tax makingtheukcompetitive 2009

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Tax – Making the

UK Competitive

IoD POLICY PAPER



Tax – Making the

UK CompetitiveWritten by Richard Baron and Corin Taylor

IoD POLICY PAPER



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About the Authors

Richard Baron is Head of Taxation at the Institute of Directors. He has worked asa tax professional in a variety of roles for over 25 years. He was Head of Taxation

at the IoD from 1996 to 2002, and then spent three years working on corporationtax policy for HM Revenue & Customs. He returned to the IoD in 2005.

Corin Taylor is a Senior Adviser in the IoD Policy Unit covering economic policy,taxation and public service reform issues. He also sits on the EconomicDependency working group at the Centre for Social Justice and has written anumber of opinion pieces on tax for the Financial Times.



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Contents

Executive Summary 3

1 Problems 5

1.1 The borrowing backdrop 51.2 The negative impact of taxation on economic growth 71.3 How the UK has lost tax competitiveness 121.4 Instabili ty 161.5 The threat to economic recovery and deficit reduction 17

2 Solutions 20

2.1 The recommended measures 222.2 The implementation plan 25

Annex A Changes to the tax system 28

A1 Introduct ion 28 A2 The taxation of capi tal 28 A3 The structu re of corporation tax 29 A4 The corporat ion tax base 41 A5 Income tax on businesses 54 A6 Income tax rates and al lowances 60 A7 The taxation of savings 60 A8 Capital gains tax and inher itance tax 73 A9 Employment income 79

A10 Indirect and local taxes 82

Annex B Costings and implementation 90

B1 The proposal and costings 90B2 Implementation 101B3 The overall impact on revenue 105



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Executive Summary

• A tax system has to raise money, but in so doing it will damage and distortthe economy. A good tax system will minimise the damage and distortion.

The UK’s system currently falls far short of that ideal.

• The public finances are currently in a dire state. A rapid and sustained pick-up in economic growth is essential to remedy this.

• Higher taxes would reduce economic growth, so they would be counter-productive. Taxes increase prices to buyers or reduce revenue to sellers, sothat consumers are more reluctant to buy and producers to sell. Higher taxesalso discourage work, saving and investment.

• The UK has slid down the league of tax competitiveness in recent years. The

overall tax burden is well above the OECD average, and the maincorporation tax rate is much less competitive than it was. The tax system hasalso grown in complexity, and compliance costs are high.

• The threat to the economic health of the UK is made clear by the decision ofa number of groups to relocate their holding companies outside the UK, andthe fact that many other groups are considering the same move.

• We therefore need to devise a plan to restore the UK’s competitiveness ontax, over a number of years. This report sets out such a plan, with a fullycosted proposal to implement it over a period of ten years.

• The central recommendation is to reduce the corporation tax rate to 15 percent over the ten-year period. We consider several other large-scale reformsto the corporation tax system, but conclude that the arguments against themare sufficiently strong that there is no compelling case in favour of them.

• There are, however, a number of simplifications to business taxation thatcould usefully be made, some of which would remove distortions.

• We propose measures to help employment. The immediate priority is toreverse the increases in national insurance that are planned for 2011. Then

there are simplifications that would make it less daunting to take onemployees.

• On personal incomes, it is important to remove disincentives. We thereforepropose a gradual reduction in the highest rate of income tax, and thereversal of the proposal to withdraw the personal allowance at higherincomes.

• We also propose a number of measures to encourage saving, aimedparticularly at helping lower-income savers. The rules for individual savingsaccounts should be made more liberal, interest income should be tax-free to

basic-rate taxpayers, dividends that are taken in the form of stock should notbe taxed until they are converted into cash, and the taxation of life assurance



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should be revised so that the rules recognise the existence of unused capitalgains tax exemptions.

• Inheritance tax should be replaced by capital gains tax on death, so as tomake people more willing to accumulate wealth to provide for their old age.

Stamp duty land tax should be reformed to remove distortions.

• Finally, the VAT rate should be increased to 20 per cent, in order to allow formore substantial and rapid tax reductions elsewhere than would otherwise bepossible.



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1 Problems

The primary purpose of taxation is to raise revenue to fund necessarygovernment expenditure, with a minimum of damage and distortion to the

economy.

The UK’s tax system is failing fundamentally to perform that task. It has becomemore burdensome and more complex, at a time when other countries have beenreducing their burdens of taxation. It suffers from chronic instability, makingbusiness planning harder. A number of companies have now relocated theirheadquarters out of the UK, citing tax as the primary factor in their decision, whileothers are considering similar moves.

Economic theory and empirical evidence also show that increases in taxationgenerally have a negative impact on economic growth. Closing the UK’s

enormous structural deficit with large increases in tax would reduce theunderlying rate of GDP growth, threatening economic recovery and making itharder to bring the public finances back into balance.

1.1 The borrowing backdrop

During the current economic difficulties, any examination of the effectiveness orotherwise of the UK’s tax system must take account of the dire state of the publicfinances, as this will determine the extent and type of reform that is possible.

It is common knowledge that the UK is facing a fiscal crisis of historic proportions.The actual numbers involved are quite staggering:

• Estimates from the Treasury, the OECD, the IMF and the EuropeanCommission suggest that net borrowing will peak at between 12.6 and 14 percent of GDP – around £178-£200 billion.1

It’s not just the headline borrowing numbers, however, that are important.Borrowing automatically rises in a recession, as tax revenues fall andunemployment benefit payments rise. The current fiscal stimulus is alsotemporary in nature. Of greatest concern, therefore, is the structural deficit, whichexcludes the fiscal stimulus and the automatic stabilisers. The structural deficit is

caused in part by the permanent loss of tax revenues from the City and fromhousing, but is also a result of excessive public spending.

• Estimates of the structural deficit from the Treasury, the IMF and theEuropean Commission suggest that it will peak at between 9 and 11.6 percent of GDP – around £130-£160 billion.2

1 HM Treasury, Pre-Budget Report 2009, December 2009, Tables B2 and B3; European

Commission, Public Finances in EMU 2009, European Economy 5, June 2009, Table V.27.1http://ec.europa.eu/economy_finance/publications/publication15390_en.pdf ; InternationalMonetary Fund, United Kingdom: 2009 Article IV Consultation – Staff Report, July 2009,Table 1 http://www.imf.org/external/pubs/ft/scr/2009/cr09212.pdf ; OECD, Economic Survey of

the United Kingdom 2009, 29 June 20092 HM Treasury, Pre-Budget Report 2009, December 2009, Table B2 (“cyclically-adjusted net

borrowing”); International Monetary Fund, op. cit.; European Commission, op. cit.



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This unprecedented level of borrowing means that returning the public finances tobalance will be extremely difficult:

• The Treasury forecasts that net borrowing in 2013-14 – four years from now –will still exceed 5 per cent of GDP, but this is based on an assumption thatgrowth will return to 3.25 per cent in 2011-12 and will remain at that high

level.3 Even after a rapid and sustained recovery, and together with theGovernment’s existing plans to tighten fiscal policy from 2011-12, borrowingwill still be higher than in any year since 1994.

• If, however, growth does not recover to the same extent, the hole in the publicfinances will be larger still. The IoD forecasts that, if growth recovers to 2.5per cent on average over the cycle and the Government’s fiscal plans arefollowed, net borrowing will exceed 8 per cent of GDP in 2013-14.

• If growth only recovers to 2 per cent on average over the cycle, the IoDforecasts that following the Government’s fiscal plans would mean that netborrowing would still exceed 10 per cent of GDP in 2013-14.

The primary reason for the UK’s fiscal crisis is an excessive increase in publicspending, based in part on high tax revenues from housing and the financialservices industry that were the result of bubbles, rather than more normalconditions. The UK not only experienced unsustainable housing and financialbooms, but also an unsustainable public spending boom:

• Between 2000 and 2007, in other words before the current economic crisisbegan, public spending increased by 7.5 percentage points of GDP, which asChart 1.1 shows, was by far the fastest increase in the OECD.4

3 HM Treasury, Pre-Budget Report 2009, December 2009, Tables B1 and B2

4 OECD, Economic Outlook No. 85, June 2009, Annex table 25



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Chart 1.1: Public spending in the OECD, 2000-2007

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U n i t e d K i n g d o m

C h a n g e i n g o v e r n m e n t o

u t l a y s 2 0 0 0 - 2 0 0 7 , p e r c e n t a g e p o i n t s

o f G D P

• Comparing projections of public spending in 2010 with the actual numbers for2000 puts the UK in an even worse light – next year, UK public spending isprojected to be 17.5 percentage points of GDP higher than in 2000, anincrease that only Ireland is expected to exceed.5

• The UK’s tax revenue has crashed, without, except for the temporary VAT cut,the economic benefit of lower tax rates. Current receipts have fallen by 3.5percentage points of GDP in just two years – from 38.7 per cent in 2007-08 toa projected 35.3 per cent in 2009-10.6 Current receipts are now lower as ashare of GDP than during the recession of the early 1990s.7

1.2 The negative impact of taxation on economic growth

The borrowing problem will not be solved by big increases in taxes. Botheconomic theory and empirical evidence suggest that higher taxes reduceeconomic growth and may not lead to large increases in tax revenue. Speculatingon the precise rate of economic growth may seem like wishful thinking when theUK economy is in recession, but the sustainability of the public finances doesdepend on a rapid, and, importantly, sustained pick-up in growth.

5

Ibid.6 HM Treasury, Pre-Budget Report 2009, December 2009, Tables B11 and B23

7 HM Treasury, Pre-Budget Report 2009, December 2009, Table B23



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Table 1.1 presents the results of academic research into the relationship betweentax and various economic outcomes, particularly GDP growth.

Table 1.1: Academic research into the relationship between tax and economicoutcomes

Study Coverage GDP impact

1 Cashin (1995) 23 OECD countriesover the 1971-1988period

1 percentage point increase in tax toGDP ratio lowers output per workerby 2 per cent

2 Engen and Skinner(1996)

US modelling togetherwith a sample of OECDcountries

2.5 percentage point increase in taxto GDP ratio reduces annual GDPgrowth by 0.2 per cent to 0.3 per cent

3 OECD – Liebfritz,Thornton and Bibbee(1997)

OECD countries overthe 1965-1995 period

10 percentage point increase in tax toGDP ratio reduces annual GDPgrowth by 0.5 per cent to 1 per cent

4 Liebfritz et al (1997)

additional modelsimulations

European Commission

Quest 2 – modelsimulations

1 percentage point of GDP rise in

labour taxes reduces UK GDP by 2.4per cent versus baseline level

5 Bleaney, Gemmell andKneller (2000)

17 OECD countriesover the 1970-1994period

1 percentage point of GDP increasein distortionary tax revenue reducesannual GDP growth by 0.4 per cent

6 Folster and Henrekson(2000)

Sample of richOECD/non-OECDcountries over the1970-1995 period

10 percentage point increase in tax toGDP ratio reduces annual GDPgrowth by 1 per cent

7 Bassanini and Scarpetta(2001)


1 percentage point increase in tax toGDP ratio reduces per capita outputlevels by 0.3 per cent to 0.6 per cent

8 Gemmell and Kneller(2001)

12 OECD countriesover three- yearperiods from 1987-89to 1995-97

1 percentage point of GDP increasein distortionary taxation reducesaverage annual GDP growth by 0.4percentage points

9 PricewaterhouseCoopers (2003)


1 percentage point of GDP increasein distortionary taxation reducesannual GDP growth by 0.2 per cent to0.4 per cent

10 OECD (2003) OECD countries overthe 1980-2000 period

1 percentage point increase in tax toGDP ratio reduces output per capitaby 0.3 per cent, or 0.6-0.7 per cent ifthe effect on investment is taken into

account11 Lee and Gordon (2004) Cross-sectional and

time-series data ongrowth rates of 70countries between1970 and 1997

10 percentage point reduction in thecorporation tax rate increases annualgrowth rate by 1.1 per cent

12 Feldstein (2006) Large sample of USindividual tax returnsfor 2001

Deadweight loss of across the boardincrease in tax rates is $0.76 for each$1 of revenue

13 Mankiw and Weinzierl(2006)

Theoretical modelcalibrated to the US

17 per cent of a labour income tax cutis self-financing; 50 per cent of acapital income tax cut is self-

financing



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14 Trabandt and Uhlig(2006)

Theoretical modelcalibrated to the USand to the EU15

US: 19 per cent of a labour incometax cut is self-financing and 47 percent of a capital income tax cut isself-financing.

