‘Absurd’ UK tax system leaves some people paying 60% Income Tax

The director of the Institute for Fiscal Studies says the UK tax system is in urgent need for reform.

Paul Johnson, director of the Institute for Fiscal Studies (IFS) thinktank, has lambasted the UK tax system, claiming that it is overly complex, "absurd" in places and shows “few signs of a wider coherent strategy”. And this is a trend that has continued across successive governments, Johnson said in a speech at a tax adviser conference.

This is due to “numerous policy reversals” and the fact that “few of those aspects of the system in most need of reform have been tackled”, often for political reasons.

This is not the first time the IFS has heavily criticised the UK tax system. Thirty years ago, similar criticisms were made by Dick Taverne, then-director of the IFS, who said that “tax reforms have been approached ad hoc, without regard to their effects on the evolution of the tax structure as a whole".

Taverne argued: "As a result, many parts of our system seem to lack a rational base. Conflicting objectives are pursued at random; and even particular objectives are pursued in contradictory ways.” But three decades on, the system is still unsatisfactory, said Johnson.

At the heart of Johnson’s speech was the argument that reform would offer “considerable scope for improving the functioning of the tax system in ways that would enhance welfare”. He gave several examples of current contradictions.

‘Hidden’ 60% Income Tax rates

The current Government’s policy of increasing the tax-free Income Tax personal allowance, and the historical aims of previous governments to reduce the Basic Rate of Income Tax show a “clear direction”. “But the wider story shows rather less coherence,” Johnson argued.

By 2015-16, the marginal rate (or tax bracket) of Income Tax on incomes above £50,000 will actually jump from 40% to 60% or higher as “Child Benefit is taxed away" as the income of the higher earner in a couple rises between £50,000 and £60,000.

People whose income rises above £100,000 will be hit with a massive marginal rate of 60% as the personal tax-free allowance is ‘withdrawn’ until they earn income of £121,000 or higher. Yet taxable incomes of £150,000 or higher will only be subject to a 45% tax rate.

Married couples could be stung for £210

On top of this, a complication in the transferrable married tax allowance, set to be introduced in 2015, means the allowance will be withdrawn if one partner becomes a higher-rate (40%) taxpayer.

So if an additional £1 of income takes either a husband or wife into the higher-rate tax band, an extra tax bill of £210 will be the result. This is what's known as a cliff-edge tax. Johnson remarked that “it never makes sense to have this kind of thing in a tax schedule”. He was also critical of the structure of the transferrable allowance, saying that it would be “extremely hard to extend without making this cliff edge at the higher-rate threshold worryingly high [which] smacks of a lack of long-term design.”

National Insurance Contributions

Johnson, also argued that National Insurance Contributions (NICs) are regarded by “virtually all tax experts outside of HMRC and HM Treasury" as no more than "an additional tax on earnings". "There is no relationship at all between how much is paid and rights to anything. They are a tax,” he said.

While the Income Tax personal allowance has been rising to relieve the burden on low income earners, NICs have also been steadily creeping up, because the point at which NICs become payable has remained. Johnson questioned the logic of this situation, as “it is hard to think of a good reason for raising the one and not the other”.

The answer seems to be that, since Income Tax rates have fallen, “it is politically easier to raise NIC rates than the more salient income tax rates”. Johnson suggests that a tax system which integrated the two would make more sense. The IFS, in its Mirrlees Review, said that “it is patently absurd… to have one tax assessed on earnings in each individual pay period and another assessed on income over the whole year.”

Inheritance Tax, VAT, Stamp Duty and Council Tax

Inheritance Tax
The Government’s frozen threshold on Inheritance Tax is planned to continue through to 2017/18, mainly to fund a cap on long-term care costs. However, Johnson points out that the “Prime Minister has proclaimed an aspiration to dramatically increase the threshold to £1 million” which represents “to say the least, conflicting messages”.

If the threshold was increased to that level, revenues could fall by up to 70%, “leaving the very basis for the continuance of this tax open to question”. The other thing he noted is there are plenty of ways to avoid the tax, as it is not applied to any transfer made more than seven years before death, or various kinds of assets (such as agricultural land). These “opportunities for avoidance exist for the very wealthy” but not to the “majority, whose major asset is the house they occupy. This rather undermines support for the tax”.

VAT
The bizarre VAT rate differences on food can be demonstrated with a few examples. For instance, a 20% rate is levied on cereal, muesli, and potato crisps – but flapjacks and tortilla chips face 0% VAT.

Stamp Duty Land Tax (SDLT)
Johnson quoted Stuart Adam, also of the IFS, to make his point of view clear: “SLDT is a strong contender for the UK’s worst-designed tax. Its structure is especially perverse because… the relevant rate applies to the full sale price, not just the part above the relevant threshold.”

This has led to the ridiculous situation where a house sold for £249,999 will be subject to a 1% Stamp Duty payment of £2,499.99. Yet a house sold for just a pound more at £250,000 will be subject to a 3% rate, with the Stamp Duty bill coming in at £7,500.

Council Tax
Council Tax, according to Johnson, is “a tax that deliberately sets out to impose a heavier burden on people with the lowest levels of housing consumption and wealth than on those with the highest levels” as it is based on the value of properties recorded back in 1991.

However, there would be no political benefit to updating these values, and even potential cost, due to the fear of “creating losers” from a revaluation programme. Johnson considers it “unlikely” that the tax will be “properly updated, let alone coherently reformed, in the near future”.

What do you think of the tax system? Is it overly complicated? Are some taxes unfair? Would integrating the Income Tax and National Insurance systems make sense? Let us know in the Comments below.

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More on tax:

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HMRC to raid 17,000 bank accounts a year to retrieve unpaid tax

Tax codes: how to check you're on the right one

Where Council Tax is rising and falling in 2014/15

Tax and benefit changes 2014/15

How to cut your Inheritance Tax bill

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