We can expect major tax reform in the new year as we head towards a new economic climate. The Treasury is clamouring to answer how will the government manage the £300bn deficit? Which is forecast for the current fiscal year. As we bear witness to the unfolding financial crisis resulting from the pandemic, tax reform is becoming increasingly necessary.

Tax reform could provide the Treasury respite from mounting cost of government schemes helping Britons through the worst recession in more than three centuries. In August 2020 the UKs economy officially entered the largest recession on record, threatening the prospects of UK economic growth in 2021. Since the outbreak of Covid19 the total number of unemployed has more than doubled, rising to 2.7 million since March and is rising at a faster pace than in the wake of the 2008 financial crisis, according to the ONS. As we draw closer to 2021, we are starting to see more of what we can expect, in the new economic climate, from postponed tax law enforcement, to full blown tax reform. 

Public Sector Pay Freeze

Record breaking public sector net borrowing jumped to £22.3bn in October, pushing borrowing to £214.9bn so far in 2020. This figure, although lower than expected, will climb again as a result of the second national lockdown which ended and gave way to the three tiered alert system on 2 December. HMRC highlighted the impact of the pandemic on the public finances, reporting that tax receipts have slumped by over £70bn so far this financial year. VAT, corporation tax, income tax, fuel duty and air passenger duty have all fallen sharply.

In HM Government’s latest spending review published on 25 November, a public sector pay freeze was announced as part of the Treasury’s arsenal against the financial crisis, amid backlash from unionists. ‘This is austerity, plain and simple.’ Said Unison general secretary Dave Prentis. Although around one million frontline NHS workers and many lower paid workers will be spared, approximately 1.3 million public sector employees will see their previously promised pay rises frozen. These include teachers, firefighters, armed forces personnel, police, civil servants and local authority workers. Much of the criticism centres on the view that the efforts of so-called key and frontline workers, besides the NHS, have too quickly been forgotten, since it was the public sector as a whole that played its part in keeping the UK running during the pandemic crisis, not only the health sector.

Making Tax Digital 

We expect to see a future of increased tax authority investigations as a side effect of the governments need to raise tax revenues. Greater corporate taxes may help reduce fiscal deficits as the world emerges from the pandemic-induced economic crisis. new steps taken, as in post-war scenarios, with the introduction of “new sources of revenue” or the modification of “the tax mix in existing systems”. 

The crisis will likely naturally increase the adoption of Making Tax Digital, especially since digital service providers are benefiting from increased use of digital services during lockdown. Authorities may well invest in the digitalisation of their own systems to assist revenue collection as “highly digitised tax administrations can increase compliance and reduce burdens on taxpayers.” Says the OECD. HMRC plans to “increase its investment in technology to better target those abusing the tax system,” according to a report in the FT, indicating that HMRC sees technological resources as fundamental to closing the tax gap. Its own investment focuses on the Making Tax Digital (MTD) strategy, mandating the adoption of tax technology among taxpayers. The latest tax gap figures show that MTD for VAT alone was already forecast to deliver additional tax revenue of £1.2 billion by 2023 to 2024, with steady state savings of around £300 million each year. The introduction of a new points-based penalty regime for VAT, scheduled for 2020, will enable HMRC to automatically award points and financial penalties. It signifies the tax authority’s intentions to ensure penalties are awarded fairly and proportionately but also more frequently and effectively through the use of automated systems.

Yet tax authorities can only enforce legislation as it exists today in the short-term, so many governments have been advocating for fundamental reform of tax regimes to yield more tax from business.

VAT

As discussed in the Treasury Committee evidence session as part of its inquiry into tax after coronavirus: Charlotte Barbour, ICAS director of taxation said: ‘Up until now anytime there has ever been any mention of doing anything to VAT, people have said “oh no you can’t do that because it’s European and you can’t touch it. Post Brexit there is going to be a huge clamour of everybody wanting everything done to VAT and it’s a tax that raises an awful lot of money so you need to be cautious that you are not going to lose a huge amount. I think VAT is quite a tricky tax, it’s the most litigated tax, because you are taxing different transactions and you’ve got to define those transactions.

Treasury Committee member and Labour MP, Angela Eagle, replied: ‘You’ve talked about the fact that now we’ve come out of Europe we can remake some of these taxes without some of the constraints that we all operated under being in the EU, but do you think that it’s possible to do that, and simplify without compromising fairness?

Anita Monteith, ICAEW senior policy advisor answered: ‘I think fairness and simplicity have always challenged one and other, for example going back to John’s [Cullinane, CIOT head of policy] example of the high income child benefit charge.