EU15: 54 per cent of a labour incometax cut is self-financing and 85 percent of a capital income tax cut isself-financing.

15 EU Commission – deMooij and Ederveen(2006)

Meta analysis of 427observations fromprevious literature

1 percentage point reduction in hostcountry tax raises foreign investmentby 2.9 per cent on average (median)

16 Angelopoulos,Economides andKammas (2006)

23 OECD countriesfrom 1970-2000

Average tax rate (tax revenue/GDP)is significantly negatively correlatedwith growth

17 Ohanian, Raffo andRogerson (2006)

21 OECD countriesfrom 1956 to 2004

Model that allows for increasing taxdistortions as observed in the data isable to account for virtually all of theaverage reduction in hours workedacross OECD countries over past 50years

18 European Central Bank – Coenen, McAdam andStraub (2007)

Two-country theoreticalmodel

Lowering Euro-area tax wedges toUS levels increases hours workedand output in the Euro-area by over10 per cent in the long-run

19 Romer and Romer(2007)

All major postwarfederal tax policyactions in the US

Exogenous (tax changes notmotivated by desire to return outputgrowth to normal) tax increase of 1per cent of GDP lowers real GDP byover 2 per cent

20 European Central Bank – Alfonso and Furceri(2008)

EU15 and 13 otherOECD countries from1970 to 2004

1 percentage point increase in tax toGDP ratio reduces output by 0.12percentage points for the OECDcountries and 0.13 percentage pointsfor the EU countries

21 IMF – Ganelli andTervala (2008)

Two-country theoreticalmodel

Income tax cut self-finances by 17per cent in real terms, andconsumption tax cut self-finances by11.5 per cent in real terms

22 Oxford University Centrefor Business Taxation –Barrios, Huizinga,

Laeven and Nicodeme(2008)

Multinational firms (906parent companies and3,094 foreign

subsidiaries) operatingin 33 Europeancountries from 1999-2003

1 percentage point increase in hostcountry tax rate reduces probability oflocation by 0.27 per cent

23 Djankov, Ganser,McLiesh, Ramalho andShleifer (2008)

85 countries in 2004 10 percentage point increase in firstyear effective corporation tax ratereduces investment rate by 2.2percentage points, FDI rate by 2.3percentage points, business densityby 1.9 firms per 100 people andaverage entry rate by 1.4 percentagepoints



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24 Reed (2008) 48 US states from 1970to 1999

1 percentage point increase in thestate tax burden (ratio of state andlocal tax revenues to personalincome) over a 5-year period is

lowers real per capita personalincome growth by 1.37 per centduring that period

The evidence is clear that taxation has a negative impact on economic growth.The theoretical reason for this is that taxation, in addition to transferringresources from individuals and corporations to the less productive public sector,exerts what is termed a deadweight cost on the economy. This means that theeconomy produces less output than it would have done without the taxation:8

• Deadweight cost occurs because taxation raises the price paid for goods orservices (including labour) by consumers and/or reduces the price received by

the suppliers. In other words, fewer producers will find fewer purchasers andoverall output is reduced.

• The deadweight cost therefore represents the loss in total output in aneconomy with taxation compared with the total output in the same economywithout taxation. This difference is over and above the revenue raised throughthe tax itself: the taxpayer’s loss from a given amount of taxation exceeds thegovernment’s gain.

• Empirical studies suggest that deadweight costs can amount to a substantialproportion of the tax collected. For example, evidence in the US suggests that“typical estimates of the cost of a dollar of tax revenue range from 20 cents to

60 cents over and above the revenue raised.”

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The deadweight cost concept can also be applied to labour supply, saving andinvestment:

• Firstly, taxes can reduce the available labour supply:

- Higher direct taxes reduce the benefit of extra hours worked. For everyadditional pound earned a higher proportion is paid in taxation and theincentive to work is reduced – leisure is made more attractive. This iscalled the “substitution effect.”

- Theoretically, higher taxes do not always reduce the labour supply. On

occasions the “income effect” can predominate. As higher taxes reducedisposable income, the income effect is the incentive on workers tomaintain their previous level of income by working longer hours.

- These two effects push in opposite directions. Better-off earners are oftenmore influenced by the substitution effect. Lower earners (whose need toearn additional income is greater) are more sensitive to the income effect.

8 For a fuller explanation of deadweight cost, see any standard economic textbook, for

example, Hal R. Varian, Intermediate Microeconomics, 1999, pp. 296-298.9

Joint Economic Committee, United States Congress, Economic Benefits of Personal IncomeTax Reductions, April 2001. This paper summarised a Congressional Budget Office literaturereview.



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- In the future, incomes and standards of living are likely to increase,meaning that the average taxpayer of tomorrow is likely to behave morelike the higher-rate taxpayer of today. More second earners, who are alsomore sensitive to changes in taxation, may also enter the workforce. Thiswill almost certainly increase the generally negative impact of taxation on

labour supply.• Secondly, taxes can discourage personal saving by reducing rates of return

and decreasing lifetime income. One IMF study recently noted that “new andcompelling empirical evidence from OECD countries over a period of 25 years… [shows] that the shares of GDP of both total taxes and income taxes havea highly significant and strongly negative impact on the household savingrate.”

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• Thirdly, by cutting the after-tax rate of return, taxes can discourageinvestment. Modelling the effect of taxation on investment is complicated.However, recent disaggregated sector studies have achieved greater success

in identifying the cost of capital effects.

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These have shown that high taxationdiscourages investment in an economy.

Given that higher taxes have a negative impact on economic growth, it followslogically that reducing taxes should have a positive impact on the economy andon public finances, although this has not been universally accepted:

• On the one hand, the more traditional “static” approach to the economymodelled no behavioural impact as a result of tax changes and no impact oneconomic growth of tax cuts. This is now a difficult position to defend.However, it still appears to be the underlying assumption of HM Treasury.12

• On the other hand, Arthur Laffer famously argued for a more “dynamic”understanding of people’s reaction to tax cuts and that tax reductions could beself-financing more often than had been supposed. The Laffer curve was intended to demonstrate that, in certain situations, a decrease in tax rateswould result in an increase in tax revenues.13

• Most economists are more circumspect. Professor N Gregory Mankiw, aprominent US macroeconomist and Chairman of the President’s Council of

10 V. Tanzi & H.H. Zee, Taxation and the household saving rate: evidence from OECD

countries, IMF Working Paper 98/36, March 199811

F. Pelgrin, S. Schich and A.de Serres, Increases in business investment in OECD countries

in the 1990s. How much can be explained by fundamentals?, OECD Economics DepartmentWorking Paper No. 327, April 2002; R. S. Chirinko, Business fixed investment spending:modelling strategies, empirical results and policy implications, Journal of Economic Literature,December 1993; R. G. Hubbard, Capital market imperfections and investment, Journal ofEconomic Literature, 199812

HM Treasury and HM Revenue and Customs produce an annual Tax ready reckoner ,which quantifies the revenue effects of changes in tax rates. It assumes that changing a taxrate by 1p will have an equal and opposite effect either way13

Tax revenues would be zero if tax rates were either 0 per cent or 100 per cent. Somewherein between 0 per cent and 100 per cent is a tax rate which maximizes total revenue. Theconcept was not intellectually new (Laffer himself claims to have developed it from JohnMaynard Keynes.) What was new was Laffer’s contention that the inflection point in the curvewas at a much lower level than previously believed and that tax rates in the 1980s were

above the level where revenue is maximized. In short, tax cuts could not just be self-financing. They could actually increase tax revenue – a position diametrically opposed to the“static” modelling approach.



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Economic Advisers from 2003 to 2005, summarises the consensual view,arguing: “Most economists are sceptical of both polar cases. They believe thattaxes influence national income but doubt that the growth effects are largeenough to make tax cuts self-financing. In other words, tax cuts pay forthemselves in part, and the open question is the magnitude of the effect.”

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1.3 How the UK has lost tax competitiveness

The theory and evidence outlined in Section 1.2 are not merely of academicinterest, but are very relevant to the UK. Over the past decade, the UK has lostmuch of the competitiveness that its tax system once enjoyed.

Measuring the overall competitiveness of a country’s tax system is not a simpletask, and selected measures may of necessity be slightly crude, but the evidencein the UK does paint a clear picture of decline.

The overall tax burden

The financial crisis and its associated effects on the tax burdens of countriesaround the world will clearly distort the data in the short term, but the longer-termtrends pre-date the 2008 crash and will no doubt re-appear once the globalrecovery is underway. Over the past 12 years, the UK’s tax burden has moved inthe opposite direction to that of other developed economies:15

• The overall burden of tax in the UK, as a share of GDP, has moved from theeighth lowest in the OECD in 1996 to well above the average today.

• In 1996, the UK’s tax burden was 38 per cent of GDP, compared with 38.5 percent in the OECD as a whole. In 2008, before the financial crisis really hit taxrevenues, the UK’s tax burden was 42.6 per cent of GDP, compared with anOECD average of 38.2 per cent.

• Compared with the eurozone, the UK’s tax burden was 8.4 percentage pointsbelow the eurozone average in 1996, but in 2008 the differential had fallen to just 2.3 percentage points.

14 N.G. Mankiw and M. Weinzierl, Dynamic Scoring: A Back of the Envelope Guide, 2005.

15 OECD, Economic Outlook No. 85, June 2009, Annex table 26



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Chart 1.2: The UK’s loss of tax competitiveness

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1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

T o t

a l t a x a n d n o n - t a x r e c e i p t s ,

% o f

G D P

UK Total OECD Euro area

Chart 1.3: The UK’s relative loss of tax competitiveness

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• On this measure, therefore, the UK’s relative loss of tax competitiveness was4.9 percentage points against the OECD average (0.5 percentage pointsbelow the average to 4.4 percentage points above) and 6.1 percentage pointsagainst the eurozone average (8.4 percentage points below to 2.3 percentagepoints below).

Rates of business tax

It is not just with respect to the overall burden of tax that the UK has lostcompetitiveness. Rates of corporation tax are also far less competitive than theywere a decade or so ago:16

• In 1996, the UK’s corporation tax rate was joint fifth lowest in the OECD. In2009, it was the joint seventeenth lowest.

• In 1996, the UK’s corporation tax rate of 33 per cent compared favourablywith the OECD average rate of 37.7 per cent. In 2009, the UK’s rate of 28 per

cent was above the OECD average of 26.3 per cent.• Compared with the EU15, the UK had the third lowest rate of corporation tax

in 1996, and its rate was well below the EU15 average of 37.9 per cent. In2009, the UK’s rate was only the ninth lowest, and above the average EU15rate of 27 per cent.

