Keep taxes simple – treat all income the same

I’ve been flicking through a 417 page consultation into reforming the UK tax system over the next decade (
www.2020tax.org

) put together by City AM’s Allister Heath, together with the TaxPayers’ Alliance and Institute of Directors, and talking it over with regular MoneyWeek and CityAM reader Nick Reid.

I’m short on time today so here’s Nick’s take on it (which by the way I entirely agree with). I’ll be writing more on the idea of a standard flat tax later in the week.

“The central tenet of the consultation is not one to argue with. It is that the UK tax system is horrendously complicated and that this results in all manner of economically damaging avoidance scams and poorly directed investment. The solution isn’t bad either. Heath and co recommend a massive simplification of the tax regime, the abolition of many trying taxes, and the setting of a standard 30% flat rate of tax on all forms of income.

“All music, I’m sure, to the ears of MoneyWeek commentators and readers alike.

“However, there is one fundamental area where Allister Heath’s argument falls into inconsistency: when he discusses the abolition of Inheritance Tax. He claims, when proposing the abolition of stamp duty and IHT: ‘At the moment, a pound earned by a worker is taxed and triple taxed: there is income tax, National Insurance (of two different kinds) and then more tax when – for example – the worker buys a house (stamp duty) or when she dies (inheritance tax).’

“But while this is certainly true for stamp duty, it simply isn’t the case for inheritance tax. The woman who dies doesn’t pay inheritance tax on her money. She’s no longer available to do so. Instead, it is the people who inherit from her who pay inheritance tax – they get an unearned lump sum as a result of her death. Allister Heath claims that there are only two types of income that should be taxed; that earned through labour and that earned through capital investment. The unearned income derived from the death of a parent relation or friend doesn’t fall into either of these two categories.

“Yet to the person receiving the inheritance there is no economic difference between receiving a £100,000 sum from a deceased parent or receiving a £100,000 bonus from a generous employer. Yet, one would quite rightly expect to pay income tax on a bonus. So why not treat all forms of income equally? That, after all, is what the commission is aiming to do. Indeed take it to its logical extreme and all cash gifts made should always be subject to tax.

“It makes sense that money shouldn’t be taxed twice. But the nub of most tax systems is that money – which is in constant circulation – is taxed at every stage it is passed on. We all buy things out of taxed earnings, that provides an income to others, who then pay tax on that income. And so it goes round. Getting rid of IHT would represent a nice tax cut for the better off. But it would be an odd gap in what otherwise is supposed to be a consistent simplified and fair tax regime.”