
capital gains tax rates. That seems rather less likely than corporation
tax.
Q246 Lord Barnett: Is it possible
ever to have a truly simple tax in relation to capital gains?
Is that not an aspiration that would do all accountants out of
business or even KPMG perhaps, which would make your position
difficult?
Ms Freedman: I would like to make clear that
I am independent of KPMG. I am employed by Oxford University.
Mr Devereux: No, we do not believe there is
a simple capital gains tax which would cover all of the points
which people would like to make about it. Indeed, that is probably
true of most taxes. I think capital gains tax is particularly
complicated from that perspective. There has to be a balance in
the way that it is designed.
Ms Freedman: This is a particularly complex
tax because of the things that we have set out in the note which
create complexities. Ideally, one would tax it in one way but
pragmatically one cannot. For example, one has to have a realisation
basis and that immediately complicates the tax situation.
Q247 Lord Barnett: Indexation of
course has been very complex. You apparently would not want to
stay with that. You recognise that it was very complex and therefore
you support the idea in principle but you are looking for an administrative
solution. I am not sure what kind. Can you spell that out?
Ms Freedman: One of the reasons for the complexity
is the continual change. Instead of trying to work at the indexation
system and improve it—perhaps one might have to apply some
rules of thumb and make it less of an elaborate indexation system
but still have an indexation system—we moved to a taper
relief which had no logic at all and then we changed the taper
relief twice. That is one of the things that has created so much
complexity. Complexity is created by constant change as much as
by the underlying system. Had we stuck with indexation but worked
on improving that it might have been a better way forward.
Q248 Lord Powell of Bayswater: Coming
on to the idea of a single rate, reading your paper I get the
impression that you think the only logical single rate would be
40%, which suggests incidentally that you are not running for
elective office in the City. Is that really feasible given the
political context of taxation? Secondly, is not the only truly
simple thing to have a single rate, possibly not 40%, and a taper
for everyone over a period of 10 or 12 years or something down
to zero or 10% or whatever? It seems to me that anything else
is bound to be more complicated. Start with the single rate. What
would you set it at?
Mr Devereux: Our basic proposition would be
that there is no particular need for a single rate. If we were
forced to have a single rate, we would have to have a discussion
about what it would be. There would be a case for 40% and there
would clearly be a case for other rates as well. The issue that
we wanted to raise was one of simplicity within the system. Is
it necessary to have a single rate in order for the system to
be simple? The point we wanted to make primarily was that what
makes a system simple is not necessarily having determined the
amount of taxable income or taxable gain what rate to apply to
it. Rather, it is how difficult it is to determine that amount
of taxable gain. If there are possibilities of different forms
of income being transferred into capital gains or vice versa,
the different rates of tax that we have on income and capital
gains are clearly very important. That is where the boundaries
in the tax system lie and where complications in the tax system
arise which the authorities have to deal with. We feel that in
some ways the difficulties and complexities also arise because
of the links between capital gains tax and other taxes, notably
income tax, in the system rather than the single rate itself.
Q249 Lord Powell of Bayswater: You
do not think all the recent anti-avoidance legislation in practice
has diminished the likelihood of people being able to shift income
into capital gains?
Mr Devereux: I am sure it has. The fact that
those anti-avoidance provisions are there at all relates to the
fact that there are boundaries in this form.
Ms Freedman: The idea would be to try to reduce
those anti-avoidance provisions which cause a great deal of cost
to everybody. One cannot do that unless one has a sensible, underlying
tax system. Ideally one should aim for a sensible set of rates
and then you could get rid of some of the anti-avoidance legislation
and have a much simpler system.
Q250 Lord Powell of Bayswater: Is
not the only simple system a single rate with a taper for capital
gains of any sort for everyone?
Mr Devereux: I would question why we need a
taper relief at all and why the tax rate that you pay on a gain
should be lower the longer that you have held an asset. It is
not clear to me in economic terms that that would be a sensible
system.
Ms Freedman: We are not recommending 40% without
indexation. Our recommendation goes hand in hand with indexation.
Q251 Lord Powell of Bayswater: The
argument concerns very short term, very speculative gains and
whether you simply encourage those.
Mr Devereux: The issue there is whether encouraging
people to hold an asset for longer has an effect on short term
speculation. More important is the way that individual investors
value things happening in the future. If everybody values things
happening in the future, say, a year away at very low rates, then
the value of the asset will reflect that. That is not necessarily
anything to do with the length of time that an asset is held.