• Among the 27 EU countries as a whole, in 2009 the UK’s corporation tax ratewas the eighth highest, and well above the average rate of 23.2 per cent.

Chart 1.4: The UK’s loss of corporation tax competitiveness

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1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

A v e r a g e c o r p o r a t i o n t a x r a t e ,

p e r c e n t

OECD average EU15 average

EU 27 average UK

12 New Mem ber States average World average

16 KPMG, Corporate and Indirect Tax Rate Survey 2009



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• On this measure, therefore, the UK’s relative loss of corporation taxcompetitiveness was 6.4 percentage points against the OECD average (4.7percentage points below the average to 1.7 percentage points above) and 5.9percentage points against the EU15 average (4.9 percentage points below to1.0 percentage points above).

Chart 1.5: The UK’s relative loss of corporation tax competitiveness

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UK OECD EU15

M a i n c o r p o r a t i o n

t a x r a t e , p e r c e n t

1996 2009 UK's relati ve loss of competi ti veness

Businesses of course pay far more than corporation tax. Corporation tax is justone of 22 different taxes affecting companies, although it is the largest. Measuresof the total taxes paid by businesses show that the UK is far from competitive:

• In a survey of FTSE 100 companies, PricewaterhouseCoopers found that totaltaxes borne were 45 per cent of pre-tax profits in 2008.17

• Out of the other countries on which data were collected using the same “totaltax contribution” methodology, the UK FTSE 100 companies faced the thirdhighest average total tax rate, behind Belgium and the US; the third highestaverage total tax rate as a percentage of turnover, behind Canada and the

Netherlands; and the second highest average figure for employment taxes peremployee, behind Belgium.18

• The World Bank has also produced estimates of the total tax rate for 183countries around the world. The UK ranks 67th on this measure.19

17 PricewaterhouseCoopers, Total Tax Contribution: PricewaterhouseCoopers LLP 2008

survey for the Hundred Group, 200918 Ibid.

19 World Bank and PricewaterhouseCoopers, Paying Taxes 2010: The global picture



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Tax complexity

The impact of a tax system is not just limited to its rates and its overall burden.Complexity and compliance costs also matter a great deal. Unfortunately, the UKdoes not score well on either measure:

• The UK is now ranked 84th out of 133 countries on the “extent and effect oftaxation” (which measures the impact of a country’s tax system on incentivesto work and invest) by the World Economic Forum. In other words, 83countries around the world have tax systems that suffer from fewerdisincentives than the UK’s. In 2004-05, by contrast, the UK ranked 18th out of104 countries and in 2005-06, 23rd out of 117.20

• The PwC survey of FTSE 100 companies referred to above also found that,on average, FTSE 100 companies face tax compliance costs of over 1.5 percent of the total taxes borne.21

• Out of the other countries that also collected data using the same

methodology, the FTSE 100 companies faced the highest average cost of taxcompliance of any country, except for the US.22

• This fall in the international rakings is not surprising when one considers thegrowth in the bulk of tax legislation. 25 years ago, the annual CCH collectionof UK tax legislation comprised two volumes, together occupying five inchesof shelf space. Today, there are seven volumes and they take up more than afoot of shelf space.

1.4 Instability

In addition to falling tax competitiveness and increased complexity, the UK’s taxsystem has been chronically unstable, with constant changes undermining theability of businesses to plan for the future. A few examples will illustrate the point:

• In 2002, a zero corporation tax rate was introduced for companies with profitsof up to £10,000 a year. The result, which was predictable (and which waspredicted internally before the announcement), was a rush to incorporate bymany small businesses, keen to take advantage of the combination of thezero rate and the low taxation of dividends. In 2004, the hopelessly complexnon-corporate dividends rate was introduced in a desperate attempt to shoreup the policy. Finally, in 2006, the policy was abandoned.

• The Home Computing Initiative was introduced in 1999, in order to encouragethe provision of computers at home with the help of employers. In 2006, thescheme was abruptly ended, causing significant disruption. Some initiativesshould be withdrawn when circumstances have changed so that they are nolonger needed, but abrupt and unforeseen reversals of policy are not helpful.

• The rules on personal service companies, popularly known as IR35, suddenlychanged the environment for thousands of contractors with effect from April2000. The disruption was very great, but there is no evidence that there havebeen more than a tiny number of successful Revenue investigations. The

20

World Economic Forum, Global Competitiveness Report, 2004-05, 2005-06 and 2009-1021 PricewaterhouseCoopers, op. cit.

22 Ibid.



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Professional Contractors’ Group found that right across the country, the extratax collected was only £1.5 million a year, and that of 1,468 Revenueinvestigations with which it had been involved, only six resulted in additionaltax liabilities.23

It is quite clear that, while there have been several sensible and helpful policydevelopments over the past decade, the Government does not get things rightevery time. There is a strong case for any government or potential government tostop and think, then to formulate and announce a sensible long-term plan for thetax system, and then to stick to that plan and not be deflected by any desire tograb a headline.

1.5 The threat to economic recovery and defici t reduct ion

The complexity and uncompetitive state of the UK’s tax system have already

been key factors in the decision of a number of large groups to move their holdingcompanies overseas, while an increasing number of businesses are consideringmaking the same move. KPMG’s most recently published annual survey on theUK’s tax competitiveness found that the proportion of groups surveyed that wereactively considering leaving the UK had more than doubled, from 6 per cent theprevious year to 14 per cent, and that those groups included four in the FTSE100.24 And initial results from a survey of 57 very large groups that KPMGconducted in its November 2009 annual survey of the UK’s tax competitivenessshowed that over half had either looked at the implications of moving out of theUK or were actively considering it. Of the 20 FTSE 100 companies surveyed, fourwere actively considering moving.25

The departure of companies from the UK is one, high-profile, way in which thenegative impact of higher taxation on economic growth, explained in Section 1.2,manifests itself.

This negative effect of higher taxes is a key threat to the sustainability ofeconomic recovery in the longer term. While higher taxes will not have a cripplingeffect overnight, they do have a significant impact on the longer-term supply sideof an economy, and hence on the underlying rate of GDP growth. Decisionstaken in the next year or so, on whether and how much to raise taxes to reducethe fiscal deficit, will be crucial to the performance of the UK economy:

•

While it is true that the fiscal tightening set out in the 2009 Budget and Pre-Budget Report envisages that the bulk of the deficit reduction will be deliveredthrough reductions in public expenditure, the lack of detail, and the continuingwillingness of the Government to make new spending commitments,26 meansthat this cannot be taken for granted.

• As was shown in Section 1.2, estimates of the precise impact of highertaxation on GDP growth vary, but a reasonable mid-point would suggest that

23 PCG Press Release, 26 May 2009

24 KPMG, UK Tax Competitiveness Survey 2008

25

KPMG press release, December 200926 See for example, the speech to the Labour Party conference by Prime Minister Gordon

Brown, 29 September 2009



18

a 10 percentage point increase in the tax/GDP ratio would decrease trendGDP growth by between 1 and 2 percentage points.

• As indicated in Section 1.1, the structural deficit is expected to peak at around10 per cent of GDP or slightly higher. If half of the fiscal tightening necessaryto close this structural deficit were to be through a higher tax/GDP ratio, then

trend GDP growth would be expected to fall by between 0.5 and 1 percentagepoints – from 2.5 per cent to 1.5-2.0 per cent.

Slightly lower trend growth may not seem like a huge problem, but cumulatively itwould make a major difference:

• An economy growing at 2.5 per cent a year would after 10 years be 28 percent larger, compared with just 16.1 per cent larger with annual growth of 1.5per cent and 21.9 per cent larger with annual growth of 2 per cent.

• After 25 years the differential would be greater still: 85.4 per cent growth forthe economy growing at 2.5 per cent a year, compared with 45.1 per cent

growth for the economy growing at 1.5 per cent annually and 64.1 per centgrowth for the economy experiencing an annual growth rate of 2 per cent.

Chart 1.6: The effect of lower trend growth on GDP

0

10

20

30

40

50

60

70

80

90

2.5% 2.0% 1.5%

Ann ual gr ow th rate of rea l GDP

C u m u l a t i v e g r o w t h o f G

D P , p e r c e n t

After 10 yea rs After 25 years

• This would make a big difference to per capita incomes. In 2007-08 GDP per

capita was £23,288.27 After 10 years of 2.5 per cent annual growth it wouldreach £29,811 in 2007-08 prices, but if annual growth was 1.5 per cent percapita, incomes would only reach £27,027. Over 25 years, GDP per capitawould reach £39,215 in 2007-08 prices if annual growth was 1.5 per cent, or£55,268 if annual growth averaged 2.5 per cent.

27

IoD calculation based on 2007-08 GDP data from HM Treasury, Budget 2009, April 2009,Table C1 and 2007 UK population data from Office for National Statistics, Annual Abstract ofStatistics 2009, Table 5.1



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Chart 1.7: The effect of lower trend growth on GDP per capita

£0

£10,000

£20,000

£30,000

£40,000

£50,000

£60,000

2.5% 2.0% 1.5%

Ann ual gr ow th rate of rea l GDP

G D P p e r c a p i t a ,

2 0 0 7 - 0 8 p r i c e s

2007 2017 2032

Slower trend GDP growth would also reduce tax revenues, and hence reduce theability of the Government to close the deficit. Indeed, various estimates presentedin Section 1.2 suggest that higher taxes do not bring in as much extra revenue asone would expect, while lower taxes to some extent pay for themselves over time.

The implications for policy are clear. As far as possible, the overall burden of taxshould not be increased to close the fiscal deficit. The tax/GDP ratio will increaseautomatically from its current low via higher profits and incomes as a result ofeconomic recovery. But it should not be increased through discretionary tax rises.



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2 Solutions

Chapter 1 has set out the problems with the UK tax system. We need to findimprovements that will make the system both more competitive and simpler. At

the same time, we need to ensure that the improvements will be fiscallyaffordable, and that they can be assembled in a coherent plan that can be set outin advance and then implemented steadily. The balance of the package must beweighted towards helping the majority of people and the majority of businesses. And we must avoid changes that would have serious adverse side-effects,whether only on implementation or in the long term. Changes can be disruptive,and they need to be justified by the benefits.

In this chapter, we set out a range of measures that we recommend, and relatethem to the problems that were identified in Chapter 1. We also outline a range ofpolicies that might be superficially attractive, but that would not really be

desirable, either because they would not do much to address current difficulties,or because they would have undesirable side-effects. Much more detail on themeasures, and the arguments for and against them, is given in Annex A. Then Annex B costs the measures that we recommend, and sets out a ten-yearimplementation plan. Fiscal constraints mean that the changes that are proposedcould not all be introduced at once.

Our plan is designed to offer adequate scope to collect tax revenue, while at thesame time being internationally competitive. It represents an evolution of the UKtax system, rather than a revolution. The evolution is quite extensive in places,but significant changes are perfectly possible, as shown by the introduction of theexemption for foreign profits in 2009.

The following tables set out the measures that we recommend and the basicreasons for recommending the measures. Section 2.1 expands on these tables.Section 2.2 sets out the rationale for the proposed implementation plan. Finally,Section 2.3 comments on measures that we do not recommend.