The Power of Tax Reform

Whilst certain an initial “bounce back” of economic growth will follow any safe removal of COVID-19 restrictions, the Treasury’s goal of ensuring robust, long-term, and sustainable economic growth will require much work and good policy choices.

Tax reform is one of the main areas on which the government can focus with the aim of boosting the economy in the long term. Implementing sustainable improvements to the tax system should attract new International business and investment, encourage domestic entrepreneurship and productivity and eliminate costs that stifle growth. Tax reform is not the only course of action, but it is one of the most impactful the government has under its control.

Marginal Tax Rates 

Adjusting down marginal tax rates is generally considered better for economic growth than raising rates. Lower marginal tax rates should stimulate economic activity. Simply, the less you tax something, the more of it you can expect to get, and vice versa. Marginal tax rates can also determine International competition by how attractive it is to businesses and investors relative to other countries. Globalisation has made moving capital highly fluid, so businesses can choose to invest in any number of countries to maximize their after-tax rate of return and quickly change their minds. If marginal tax rates are too high in the UK compared to other developed economies, investment is likely to go elsewhere, and economic growth will suffer as a result.

Neutrality 

The primary purpose of the tax system is to raise the revenue needed to pay for government spending. As such, the goal is to raise this revenue without distorting the decisions that individuals and firms would otherwise make for purely economic reasons. For example, in an efficient economic system people would choose between chocolate chip cookies and oatmeal cookies based on their own personal tastes and the costs of these products. If policymakers imposed a tax on chocolate chip cookies but not on oatmeal cookies the result would be that people would now factor taxes into their choice about which type of cookie to consume—and possibly end up consuming the less desirable cookie because it was cheaper. In other cases, deviations from a neutral tax system reflect the goals of policymakers. For example in the case of the Soft Drinks Industry Levy, more commonly known as the ‘Sugar Tax’ introduced in April 2018. The government’s aim here was to tackle childhood obesity by influencing both consumer behaviour and encourage manufacturers to reduce the sugar content of drinks. In addition to distorting choices, non-neutralities in the tax system may influence taxpayers to transform the form or substance of their activities to reduce their tax payments, most often done by hiring lawyers and accountants to structure financial transactions in a manner that minimises tax liability. 

Balancing Act

In practice pro-growth, tax system neutrality commonly takes the form of combining lower tax rates with broader tax bases. Taxes should apply as equally as possible across the economy, without targeted tax breaks (or special tax regimes) for particular products, sectors, or groups of individuals. There is an important qualification here though: in a few cases, a broader tax base can actually cause economically damaging distortions of its own. For example, a corporation tax base that does not allow the deduction of investment costs creates a bias against capital-intensive industries. An effective balance among different sources of revenue is key to achieving pro-growth tax reform. The Treasury is aware that some taxes are more harmful for growth than others. A pro-growth tax system would therefore seek to maximize revenue from the least distortive taxes, while minimising reliance on the most harmful ones. For example, widely cited research by the OECD suggests that corporate income taxes are the most damaging type of tax in terms of GDP per capita, followed by taxes on personal income. Recurrent taxes on immovable property are the least economically damaging source of revenue, followed by consumption taxes and other forms of property tax.

Overhaul of Capital Gains Tax

A recent government review has urged a major overhaul of capital gains tax in an effort to raise revenue. The Office for Tax Simplification (OTS) report commissioned by Rishi Sunak said that cutting exemptions and doubling rates on Capital Gains Tax could raise £14 billion for the Treasury. Recommendations include a ‘tax raid’ on buy-to-let properties and other forms of wealth. It notes that the final figure could be substantially less, due to “behavioural effects” such as people choosing to delay the sale of a property. The OTS stressed it was not calling for higher taxes, as setting rates was government policy. 

The OTS report acknowledges that cutting exemptions and doubling rates could affect how people approach their finances, stating: ‘The disparity in rates between capital gains tax and income tax can distort business and family decision-making, and creates an incentive for taxpayers to arrange their affairs in ways that effectively re-characterise income as capital gains.’

In September, Mr Sunak reassured Tory MPs there would not be a ‘horror show of tax rises with no end in sight’. Bill Dodwell, tax director of the OTS, said: “If the government considers the simplification priority is to reduce distortions to behaviour, it should consider either more closely aligning capital gains tax rates with income tax rates, or addressing boundary issues as between capital gains tax and income tax.”

How Can Prestige Business Management Help You 

We will be keeping you abreast of tax-reform announcements as they happen, how these may affect your business and how to remain compliant and protect your business in the forthcoming months and years as we all adjust to the economic climate.

Prestige Business Management can help you understand how MTD works and how digitised accountancy records can be maintained thanks to QuickBooks accounting software. Call us today on 0203 773 2927