The Institute for Fiscal Studies (IFS) has produced a thought provoking and far reaching report into the possibilities and logical grounding for radical tax reform.
As the current tax system stands, three people carrying out largely similar business activities would pay radically different amounts of tax, depending on whether they were an employee, self-employed or trading through a personal company. Of the three categories, the one paying the most tax would be the employee.
This is possibly one reason that the percentage of people in the other two, lower-tax options has increased to approximately one fifth of the workforce. It is estimated that the tax revenue lost due to these differences in taxation is £15bn per annum.
One unintended consequence of this imbalance is that people may choose business structures with more consideration of the tax position than the best structure to run the business efficiently.
It is not unusual for people who are not financially savvy to feel pushed into structures which are too complex, difficult to run, or which they do not understand, leading to problems such as the current loan charge issues.
At the other end of the spectrum, the well-advised can set up structures which reduce their tax burden, eroding the overall tax base and society’s faith in the tax system.
The report suggests that an ideal tax system could be set up to prevent tax influencing the choice of vehicle, the source of financing, the form of profit extraction and to avoid creating risk-aversion.
The IFS proposes a tax system without the current divisions between different business structures, with tax rates levelled up to remove distortions in choices. Clearly this would be a massive change and would produce both winners and losers. As they say, there is no correct answer, but the report sets out a wide variety of possible scenarios.
It would require considerable political courage to radically reform the tax system, and now is possibly not the best time to add extra change to the difficulties of dealing with coronavirus and Brexit. Long term, however, the huge complexity of the UK tax system as it currently stands, and the distortions it introduces to taxpayers’ behaviour, means change is needed.