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Businesses

Measure Reasons

Reduce the corporation tax rate to 15 per cent Competitiveness Abolish stamp duty and SDRT on securities Competitiveness

Phase out venture capital reliefs Simplification, remove distortions Allow deductions for capital items currently disallowed SimplificationPhase out reliefs for particular types of spending Simplification, remove distortionsExempt companies’ gains on shares Simplification, competitiveness,

reduce avoidanceReduce restrictions on the relief of companies’ losses Competitiveness, simplification Allow accounts depreciation for unincorporatedbusinesses

Simplification

Allow unincorporated businesses to ignore small profitadjustments

Simplification

Allow small unincorporated businesses to use a cashbasis

Simplification

Introduce a disincorporation relief Give flexibility in business

structures

Employment

Measure Reasons

Reverse the 1 per cent increases in national insurance Competitiveness Abolish class 2 national insurance SimplificationHarmonise employment income and national insurancebases

Simplification

Transform employers’ national insurance into a payrolltax

Simplification

Reduce national insurance on employment CompetitivenessRelax the rules on employees’ expenses Simplification

Personal incomes and spending

Measure Reasons

Reverse the withdrawal of personal allowances CompetitivenessReduce higher income tax rates CompetitivenessTax dividends at full income tax rates, but do not taxstock dividends and allow gross roll-up funds

Simplification, encourage re-investment, European Law, reduceincentives to incorporate,encourage saving

Tax interest income of individuals only at the excess ofthe higher over the basic rate

Encourage saving

Allow the full ISA limit to be used in any way Encourage savingPhase out the Enterprise Investment Scheme Remove distortionsSwitch from taxing life assurance profits as they ariseto CGT on withdrawal

Encourage saving

Simplify restrictions on pension contributions SimplificationMake the CGT annual exempt amount proceeds-based SimplificationIntroduce CGT on death and abolish inheritance tax Encourage savingIncrease VAT rate to 20 per cent Fund other measuresChange stamp duty land tax to a slice scale Remove distortions



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2.1 The recommended measures

Businesses

Businesses must not be over-taxed. All taxes are ultimately taxes on individuals,

but if too high a burden is imposed at the level of businesses, it will have twoseriously deleterious effects. The first is that internationally mobile capital willseek other homes. The second is that entrepreneurs will be deterred fromstarting, or expanding, businesses. Either effect would strike directly at theemployment opportunities of ordinary people, and at the tax base that is neededto allow public services to be financed.

The most important recommendation is to reduce the corporation tax rate to 15per cent over a ten-year period. In the first seven years, both the main and thesmall companies rates would be reduced by 1 per cent a year. At the end of thatperiod, the small companies rate would be 15 per cent but the main rate would

still be 21 per cent. So in the last three years, the main rate would be reduced by2 per cent a year. Chapter 1 set out how the UK’s corporation tax rate is nolonger competitive. A 15 per cent rate would be competitive in itself, and a clearcommitment by the Government to reach that rate over a set period would makethe UK attractive even before the rate was reached. Reductions in the smallcompanies rate in parallel with reductions in the main rate would support smallerbusinesses from the outset.

Further support could be provided to businesses that were temporarily loss-making, but that were viable in the longer term, by freeing up the use of losses. Atthe moment, if a business wishes to set a loss that is made in one year against aprofit that is made in a later year, the rules severely restrict the type of profit

against which a loss may be set. This can delay loss relief, and hence delayaccess to funds that would allow a business to expand, or to catch up on itsinvestment in fixed assets, following a period of loss.

Some proposed improvements are aimed at enabling the efficient management ofcapital, so that businesses can easily move to the ownership where there are thegreatest synergies, and so that the cost of capital can be reduced. There shouldthen be more opportunities for businesses to thrive, increasing employment. Wepropose taking all gains and losses made by companies on shareholdings out ofcharge to tax, and abolishing stamp duty and stamp duty reserve tax on sharetransfers. The latter would also give a competitive boost to the financial sector,

which remains a major earner for the UK but which could lose its position toforeign competitors at any time.

There is also a strong case for simplifying the tax system, so that directors arefreer to focus on business decisions and have less reason to worry about taxtechnicalities. Special reliefs should be phased out, partly in order to facilitatethis, and partly in order to remove distortions that can all too easily mis-directcapital by substituting the judgement of politicians for the judgement of themarket. We therefore advocate the phasing out of special reliefs for venturecapital investment and for particular types of spending. Reductions in thecorporation tax rate should ensure that no viable businesses would, on balance,

suffer, and the proposal is to use the tax money saved to finance other taxreductions, not to increase total tax revenues.



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The owners of unincorporated businesses suffer income tax on the businesses’profits, rather than the businesses suffering corporation tax. We proposeimprovements to make the computation of profits simpler. One is to allowaccounts depreciation instead of capital allowances, and a second is to allow

small adjustments to profits to be disregarded. The overall effect should be toallow a great many businesses simply to pay tax on the profits that are shown intheir accounts. And small unincorporated businesses could be spared thecomplexity of preparing accounts, as opposed to maintaining a record of cashreceived and spent, by allowing them to pay tax on profits computed on a cashbasis.

Some unincorporated businesses would not find such arrangements congenial, orwould be attracted by a low corporation tax rate, and might choose to incorporate,although there should be no rush to incorporate because our proposals on thetaxation of dividends should limit the attractions. Their circumstances might thenchange, making it advantageous to revert to an unincorporated form. Under thecurrent rules incorporation is easy, but disincorporation is not. We thereforepropose a disincorporation relief. It would be foolish, and a threat to the jobs ofthe employees of some businesses, to make it hard for businesses to move to theright legal forms for their individual circumstances.

Employment

Ordinary people need jobs, and the very last thing that a tax system should do isstand in the way of employment. For many years, employment income hassuffered not just the burden of income tax, but the burden of national insurancetoo. Substantial reductions in this latter burden are not fiscally feasible in the

short to medium term, but there are still things that can be done in order toencourage employment.

The first move must be to reverse the 1 per cent rises in national insurance ratesthat are to take effect in 2011. Both the increases in employees’ rates and theincreases in employers’ rates will make employment less economically viable andwill destroy some jobs at the margin. Reversing the rise for employees would alsogive an immediate and direct boost to pay packets at all levels of earnings aboveabout £6,000 a year.

There is also an opportunity to encourage self-employment. An immediate piece

of bureaucracy with which the newly self-employed must tangle is weekly class 2contributions. Even someone who takes on some part-time self-employmentalongside his or her regular job must either start paying this, or apply forexemption. At the same time, the revenue raised is modest. We proposeabolishing these contributions, and amending the test of qualification forcontributory benefits accordingly.

A common complaint of employers is that a lot of work is generated by having twoimpositions, income tax and national insurance, on roughly, but not precisely, thesame amounts. Effort expended on devising payroll systems and collecting thenecessary data for each payday is simply wasted effort. A merger of income tax

and national insurance would, however, have huge redistributive effects, becausethe amounts involved are so large and so significant as proportions of total tax



24

revenue. There are, however, practical ways to reduce the administrative burden.We propose a better alignment of the bases for the two impositions, and thetransformation of employers’ contributions into a more straightforward payroll tax.Such changes should make the expansion of a one-person business into abusiness with employees less daunting.

We do propose the long-term goal of reducing national insurance contributions onemployment income. But the amounts involved mean that this can only be a goalfor the period beyond the ten years that we propose to use to implement all of theother proposals.

We have one proposal related to income tax on employment income. The currentrules on the tax-deductibility of employees’ expenses are very strict. Extensiveand burdensome monitoring is required in order to ensure compliance. Wepropose relaxing the rules, in the interests of making it easier to run businesses.

Personal incomes and spending

There are three priorities for the income tax system:

• We need to encourage savings by those on modest incomes. People need tobuild up funds for their retirement and for emergencies. The focus is onreducing the tax on interest income, especially for those who only pay basic-rate tax, because people on modest incomes are most likely to choosesavings vehicles that pay interest rather than dividends. We therefore proposenot taxing interest received by basic-rate taxpayers. We also propose givingmore freedom in how money that is put into individual savings accounts(ISAs) can be invested.

• The income tax system must be made a good fit with the corporation taxsystem, in order to avoid creating a tax bias in favour of incorporation. Giventhat we propose a low corporation tax rate, we also propose taxing dividendsat normal income tax rates. But dividends that are re-invested in a business,through the shareholders taking stock dividends rather than cash dividends,should not be taxed at all until they are taken in cash. Not only would thisencourage re-investment. It would also be compatible with the introduction ofgross roll-up funds, which would give the UK fund management industry aboost and which would be a further incentive to the accumulation of savings.

• We need to reverse the current slide into a high-tax regime. It is true that the

main targets of higher tax rates are the small minority of the population whohave six-figure incomes, but there are still adverse effects lower down theincome scale. Those who aspire to such levels are deterred by higher taxrates. Those who aspire to good incomes below that level justifiably fear thatthey may be next in line for higher taxes. The proposed 45 per cent rate wasafter all increased to 50 per cent, and the proposal to withdraw personalallowances in two stages was changed to a proposal to withdraw them in onestage, even before the implementation date for these proposals. The slidedown the slippery slope has already started. Furthermore, high-income peoplebenefit not just themselves, but those with whom they spend their money. Theowner of a corner shop would be glad to have high-income people living in theneighbourhood. We therefore propose reversing the withdrawal of personalallowances, then gradually reducing the 50 per cent tax rate to 40 per cent,then gradually reducing the 40 per cent rate to 35 per cent.



25

Other changes should also encourage saving:

• The replacement of inheritance tax by a charge to capital gains tax on deathwould ensure that only gains on assets were taxed, not the value of theassets themselves (which have often been bought out of taxed income). Thiswould make people happier to accumulate wealth to see themselves through

their old age, safe in the knowledge that early death would not mean leaving alarge legacy to the Exchequer.

• The tax treatment of life assurance could be changed, so as to favourinvestors of modest means whose capital gains tax annual exempt amountscurrently go to waste. And the operation of the exempt amount could besimplified.

• The ludicrously complex new restrictions on tax relief for pension contributionsshould be replaced by a far more straightforward limit on total contributionswhich would have much the same effect.

As part of the package, distortions should be removed:

• The Enterprise Investment Scheme, which encourages investment inparticular types of company, should be phased out. Tax privileges that haveaccrued on existing shares should be preserved, so as to avoid retrospectivetaxation. But lower tax rates across the board should be the watchword for thefuture, rather than biases in favour of particular types of investment.

• The current slab scale for stamp duty land tax should be replaced by a slicescale, removing the current distortion of the market in the region of thethresholds for the different rates.

Finally, it must be acknowledged that even in better fiscal times, an extensiveprogramme of tax reductions will not be easy to fund. We therefore proposeincreasing the standard rate of VAT, in order to help fund a package that will stillinvolve a substantial overall reduction in tax revenues. This is in line withaccepted economic theory, that it is better to tax consumption than it is to taxproduction.

2.2 The implementation plan

We propose implementing the measures set out above, apart from significant

reductions in national insurance, over a period of ten years, the life of two fullParliaments. It should be politically feasible to stick to a single programme ofreform over that period. It would not of course be possible for any Parliament tobind its successor beyond a general election. But a clear commitment by theGovernment of the day, and preferably by opposition parties too, to implement aprogramme of reform would do much to restore confidence in the futurecompetitiveness of the UK’s tax system.

The implementation plan is set out in detail in Section B2, and the overall effecton tax revenues is summarised in Section B3. The thinking behind the prioritiescan be summarised as follows.