It is more to do with the discount rate which people are discounting
in the future.
Q252 Lord Powell of Bayswater: If
you are building up a business, you presumably take a longer term
view, if you want to encourage people to build up businesses?
Mr Devereux: Indeed, but it is not clear that
you need taper relief within the tax system to do that. Capital
gains tax itself implies a lock in effect because the longer you
hold onto an asset the further away you can defer payment.
Q253 Lord Powell of Bayswater: Is
this not how the German system encourages the development of medium
sized companies?
Mr Devereux: I am sorry; I am not familiar with
the German system.
Ms Freedman: There are many circumstances other
than tax that created the German system and we should be careful
about giving too much credence to tax as a way of encouraging
any particular activity. It would be much better to have a neutral
tax system and let tax activities depend on commercial considerations.
Q254 Lord MacGregor of Pulham Market:
Taper relief in one sense does help to deal with the indexation
point and does mean at some point that you do not have to pay
capital gains tax at all. You are advocating that you would prefer
to have indexation but I take it you are very critical of the
fact that there is now neither indexation nor taper relief in
the system so that inflation gains are going to be taxed?
Mr Devereux: Indeed, yes. We would argue that
there is a case for indexation. We believe there is less of a
case for taper relief. In practice they are not very close.
Ms Freedman: Clearly, the lower rate is intended
to be some kind of crude compensation for the lack of relief.
Q255 Lord MacGregor of Pulham Market:
It is a pretty crude way of dealing with it. Can I explore further
the point about people switching from income into capital because
that is obviously a very real risk. Some of our evidence has suggested
that the anti-avoidance rules and the need to get Revenue clearance
for particular schemes will more or less deal with this problem.
It sounds as if you are not convinced of that.
Ms Freedman: There are anti-avoidance rules
but relying on these has its problems. You cannot get Revenue
clearance in some types of case. It is not always available. The
provisions for getting clearance have expanded but you cannot
for example get a clearance if it is considered that you are engaged
in an avoidance scheme. Who defines whether you are engaged in
an avoidance scheme? That may depend on who is making that decision.
Getting clearances delays things. If you want a competitive, commercial
system you do not want a system in which you have to get a lot
of clearances. I would have thought you would want a system where
you can tell what the law is and not have to rely on going to
the Revenue for a clearance.
Q256 Lord MacGregor of Pulham Market:
Given the present scheme, what is your solution to the risk of
people switching from income to capital gains?
Ms Freedman: We would not start from here so
they would not have that opportunity to switch. Once you have
built in the opportunity, you are going to have to have anti-avoidance
provisions of some kind or another. You may need more. I do not
have a particular idea for what might be needed but it may emerge
as people in the City work things out and come up with schemes.
It may be that these schemes will be disclosed and new provisions
will have to be introduced, so we will have a larger Finance Bill
for you to look at next year.
Q257 Lord MacGregor of Pulham Market:
With all sorts of technical responses to those press stories about
avoidance or switching taking place.
Ms Freedman: Yes. There will be such responses.
Q258 Chairman: You say in your written
evidence that it is difficult to justify on any economic rationale
the distinction between business and non-business assets. Could
you expand on that?
Mr Devereux: The starting point would be fiscal
neutrality. Unless there is a particular rationale for favouring
some forms of assets over others, ideally the tax system should
be neutral between them. Within the context of business versus
non-business, I think there would therefore be a presumption of
evidence and proof required on those who would advocate a special
provision for business assets. Is there some particular value
in those to the economy at large relative to these other forms
of assets? Broadly, it is one of fiscal neutrality and asking
what particular benefits are there for business assets as opposed
to other assets.
Q259 Chairman: You do not think it
would be productive or more likely to be?
Mr Devereux: It may be. Some business assets
are going to be more productive than others. One could ask the
question why we need to give relief to all forms of business asset.
One could say let us only give relief to productive business assets
or those which have particular effects on the rest of the economy,
rather than on the private individual who owns those assets. There
are a number of ways in which one could try and identify the benefits
to society generally of any particular tax measure. But it is
extraordinarily hard to do so in practice and it is extraordinarily
hard also to come up with a system which has the desired effect
of promoting more investment in productive assets, if indeed it
is believed that there is not enough investment in productive
assets at the moment.
| 
