The world has changed and so should our tax system

This long history of taxation has a great advantage for the Chancellor of the Exchequer. People and businesses are used to paying these various taxes and accept them as part of their day-to-day life. But there is also a need to update and reform the system to meet the needs of a modern economy and society.

Since the 1990s, the global economy has expanded to embrace many developing and emerging market economies. This has dramatically changed the nature of the global economy in which business now operates and in which a country like the UK has to compete.

Our economy is being shaped by other major trends – an ageing population, the impact of digital and related technologies, an increasingly service-sector oriented economy, rising inequality of incomes, a need for greater flexibility of employment and big energy and environmental challenges. We need a tax system which is helping us manage and address these challenges and changes, rather than one rooted in the past.

The last big wave of tax reform in the UK took place under the 1980s Thatcher administration – three decades ago. Since the early 1990s, there has been relatively little reform and restructuring.

Businesses and individuals are struggling to deal with an increasingly anachronistic and disjointed tax system. That needs to change if we are to have a tax system fit for the 2020s and beyond. And there is no shortage of areas where a future reforming Chancellor could focus their attention.

First, we are still heavily reliant on generating revenue from taxes on income and earnings from employment. Income tax and National Insurance generate almost half (46pc) of total government revenue. These taxes penalise the proceeds of economic success – income and employment – and create a significant gap between what an employer pays out and what the employee receives in their pay packet. Ideally we should tax earning less and spending more.

National Insurance is a particularly heavy burden on average and lower earners. It is levied on earnings over £111 per week (£5,772 per annum) and is charged at a combined rate of nearly 26pc – an employer “contribution” of 13.8pc plus 12pc paid by employees. This is a higher rate than income tax (20pc) and cuts in at a much lower earnings level (now that the income tax threshold has been raised to £10,000.)

Second, the taxation of various forms of spending is uneven and based on outdated concepts. VAT is levied at 20pc – but only on about half of our household expenditure. Many items which are deemed “essential” are zero-rated, including food, children’s clothes, books and public transport. This means that caviar is zero-rated because it is a food, whereas other essential items in the household budget carry the full burden of VAT. A printed book is zero-rated but the equivalent e-book or audio book carries 20pc VAT. None of this makes any sense in the modern world and a thorough review is overdue. A more rational system of VAT with fewer zero-rate exemptions could yield more revenue over the longer term – creating scope for tax reductions elsewhere in the economy.

A third area much in need of review is the way businesses are taxed. Corporation tax is levied on company profits, but businesses pay many other taxes – including National Insurance and business rates. These other taxes fall particularly heavily on smaller businesses. While we need to ensure that large and successful businesses pay their fair share of corporation tax, it is also important that we do not stifle smaller, dynamic and entrepreneurial businesses with other taxes.

Environmental taxes must also be overhauled. The environmental taxes currently in place – such as the Climate Change Levy, Air Passenger Duty and the Landfill Tax have been introduced on an “ad hoc” basis. Motorists pay very high rates of duty on petrol and diesel but other activities that cause environmental harm are lightly taxed – if at all.

Another key issue highlighted by PwC’s recent Citizens’ Jury is the complexity and lack of transparency of taxation. The number of pages of tax legislation has increased substantially, making life much more difficult for ordinary people and businesses.

These issues can’t be addressed in isolation. Tax changes in one area may require revenue to be recouped elsewhere. But we are long overdue a serious overhaul of the UK tax system, to ensure it is in tune with the needs of a modern competitive economy. This should be high on the agenda for the government in power after the election.

Andrew Sentance is senior economic adviser to PwC and a former member of the Bank of England Monetary Policy Committee. PwC is interested in views from the public and business on the future of the tax system. To join the debate visit: http://www.pwc.co.uk/issues/futuretax/index.jhtml

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