26

It is essential to re-establish the competitiveness of the UK’s tax system byimplementing a programme of reductions in the corporation tax rate. Animmediate reduction to 15 per cent would not be feasible. But a timetabledreduction, which started immediately rather than remaining a mere promise forthe first few years, would do much to restore international confidence. We

therefore propose steady reductions, right from the start.

Likewise, the immediate reversal of the forthcoming national insurance riseswould be needed to send a positive signal and to encourage employment. Thesame concern, together with the need to eliminate a complex policy that is goingto be very hard to administer through the PAYE system, justifies the promptreversal of the decision to withdraw personal allowances as income rises. It also justifies immediate reform of the new restriction on the tax-deductibility of pensioncontributions, although we propose replacing that restriction with something thatwould have a similar effect and that would not affect tax revenues.

Another very useful indicator of determination to restore competitiveness to theUK tax system would be to start the reduction of the top rate of income tax fromthe start. We therefore propose reductions in the 50 per cent rate, down to 40 percent, over the first five years, with reductions in the 40 per cent rate to follow.

The fiscal credibility of a programme of reform must also be established byaction, rather than by promises, from the outset. We therefore propose increasingthe standard rate of VAT from the outset, and phasing out special reliefs early on.

Reasonably early action is also needed to encourage saving, especially amongthose on modest incomes. The restrictions on the use of money that is put intoISAs could be removed early, although the removal of tax from interest income

earned by basic-rate taxpayers would have to wait a few years because of thehigh Exchequer cost.

Once these important demonstrations of the direction of reform had been given,attention could turn to more detailed reforms of the taxation of businesses,including taking companies’ gains and losses on shares out of charge to tax,minor simplifications of profit computations, a programme of simplification forunincorporated businesses, the simplification of national insurance, and a betterregime for employees’ expenses. This programme would be rounded off with thereduction in restrictions on the use of companies’ losses.

We propose that towards the end of the ten-year period, substantial changes tothe treatment of savings be made. The full taxation of dividends should beintroduced, but only once the corporation tax rate had been significantly reduced. At the same time, dividends taken in the form of stock should become tax-free,and gross roll-up funds should be permitted. Other reforms to bring in late in theprogramme, when they should be more affordable, include the replacement ofinheritance tax by capital gains tax on death, and changes to the taxation ofinsurance policies.

One reason for delaying some of the more expensive reforms until late in theprogramme is that early reductions in the tax burden on business would increase

the rate of economic growth. That would in turn increase tax revenues, making



27

later reforms more affordable. We show what a difference this dynamic effectcould make in the summary costing in Section B3.

2.3 Measures that are not recommended

Many possible reforms to the tax system have been debated in recent years. Themost significant ones have been radical changes to the structure of thecorporation tax system. These include a full imputation system (in which full creditis given for corporation tax against income tax on dividends), a tax only ondistributions, a deduction for the cost of share capital analogous to interest, andthe denial of a deduction for interest expense.

All of these options are worthy of discussion, and we examine their advantagesand disadvantages in Section A3. The main arguments in favour of them are thatthey would help to level the playing field between equity and loan capital, and that

some of them would yield tax revenue that could be used to fund reductions inother tax rates. In the end, we come out against all of these options. A lowcorporation tax rate will also help to level the playing field, by making thededuction for interest expense less significant. And the revenue that could beraised from some of the other measures would not be nearly as significant asmight be hoped. It is, however, important that we have a full debate on suchideas, in order to understand all of the arguments, before any final policydecisions are taken.



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Annex A

Changes to the tax system

A1 Int roduct ion

In this annex, we set out the details of our plan for the tax system, give a fullrationale for the measures that we propose and discuss some measures that wedo not recommend.

A1.1 The basel ine

The baseline is the tax system as it will be under current plans, because theseplans have been factored into revenue projections. It therefore includes the

planned increases in national insurance, the planned increase in the smallcompanies rate to 22 per cent, the planned 50 per cent income tax rate and theplanned withdrawal of personal allowances at high levels of income. It alsoincludes a VAT rate of 17.5 per cent, not the temporary rate of 15 per cent thatapplied throughout 2009.

A2 The taxat ion of capital

A number of taxes bear on returns to capital, or on capital itself. Capital gains taxtaxes returns to capital, as does income tax on dividends on shares. Inheritance

tax bears on the ownership of capital at death, and on gifts of capital in thepreceding seven years.

The picture is, however, not clear-cut. Corporation tax and income tax ondividends can both tax returns to labour, as when an owner-manager chooses notto take a salary (which would be tax-deductible for the company, reducing thecorporation tax due, and which would also be an alternative to dividends), butchooses to bear corporation tax on the company’s profits and then takedividends. And the rise in value of a company’s shares will reflect the value oflabour for that company which has not been fully rewarded through salary ordividends.

Despite these complications, it makes sense to treat a range of taxes, corporationtax, income tax on the returns to savings and capital gains tax together. Theyneed to form a coherent set of taxes, which interact in appropriate ways. Inaddition, income tax on business profits must be arranged so as to cohere withcorporation tax. And inheritance tax, as the tax on capital itself rather than onreturns to capital, should be considered at the same time. In Sections A3 to A8,we consider all of these taxes.



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A3 The structure of corporat ion tax

Corporation tax works by computing an amount to tax – the tax base – and thenapplying a tax rate to that amount. There is also an important interaction with thetaxation of providers of capital. Dividends on shares are not tax-deductible for the

paying company, are not generally taxed in the hands of company shareholdersand are taxed at reduced rates in the hands of individual shareholders. Intereston loans is deductible for the paying companies and is taxed at normal rates inthe hands of the recipients, whether companies or individuals.

This section concentrates on the overall structure of corporation tax and on thetaxation of providers of capital. Section A4 covers more detailed aspects of thetax base.

There are several reasons why it is appropriate to consider changes to thecurrent structure of corporation tax, as follows:

• The tax treatment of financing costs and of the returns to providers of capitalcan have a significant effect on the international competitiveness of acountry’s tax system. It can also encourage businesses to finance themselvesthrough higher levels of debt than is prudent.

• The basic structure of the current system gives multinational groups theopportunity to save large amounts of tax by diverting profits overseas. It istherefore necessary to add burdensome anti-avoidance provisions, inparticular the rules on transfer pricing, on thin capitalisation (which has since2004 been dealt with through transfer pricing rules) and on controlled foreigncompanies. The main complaint against the Government’s 2007 proposals onthe taxation of foreign profits was that they included a new controlledcompanies regime which was perceived to be even more burdensome thanthe existing controlled foreign companies regime. The Government gave itsinitial response to these concerns in July 2008. In November 2008, itannounced that most, but not all, foreign dividends received by UK companieswould become tax-free, and that changes to the controlled foreign companiesregime would also be made. Consultation on those changes is currently inprogress, but it is clear that the Government has recognised the need tointroduce a regime that is more business-friendly than what was proposed in2007.

• The basic structure of the current system allows extensive tax planning by

small businesses, which has to be countered by the use of complex andimpractical anti-avoidance legislation.

• The current system has been subject to a number of legal challenges basedon European law, and may face new challenges.

Not only should any new corporation tax regime address the issues identifiedabove. It would also have to respect the following constraints.

• Any new regime would have to be internationally competitive, otherwisemultinational groups would bypass the UK and the UK would lose investmentand jobs. The key question is that of whether the UK takes a higher proportion

of profits in tax than other developed countries. If it does, then the UK will notbe competitive.



30

• Any new regime would have to place smaller businesses in a satisfactoryposition, in particular not attaching significant tax penalties or benefits toincorporation.

• Tax would have to be imposed on a base that could not be spirited away bytax planning.

• The regime would have to comply with recognised international principles, inparticular not seeking primary taxing rights over profits that arose in non-UKestablishments.

• The regime would have to respect the terms of European Union law. Inparticular, it would have to avoid restricting freedom of establishment or thefree movement of capital. The regime would also have to comply with theParent-Subsidiary Directive’s prohibition on cross-border withholding taxeswhere there is a corporate shareholding of 10 per cent or more (Directive90/435 as amended), unless member states agreed to change that directive.

Our discussion of ways in which the corporation tax system could be improvedstarts with the tax rate. Although the rate is not a structural feature, both the ratein itself and its relationship to tax rates in other countries have significantimplications for the system as a whole.

A3.1 A reduced corporation tax rate

The headline rate is important to perceptions of a tax regime’s competitiveness.Given the distribution of rates at the moment and the reductions in rates inseveral countries in recent years, as set out in Chapter 1, a 15 per cent rate

would be a very good target. A low rate would have a number of advantages,including the following:

• A low rate would enhance competitiveness, reducing the proportion of profitstaken in tax and the proportion of total tax revenue which came from businessprofits. While all taxes are ultimately borne by individuals, the critical point formobile businesses choosing countries in which to reside is the level oftaxation of their profits. Considerations of fairness in the distribution of a givencountry’s tax burden are irrelevant when a business is choosing betweencountries. Not only is a group which fails to seek out the best deal on taxfailing in its duty to its shareholders. It also puts its competitiveness as againstgroups which do seek out the best deal at risk, thereby jeopardising jobs andits contributions to tax revenues in the countries where it does pay tax.

• A low rate would make the tax base less exposed to manipulation, because itwould reduce the incentive to divert profits to other countries. There is nopoint in diverting profits to countries with higher tax rates, and it may not becost-effective to divert them to countries with only moderately lower tax rates.Measures to prevent such diversion, such as the controlled foreign companiesregime, could be less severe and would need to be applied less frequently.

• Some special reliefs would be less significant than with a high rate, allowingtheir restriction or elimination in order to create a simpler tax system whichwas even less open to manipulation, and in order to finance a still lower rate.



31

• A significant reduction in the rate would facilitate the making of other changes,because it would compensate businesses which would otherwise beadversely affected.

• A low rate would make it practical to have a classical system, under whichnon-company recipients of dividends would pay income tax on thosedividends at normal rates, without tax credits, as proposed in Section A7. Ahigh rate would mean that under a classical system the overall burden onreturns to share capital would be too high.

A3.2 The taxat ion of prov iders of capital through corporat ion tax

Corporation tax is computed on profits after deducting the interest expense whichis the return to the providers of loan capital. It is therefore effectively a tax on thereturn to the providers of share capital, although it can also be a tax on labourwhen a shareholder, often an owner-manager, supplies labour to a company and

takes dividends, or an increase in the value of the shares, rather than taking a fullreward for the labour in the form of a salary.

Ideally, the tax system should not bias companies as between loan capital andshare capital. It is worth focusing on the ways in which that bias could beavoided, because that allows us to consider a number of different possiblechanges to the corporation tax system in a structured way. But the avoidance ofthe bias is by no means the only objective that we should have. Some of theoptions listed here would have disadvantages as well as advantages.

The ways in which the bias between share capital and loan capital could be

avoided include the following:

• There could be a full imputation system, so that corporation tax wasdeductible from the tax due on dividends. The UK has gradually moved awayfrom this to an ever more limited imputation system, as the tax credit ondividends has been reduced.

• There could be a tax only on distributions, so that there was no corporationtax on profits as they were made. If dividend income and interest income werethen taxed at the same rates, the bias would be eliminated.

• There could be a deduction for dividends, or for a standard rate of return onequity (the allowance for corporate equity), in computing corporate profits,corresponding to the deduction for interest expense. If dividend income andinterest income were then taxed at the same rates, the bias would be reducedor eliminated.

