How to put an end to tax avoidance

I've written here before about the concept of 'excess burden': the cost to economic growth of the distorting effects of taxation. One of the things that creates excess burden is tax avoidance. That's because avoiding tax takes time and effort and because, in doing so, it diverts resources from genuinely productive activities.

Take the 50% tax rate. It is said not to have raised the amount of money hoped for, thanks to massive avoidance. This lack of revenue is irritating. But think, too, of the extra costs of the failure to raise those revenues.

There's the time that people taxed via pay-as-you-earn (PAYE) have spent wrangling with employers to have bonuses or pay rises brought forward. There's the huge number of new companies set up so that those with freelance or short-term contract earnings can 'smooth' their income to avoid the higher rate. There is the vast amount of cash diverted from current consumption into pensions, again to avoid the 50% rate. And there are the people who have upped sticks and moved away taking their taxable earnings and their consumption-oriented families with them.

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This all matters. When we make it possible to avoid tax or when we set tax rates at levels that encourage tax evasion we end up pushing the population into a competitive, rather than a co-operative relationship with the taxman.

That competition is time-consuming and grotesquely unproductive.

This brings me to the Budget. It wasn't exactly brilliant, but it did make a clear stand against tax avoidance by closing some of the endless loopholes that exist in UK tax law.

Take the issue of salary sacrifice payments into pensions. It makes sense if you are employed to have your company pay into your pension for you and hence for you to save on National Insurance (NI) and income tax along the way.

But if you have hit your own £50,000 pension contribution limit, does it make sense for your employer to contribute into a pension for your spouse and for you to get the same tax and NI relief? Not really.

It is within the law, if not the spirit of the law. From 2013 it won't be. So no one will have to think about it, worry about the morality of it or do any of the administration associated with it.

It's the same with the plan to prevent people buying houses via companies to avoid stamp duty. The fact that this trick will now attract a special 15% stamp duty tax should bring it to a natural end.

No longer will people buying a house have to waste hours talking to their accountants about the pros and cons of holding it via a company. They can just pay their tax knowing there is no choice and be done with it.

Also of interest when it comes to measures to prevent avoidance is the mention in the Budget of a clampdown on some 'personal service companies'. This is intended to prevent people avoiding some of the income tax and NI the rest of us have to pay by setting up companies and channelling their earnings through them despite effectively being employees of another company. Quite right, too!

Next is the cap on unlimited tax reliefs. This is going to suffer a consultation. But the idea is that, from next year, if you want to use more than £50,000 of tax relief from uncapped sources ie, not including the tax relief available on pensions and enterprise investment schemes, both of which already cap the amount of tax relief they can offer you can't claim relief on a total of more than 25% of your income.

That effectively introduces a minimum marginal tax rate of 30% for 40% taxpayers and 33.5% for 45% taxpayers. It is still unclear exactly how this will play out. Already, the charitable sector which benefits from unlimited tax relief is up in arms and it is hard to see which reliefs might be included.

However, it still looks a bit like the 'tycoon tax' that Nick Clegg said he wanted last week or even like the 'alternative minimum tax' system from the US (which is supposed to prevent anyone paying income tax at a rate below 26%).

Finally, there is the most important bit of legislation of all: the coming introduction of a general anti-abuse rule (GAAR).

This kind of thing is tough to formulate in a complicated tax system such as ours. But, if the government can get it right and, in the process, make it absolutely clear to everyone that they might as well just play it straight with their taxes and devote no time and effort to thinking about the alternatives we will surely all benefit.

If, at the same time, the government can make public spending both lower and more efficient, it might find it is on to something.

A study into all this by Ralph C Bayer of the University of Adelaide concludes that the more a tax system "is conceived as fair," as having an "efficient expenditure policy" and as supporting "a good government performance", the more likely people are to pay their taxes. In other words, the best way to stop people trying to avoid tax is to govern well.