• There could be no deduction for interest expense. If dividend income andinterest income were then taxed at the same rates, the bias would beeliminated.

We will now consider these options, and their wider advantages anddisadvantages. We will find that perfection is not attainable, mainly because ofthe fact that shareholders can be either UK or non-UK, and can be either

companies or non-companies.



32

A ful l imputat ion system

Full imputation would mean giving tax credits at the main corporation tax rate, sothat with a tax rate of 28 per cent, a shareholder who received a net dividend of£72 would be treated as receiving income of £100, on which tax of £28 had

already been paid. Dividends would effectively be treated as if they were paid outof pre-tax profits. This would match the treatment of interest, which does comeout of pre-tax profits and is then fully taxable in the hands of the recipient.

There are however arguments against this approach. There would be significantdifficulties in devising a system which complied with European law, while at thesame time fully protecting UK tax revenues, following the CJEC (Court of Justiceof the European Communities) decision in case 319-02 Manninen. It is also likelythat in negotiating tax treaties, the UK would have to allow payment of at leastsome of the tax credit to foreign investors who would not pay any UK tax on theincome.

A tax only on distributions

A tax on distributions would mean applying a single rate of tax to dividends paid.Dividends would not be taxable income in the hands of the recipients. Interest, onthe other hand, would continue to be taxable in the hands of non-corporaterecipients but would not give rise to the new tax charge on the paying company,thus allowing parity of treatment for share and loan capital if suitable tax rateswere chosen. (Interest would not be taxable in the hands of corporate recipientsexcept to the extent that they converted it into dividends paid out, which wouldthen not then be subject to further taxation. And the question of the deductibilityof interest payments would not arise, because distributions rather than profits

would form the basis for corporation tax.)

Taxing only distributions would favour re-investment, which would be a goodthing if there was a tendency to under-invest in order to make distributions but abad thing if the re-allocation of capital was deterred and capital was retained inless productive uses because of the tax penalty on distributions. It would alsohave the advantage that because the amounts of distributions are obvious,elaborate computations of taxable profits would not be necessary.

While this approach would have some advantages, it would unfortunately sufferfrom one very serious disadvantage. It would be very hard to find a way to allow

its application to corporate shareholdings of 10 per cent or more, given theParent-Subsidiary Directive’s prohibition on withholding taxes. A withholding taxwould have to be limited to shareholdings of under 10 per cent. (It is customary torefer to large shareholdings as direct investments and to smaller ones as portfolioinvestments. This terminology will be used here, with a holding of 10 per cent ormore being regarded as a direct investment. Dividends from the two types ofinvestment will be referred to as “direct dividends” and “portfolio dividends”respectively.) A withholding tax might be applied to direct dividends paid to non-European investors, but they could avoid the tax by inserting an intermediateholding company in another European Union member state with an appropriatetax regime, unless it was possible under European Union law to craft a provision

which would mean that such conduits would be ignored even when they hadsome other activities in order to avoid being pure conduits.



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One might try to make the proposal compliant with the Directive by describing thetax base as distributable profits as shown in the accounts, minus amounts takento reserves and plus amounts released from reserves which representedamounts that had at any time been distributable profits. That is, distributableprofits would be taxable but taxation could be deferred by not distributing them.

The point of such a characterisation would be to allow an argument that the taxbase was profits, with a deduction for retentions, rather than simply beingdividends. It should also be noted that following the CJEC case C379-05 Amurta,Estonia took the view that its system of taxing only distributed profits compliedwith European law. The position is, however, not certain enough to make itsensible to build any new tax system on this basis.

An alternative approach would be to tax dividends received in full, whetherreceived by companies or by individuals, and not to tax companies’ profits at all.The difference between this and the previous proposal would be that the taxcharge would be on the investor, so that there no withholding tax was imposed atthe level of the dividend-paying company. This would initially appear to avoid thedifficulty with the Parent-Subsidiary Directive.

Unfortunately, in order to make the tax charge effective on foreign shareholders,it would be necessary to have a fall-back requirement to pay, imposed on thecompany, when the shareholder did not pay. Such a fall-back requirement wouldlook very like a withholding tax, and so would be at considerable risk of falling foulof the Parent-Subsidiary Directive.

There would also be other disadvantages of the option of taxing only distributionsto consider, including the following:

• It would be hard to define distributions. Transfer pricing law would play a vitalrole in preventing the disguise of distributions as sales. Payments out of sharepremium account would be an issue for companies that were incorporated incountries where such payments were allowed.

• It would be necessary to decide whether there should be any deduction forcapital put in, for example by deduction from taxable distributions until thecapital put in was exhausted.

• Some companies would refrain from distributing profits, leaving the tax chargeon the capital gains made by shareholders as the only charge. This chargemight not be effective. There would be no charge on some corporate

shareholders or on any non-resident shareholders unless the law waschanged, and even then there would be no way of making a charge effective ifa sale was from one non-resident to another non-resident.

• Even if there were an effective charge on gains made by shareholders, therewould be avoidance opportunities to address, such as putting debt into acompany before its sale for a reduced price.

• Overall, the proposal would give so many opportunities to defer the paymentof tax, and would so reduce total tax revenues, that it would not be practical tointroduce except when tax revenues significantly exceeded what was neededto finance government spending.

• There would be a transitional issue as to whether profit taxed as such beforethe change should be taxed on distribution after the change.



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• We discuss below the advantages of getting the Parent-Subsidiary Directivewithdrawn by agreement between all member states. If that were to happen,one might re-consider taxing only distributions. The other disadvantagesmentioned here would, however, remain.

A wi thhold ing tax on port fo lio dividends or on dividends not paid tocompanies

While it might not be possible to tax distributions in general, a withholding taxcould be imposed on portfolio dividends, and/or on dividends not paid tocompanies. This would be a way of increasing the tax burden on some foreigninvestors in UK companies to the same level as that on UK non-corporateshareholders, or part-way towards that level. In the interests of simplicity inadministration and the facilitation of flexibility in group structures, it makes sensenot to tax dividends paid between UK companies, so the dividends taxed wouldonly be portfolio dividends paid to foreign companies, and/or all dividends paid to

non-companies.

This would both raise some tax (to be returned by tax reductions elsewhere) andreduce the bias in favour of having UK equities in the hands of foreign investorsrather than UK investors. It would also give the UK a withholding tax to negotiateaway in treaty negotiations, in order to gain concessions on other issues.

There would be no incentive to fragment holdings, because the shareholderwould seek to show that a holding was of at least 10 per cent. It would howeverbe necessary to have measures against avoidance which was designed to createthe impression of having a holding of at least 10 per cent by using trusts whichcreated associations with other shareholders. One possible anti-avoidancemeasure would be to say that no association, or none other than membership ofthe same group of companies (suitably tightly defined) would lead to theaggregation of holdings for this purpose.

A tight limit on aggregation would however be at risk, albeit fairly low risk, ofleading to non-compliance with the Parent-Subsidiary Directive. If compliancecould not be achieved, it would only make sense to limit the tax to dividends paidto non-EU shareholders if it was feasible to act against the use of intermediatecompanies in other member states as conduits which could receive dividends andpass them on to the ultimate owners.

There would also be a risk of non-compliance with European law if the onlycorporate shareholders that suffered the withholding tax were non-UKshareholders. It might turn out to be necessary to impose it on intra-UK corporateportfolio shareholders. That would not be desirable, because the imposition ofcorporation tax on dividends paid between UK companies would be a source ofgreat complexity, even if it were fully recoverable by companies that receiveddividends.

There is certainly a case for having a withholding tax on dividends paid to non-companies, a tax which could then be reclaimed by selected shareholders suchas pension funds, or even not charged in the first place on dividends to such

selected shareholders (although exemptions for non-individuals might have to beextended to corresponding entities in other member states). A withholding tax



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would indeed be the most efficient way of collecting tax from individuals. Ourproposals for tax-free roll-up in Section A7 do however mean that there should beno withholding tax on stock dividends.

There is less of a case for imposing the tax on portfolio dividends paid to

companies outside the UK, given that the UK’s absence of a withholding tax hasbeen one of its attractions. But the option could still be considered, especially ifthe tax was negotiated away in return for concessions in treaties with other majorcountries.

There is also a case for seeking to have the Parent-Subsidiary Directivewithdrawn, so that a withholding tax could be imposed on direct dividends paid tonon-UK companies. That would allow the UK a choice, in respect of each country,between imposing an overall level of tax comparable to that which would beimposed on the profits of a company that was owned by UK shareholders (thelow corporation tax rate plus either income tax or the withholding tax), orbargaining the withholding tax away in return for benefits for UK investors whennegotiating tax treaties. The UK would not be the only member state that wouldbe happy to see the Directive withdrawn. It would however be necessary to makeother changes to European law, in order to ensure that the withholding tax couldbe applied to dividends paid to non-UK companies but not to dividends paid toUK companies, without risk of an infraction of European law.

A deduct ion for dividends

Schemes to give a deduction for the cost of corporate equity have been proposedin the past, and there are economic arguments for them. Unfortunately, theywould vastly reduce the tax base, requiring a large increase in the tax rate. Given

that corporate tax rates are falling in many competitor economies, this wouldhardly be a sensible move.

Disallowing net interest payments

It would be possible to disallow the deduction of interest paid to the extent that itexceeded interest received. That is, there would be no deduction for loanrelationship debits in excess of credits. Trading and non-trading debits would bemerged into a single category. Net interest received would remain taxable.

Such a move would be radical, but it is worth considering because it would have

the following advantages:

• It would fund a reduction in the corporation tax rate. The reduction is hard tocalculate, but it would probably be about 4 per cent. If interest were to bedisallowed, the broadening of the tax base should immediately be matched bya proportionate reduction in the rate. The smallness of the estimated ratereduction reflects the fact that much of the interest that currently arises is paidbetween group members, and a high proportion of that is paid between UKgroup members. Intra-UK-group interest would disappear as soon as adisallowance was introduced, and a large proportion of interest that was paidto non-UK group members would probably disappear, with equity replacingloan capital. Thus the broadening of the tax base would by no means equalthe total interest that is currently paid by companies. (To the extent that therewas a supplement to group relief to allow the matching of payments and



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receipts within the same group, as discussed below, there would be no needto eliminate intra-group interest, but equally there would be no broadening ofthe tax base.)

• It would put debt capital and equity capital on the same footing, with nodeduction for the cost of either. This would remove the bias in the tax system

towards higher gearing.

• It would allow the repeal of a great deal of anti-avoidance legislation, much ofwhich relates to interest.

• It would save the UK fisc from subsidising foreign fiscs. At the moment, theUK’s generous rules on the deduction of interest mean that a disproportionateamount of debt of multinational groups is located in the UK. Deductions aretherefore made from UK profits, when some of them should be made fromprofits made in other countries.

On the other hand, the disallowance of net interest payments would have the

following disadvantages:

• It would remove what is perceived as a large competitive advantage of theUK, the absence of restrictions on the deductibility of interest. (The worldwidedebt cap which takes effect at the start of 2010 will impose a restriction, butnot a severe one.)

• It would affect the distribution of the tax burden between highly-geared andlowly-geared businesses, leading to some disruption and frictional costs. Re-structurings of groups would be required.

• Non-UK groups investing in the UK would be placed at a disadvantage

compared to the current position. There would also be a risk of interest beingdisallowed in the UK but taxed abroad.

• This disruption would extend to the customers of businesses. If for example aproperty company was financed largely by borrowing, it would have toincrease rents charged to its tenants. To the extent that property sector wasmore highly geared than the economy as a whole, there would be an overallredistribution of the tax burden towards property-intensive businesses such asretailers. This would not however apply where properties were owned bypension funds, which would notice no difference because they are notgenerally taxed in any case.

• Debt-financed companies in distress would have to pay tax on their pre-interest profits, as well as having to pay interest on their debt capital.

There would also be some more detailed points to consider, as follows:

• It would be necessary to define interest carefully, so as to apply the desiredtax treatment to payments which were in substance interest. Finance leasepayments, for example, are effectively repayments of loans at interest, andthe interest element in each payment would need to be identified. It iscurrently identified under financial reporting standards, but the difficulty wouldbe to ensure that the categories of expense which financial reportingstandards identified as interest were the correct categories to treat as interest

for tax purposes. (Once the correct categories had been identified, the



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amounts identified by financial reporting standards could be used for taxpurposes.)

• The treatment of fixed-rate preference shares would need to be appropriate.They could easily be used as a replacement for loans. But if they were treatedas loans, a careful definition of the affected shares would be needed. Too

narrow a definition would lead to avoidance, for example by introducing smallvariations in the rate due, or variations that would depend on events which,while theoretically possible, would never in fact occur. Too broad a definitionwould lead to the treatment of equity being assimilated to the treatment ofdebt. That might well be undesirable, depending on what the treatments ofequity and of debt were.

• There would be a danger of unfairly taxing a company which happened tohave a payment of interest just before a year-end and a receipt just after, orvice-versa. It might therefore be appropriate to allow interest payments orreceipts to be matched with one another if they fell within a few months of one

another, even if there was an intervening year-end. However, it would beimportant not to construct any such rule in a way that allowed for continuingrelief for interest payments by artificially increasing interest payments andreceipts in turn, year after year (a form of teeming and lading).

• Some supplement to group relief would be needed to allow the matching ofinterest receipts and payments made by different companies within a group. Any such supplement would need to be carefully designed so as to be botheffective and compliant with European law. Effectiveness would dictate thatmatching should only be possible between UK companies, so that interestincome in the UK could not be matched with interest expense outside the UK.On the other hand, European law might make such a restriction difficult.

Something along the lines of the amendments that were made to group relieffollowing the Marks & Spencer case (CJEC C-446/03), in Taxes Act 1988,sections 403D to 403G, might give acceptable Exchequer protection, althoughin October 2009, the European Commission referred the UK to the CJEC forfailing to implement the Marks & Spencer decision properly. At the very worst,it should at least be possible to ensure that interest expense could only berelieved against interest income.

• Aside from the international aspect of the supplement to group relief, it wouldbe necessary to define a group appropriately to prevent avoidance bystructures involving companies being in groups for tax purposes despite alack of sufficient economic interest.

• It might also be necessary to secure against avoidance by forbidding the useof other losses against interest income. If that were necessary, and it is by nomeans clear that it would be, that would be a significant restriction whichwould disrupt a number of existing business structures.

• It would be necessary to accommodate securitisations – a lesson learnt fromthe formulation of the current transfer pricing rules in 2004. Whilesecuritisations may be temporarily out of favour, they may well come back,and they are very significant for Private Finance Initiative (PFI) projects. Accommodating securitisations would require some detailed technicallegislation.



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The conclusion has to be that while a disallowance of net interest expense mightbe worth consideration, it could only be introduced in conjunction with asubstantial reduction in corporation tax rates, which would itself help to level theplaying field between debt and equity. Our proposal to reduce the tax on interestreceived by individuals would not significantly increase the bias in favour of debt

rather than equity, because substantial lending to companies tends to be madeby banks and other corporate entities. There would be some effect, to the extentthat banks obtained funds from UK individual depositors, but the effect would belikely to be diffuse, and not so great as to have a significant impact at the level ofthe ultimate borrower.

Conclusion

Several of the options would have significant disadvantages. The ones which areworth considering are a withholding tax on dividends paid to non-companies andto companies with portfolio shareholdings, and a disallowance of interestpayments. Even these would have disadvantages, and further study that useddata from tax returns would be needed before reaching a firm conclusion.

There is however another way to reduce the disparity between the treatments ofshare and loan capital, which has clear advantages. This is to reduce the rate ofcorporation tax, so that the difference between the deductibility of interest and thenon-deductibility of dividends becomes less significant. This is something whichwe therefore strongly advocate, for this reason as well as for the other reasonsthat were set out above.

A3.3 The taxat ion of prov iders of capital at the level of the providers

We can now move on to consider the taxation of dividends and of gains onshares at the level of shareholders, on the basis that there would be a low rate ofcorporation tax.

Tax rates on dividends

The current system treats companies and non-companies differently. Companiesenjoy exemption from tax on UK dividends and on most foreign dividends. Non-companies are taxable on dividends, but they get a non-repayable tax credit of1/9 of the net dividend, for UK dividends and most foreign dividends. That is, a

dividend of £90 is treated as income of £100 on which tax of £10 has been paid,and the rates of tax are 10 per cent and 32.5 per cent instead of the usual 20 percent and 40 per cent.

A low rate of corporation tax would have the great advantage of reducing the taxavoidance risks that attach to the corporation tax exemption for foreign dividends.The exemption, introduced in 2009, naturally tempts groups to divert profits tolower-tax jurisdictions outside the UK and then return the profits to the UK as dividends, but the lower the UK tax rate, the less point there would be in doingthis.

Dividends received by non-companies could be taxed at the same rates as otherincome, without a tax credit, provided that the rate of corporation tax was low



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enough. There would be an element of double taxation, but a low rate ofcorporation tax should make this acceptable. Furthermore, taxation could bepostponed by taking stock dividends rather than cash dividends, as proposed inSection A7. The reason for advocating this system, a classical system, is that itwould avoid the complications and European law risks of an imputation system. It

would also be likely to generate revenue that would allow a lower corporation taxrate than would otherwise be the case.

The introduction of such a classical system, with corporation tax on profits and fullincome tax on dividends when taken in cash, would mean re-negotiating the UK’stax treaties, but that was done when an imputation system was introduced in1973 and it could be done again. If a withholding tax could be introduced, an offerto waive or reduce that tax could be used in treaty negotiations.

Gains on the sale of shareholdings

The taxation of income from shareholdings needs to be consistent with thetaxation of gains on the sale of shareholdings, otherwise returns will simply beextracted in the most tax-favoured form, whether income or gains.

For non-company shareholders, consistency which was at least as great as thecurrent level, although not perfect, would be easy to achieve. Both dividends andgains could be taxed when they were turned into cash. For dividends, this wouldbe when dividends were paid in cash, or when shares taken as stock dividendswere sold for cash. The only proviso is that we do not envisage any rollover ofgains, where shares in one company are sold and shares in another are bought,aside from paper-for-paper deals within the scope of the existing reconstructionreliefs, because that would mean that tax would be collected too rarely. For

proposed rates of tax on gains on shares, see Section A7. The proposal is to useincome tax rates for gains that correspond to rolled-up dividends, and a capitalgains tax rate for other gains.

The way to achieve full consistency for company shareholders would be toexempt all gains on shares made by them, and correspondingly to ignore losses.This would have the following advantages:

• Losses could no longer be multiplied by using several layers of shares.

• At present the exemption for gains on substantial shareholdings is restrictedto companies that have been trading within the previous three years. This

gives great scope for avoidance by delaying the liquidation of loss-makingsubsidiaries until the exemption no longer applies.

• The disposal of businesses would become even simpler, encouraging thetransfer of businesses to groups where there were the greatest opportunitiesfor synergy.

On the other hand, the exemption would have the following disadvantages:

• It would become too easy to sell other assets in corporate envelopes andavoid paying tax on the gains on those assets. An anti-avoidance measurewould therefore be needed. One possible anti-avoidance measure would be

to distinguish between the assets of a business and other assets which hadsimply been placed in a corporate envelope, either on their own or alongside



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a business. The obvious test would be to tax gains on the underlying assetswhen, and only when, they had been put into a corporate envelope with aview to their sale. If assets were transferred into companies within, say, twoyears before the sale of the company, there would be a rebuttablepresumption that this had been done with a view to their sale. Such assets

could be treated as sold by the group, disregarding any corporate envelope,with the gain being computed by reference to their base cost to the group.

• Other tax avoidance opportunities might be created. Further anti-avoidancelegislation would then be necessary.

It would also be very helpful to extend the new exemption to the sale of wholebusinesses, so that where a company placed its separate businesses in divisionsrather than in legally separate subsidiaries, it could still benefit from theexemption. Such an extension would however raise difficult issues of thedefinition of a business.

Life assurance companies

The taxation of the policyholders’ share of profits made by insurance companiesis discussed in Section A7. The taxation of the shareholders’ share should followthe pattern of the taxation of the profits of other companies.

Smaller companies

There are two main corporation tax issues that are specific to smaller companies.One is that of the small companies rate. The other is that of tax-motivated choicebetween incorporated and unincorporated structures.

The existence of the small companies rate gives rise to some complexities, butthese can be removed by reducing both the main rate and the small companiesrate to a common level which is below the current small companies rate.Reducing the rates in parallel, rather than first reducing the main rate to 22 percent and then reducing the single rate, would mean that there were two separaterates for a little longer than would otherwise be the case, but it is important to givesmall companies a lower tax rate as soon as possible.

On tax-motivated choice of structure, the main thing is to ensure that the overallrate on profits made by a company and distributed is not significantly less, or

greater, than the rate on profits made by a sole trader or a partnership. A reducedcorporation tax rate would help to ensure that the rate on profits made bycompanies was not greater than that on profits made by sole traders andpartnerships. Reform of the system for taxing dividends, as proposed in Section A7, would also help to ensure that it was not less.

One option, which would at least ensure that the actual legal form of businesseswas not determined by the tax system, would be to allow all businesses below acertain size to elect either for unincorporated or for incorporated treatment. Thiswould, however, introduce new complexity into the tax system. Given that a verylargely common set of rules for computing taxable profits is likely to continue toapply to unincorporated and incorporated businesses (the principal differencesbeing in the area of capital gains), any differences in tax burdens would either be



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consistently too small to make a significant difference, or consistently largeenough to ensure that practically all businesses would make the same choice.

A3.4 The overall proposal

We propose the following:

• Significant reductions in the rate of corporation tax, leading to a rate of 15 percent, in order to make the UK internationally competitive

• The exemption of gains on shares when disposed of by companies, subject tothe anti-avoidance restrictions set out above

• The introduction of a classical system, with dividends and gains on sharesowned by individuals and trusts being taxed as set out in Section A7.

We do not propose the other changes discussed in this chapter, but they would

be worth further investigation if it appeared that they might be useful inaddressing specific concerns.

A4 The corporation tax base

Corporation tax works by computing an amount to tax – the tax base – and thenapplying a tax rate to that amount. In this section, we discuss the computation ofthe tax base.

A4.1 Princip les of a good tax base

A good tax base is one that is:

• well-correlated with ability to pay, so that it does not impose unacceptablecash-flow burdens on businesses;

• not economically distortionary more than is inevitable with taxation;

• not prone to manipulation by tax planning;

• easy to understand, so that it does not cloud the taking of commercialdecisions;

• easy to compute, so far as possible using information that a company wouldgather anyway for commercial purposes rather than requiring extrainformation to be collected.

Not all of these objectives can be achieved at once. For example, features of atax system which allow for losses, or for the fact that a group’s overall results maynot be simply the sum of the profits of the members of the group, in the interestsof avoiding distortion, lead to complexity and create opportunities formanipulation. There is unlikely to be any perfect tax base. It is, however, stillworth asking how far the current tax base satisfies the above criteria, andwhether it would be worth changing the tax base.



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The structure of corporation tax, computing a base and then applying a rate,means that changes considered here could be made independently of otherchanges discussed in this report. Conversely, those other changes could bemade without making the changes that are considered here.

A4.2 The case for and the case against change

The current tax base is reasonably well-correlated with ability to pay. Thestarting-point is accounting profit, and that is then adjusted. Allowances for capitalexpenditure are on average more generous than depreciation, although not asgenerous as they have been in the past. Losses can mostly be set againstcurrent and future profits of the same type. The most significant types of loss canalso be set against current profits of any type, either within the same company orelsewhere in the group. Unrealised profits on capital assets are generally nottaxed. Occasionally a company may find that its corporation tax bill is

disproportionate in relation to the profits that it has managed to turn into cash, butthat does not happen often.

Economic distortions do exist in the current tax base. There are some areas, forexample expenditure on capital items, where there can be distortion in eitherdirection. Some capital items, such as buildings, attract no allowances apart fromthe deduction of the cost from any sale proceeds in computing a capital gain, andtax relief for the interest on money borrowed to fund the purchase. Others, suchas plant and machinery, attract allowances which are in general, but not always,more generous than depreciation. There is an argument that it would be lessdistortionary to allow depreciation, and a contrary argument that the leastdistortionary thing to do would be to allow a full deduction in the year of purchase

because that would keep the post-tax net present values of alternative investmentdecisions in the same ratio as the pre-tax net present values. What is clear is thatthe tax system is in some respects liable to favour capital-intensive businesses,and in other respects liable to favour labour-intensive businesses. There areother areas where both the existence and the direction of distortion are manifest.There are, for example, special reliefs for investment in research anddevelopment and in film-making, favouring particular activities.

The current tax base is certainly prone to manipulation by tax planning. We cansee this from the very large amount of anti-avoidance legislation that has beenput in place, and from the need that the Government has felt to create a system

that requires the reporting of tax avoidance schemes. Such reports can lead tofurther legislation. The result is ever-increasing complexity, which can affect not just those contemplating tax avoidance, but other taxpayers who simply want tocompute their profits correctly.

Turning to ease of comprehension and of computation, the current tax system isnotorious for its complexity. The computation of taxable profits is a significantsource of that complexity. The corporation tax return form is eight pages long,and there are several supplementary pages for special situations, although thereis a four-page version of the form for companies which have straightforward taxaffairs and which do not have any one of a whole range of types of income, nor

claim any one of a whole range of reliefs. The guide to the return form has 22pages of detail to read. A study in 2005 found that the total administrative cost



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imposed by the need to make corporation tax returns, including the cost ofsupplementary returns and of checks, was £608m, of which £358m fell onbusinesses with fewer than 50 employees ( Administrative Burdens – HMRCMeasurement Project, KPMG, 2006, volume 2, part 7, pages 12-15).

Thus to the extent that there is a case for change, it is primarily a case based oncomplexity. A different tax base might be simpler to use and less likely to cloudcommercial decisions. It might also be more likely than the current tax base to bestable, if it was less prone to manipulation and did not therefore need to bepatched up repeatedly with anti-avoidance legislation. There might also be scopeto reduce economic distortion. The removal of highly specific reliefs, for example,would both directly remove some distortions and simplify the tax system.

While the current system may not be perfect, it is one to which companies haveadapted. There is therefore a case against any changes which would requiresignificant changes to the ways in which information was gathered, andparticularly against changes which would require new information to be gathered.Merely withdrawing a specific relief should occasion little disruption, but changingits terms, or introducing a new one, could be much more disruptive. Even themere withdrawal of a more general relief, such as a loss relief, could be disruptiveif it required the re-arrangement of a group’s affairs in order to maintain taxliabilities at current levels. The case for any change that might be disruptiveneeds to be strong, before one can be sure that it would be worthwhile.

Another argument against change is that it is redistributive. Even if no-one’s taxbill were to rise, because of tax reductions which accompanied other, potentiallytax-increasing, changes, there would still be an effect because the current patternof reliefs and a different pattern of reliefs would distribute the benefit of overall tax

reductions in different ways. And it is more likely that change would lead to sometax bills rising, generating political pressure against any changes which wouldhave that effect. What is essential is that the overall tax bill does not rise. Thus achange which would increase tax should be accompanied by other changeswhich would decrease it, or by a proportionate reduction in the tax rate. But withinthis overall constraint, changes which would increase the tax burden on somebusinesses must be allowed, otherwise change will be impossible. It is not unfairto say that a profit of a given amount generated in a future year will bear more taxthan an equal profit generated in a past year: nothing is being taken away fromthe taxpayer in question when that happens. But there must be appropriatetransitional periods, to recognise the fact that businesses make long-term

investments. There must also be no increase in the overall tax burden, notbecause that would constitute some kind of unfairness (it would after all amountto a large number of taxpayers each being treated in the same way that we have just stated not to be unfair in relation to one), but because that would beeconomically damaging.

A4.3 Adjustments to account ing prof it

The current starting point for computing the tax base is the profit shown in theaccounts. Several adjustments are then made, some significant (such as the

replacement of depreciation by capital allowances) and some less so (such asthe disallowance of expenditure on business entertaining). For all companies,



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relief for remuneration in the period for which it is debited is restricted to amountspaid within nine months after the accounting date. This has particular significancefor smaller companies, where remuneration to the owners is voted after theaccounts have been prepared.

One possible change would be to sweep away all of these adjustments, andsimply to say that the accounting profit was the tax base. The corporation tax ratewould be changed in proportion so as to avoid an increase in the total burden ofcorporation tax.

This would have the merit of simplicity, but a number of issues would arise. Someof these were raised in responses to the Government’s consultation oncorporation tax reform, launched in August 2002, which contemplated changealong these lines. The issues to address would include the following:

• Accounting standards are no longer as focused on the computation of profitas they once were. Instead, they tend to concentrate on the movement in the

overall value of a company. This might lead to tax liabilities ceasing to besatisfactorily correlated with ability to pay. One source of this risk would be theinclusion of unrealised profits in profits as measured by accounting standards.International Accounting Standard 40 (IAS 40), for example, allows thevaluation of investment properties at fair value, leading to the inclusion ofunrealised profits in the profit and loss account. IAS 39 requires the valuationof some financial assets at fair value. Another issue would be whether to taxthe result shown in the comprehensive income statement or that shown insome more narrowly defined profit and loss account.

The general point that accounting standards are no longer as focused on thecomputation of profit as they were is one that arises under the current system just as much as it would arise if accounting profit were to be taxed, becausethe current system takes accounting profit as the starting point, but the currentsystem allows adjustments to be made, in particular to remove unrealisedprofits from the tax base. The taxation of unrealised profits would be a seriousissue so long as the corporation tax rate remained high, but it might become aless serious issue if the rate fell substantially. To the extent that it was aserious issue, the solution would be to have a single memorandum account towhich all unrealised profits were taken, and from which they were released totaxable profit on realisation.

• It would be possible for a company significantly to affect its taxable profit by

changing its accounting policies, for example by changing its depreciationrates. Some such changes would only result in timing differences, but it couldbe worth a company’s while to create such differences in order to defer thepayment of tax.

This is an issue of fairness, but probably not a very serious one. Variations indepreciation rates and in other accounting policies would be limited by therequirement for accounts to give a true and fair view, and all companies wouldbe able to take advantage of the scope for variation.

• Losses are not carried forward and set against future profits in accounts, butare debited to reserves. Some form of loss relief would therefore need to beadded. Furthermore, either losses of specific types brought forward frombefore the change would need to be restricted to use against thecorresponding types of profit after the change, necessitating the identification



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of those types of profit, an exercise which would not be required foraccounting purposes, or some other measure to control the cost of allowing afree set-off of losses brought forward would be needed.

The remedy for the first problem would be a memorandum account to holdlosses, which could then be released against taxable profit. Unfortunately the

second problem, the transitional one of brought-forward losses, probablywould require some form of streaming of losses for a few years, simply inorder to control the cost.

• Individual companies are currently taxed, but the accounts for individualmembers of a group are less meaningful than the accounts for the group as awhole. On the other hand, if one were to move to taxing the profit shown inthe consolidated accounts, it would be difficult to separate out the non-UKelement. There would also be the question of whether to deduct any minorityinterest in the results of subsidiaries.

It would in principle be better to tax groups. That would bring the system

closer to taxing economic entities, and would eliminate the need for grouprelief. Indeed, if the Companies Acts definition of a group were used, it wouldamount to a substantial liberalisation of group relief. In order to minimise thedouble taxation that might otherwise arise on the profits of joint ventures,associated companies and group members in which there were minorityinterests, and on profits made abroad, it would probably be necessary to havea rule that where profits made were demonstrably liable to tax more thanonce, adjustments should be made, but on the basis that if profits were madein the UK, the UK should always have full taxing rights even if another jurisdiction also claimed taxing rights. The idea would be to ensure fulltaxation of UK profits, but to forgo UK taxation of non-UK profits which were in

fact taxed abroad. It would be necessary to work up something a lot morespecific than this, and it would also be necessary to avoid creating rules whichmight, because of European law, have the effect of taking taxing rights overUK profits away from the UK. It would, for example, be a mistake to specifythat profits should only be taxed at the highest possible UK level in a group,because European law constraints might make that the restriction to a level inthe UK ineffective.

• In addition to the above adjustments to avoid double taxation, adjustmentswould be required to avoid the taxation of inter-company dividends in general.

• The transition would be complex, largely because of differences between the

tax written-down values of assets and their values in the accounts.

The conclusion must be that there are arguments in favour of taxing accountingprofits, but that the difficulties would be considerable. We cannot thereforepropose a move to the taxation of accounting profits as one which shoulddefinitely be made. It is however worth considering changes to the tax base whichwould have comparable effects, with a view to getting to a point where a largeproportion of companies could simply pay tax on their accounting profits. We nowconsider some such changes.



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A4.4 Adjustments to account ing prof it – capital al lowances

One option would be to replace capital allowances by accounts depreciation. Thisoption was considered and in the end rejected in the Government consultation oncorporation tax reform that ran from 2002 to 2005, but the rates of capital

allowance have since changed, and this does make it worth re-considering thequestion.

The main advantages of such a change would be as follows:

• There would be no need to identify capital expenditure just for tax purposesand categorise it correctly.

• Depreciation would be available on all capital assets which were depreciatedin the accounts. Capital allowances are only available on certain types ofasset, and not, for example, on buildings.

• Special legislation for leased assets would not be necessary, because the

accounting and tax profits of lessors would not get out of line, nor would theaccounting and tax deductions of finance lessees.

• There would be no scope within a pure depreciation system for governmentsto give special incentives for particular types of expenditure or to particulartypes of business. Some would see this as a disadvantage. We do nothowever believe that it is appropriate for governments to micro-manage theeconomy, and we would be happy to see obstacles placed in the way of suchinterference.

The main disadvantages would be as follows:

• It would be possible to manipulate taxable profits by choosing highdepreciation rates, subject to the requirement to produce accounts whichshowed a true and fair view. This would generate timing differences, whichwould amount to the permanent deferral of tax if investment in capital assetsgrew steadily. This opportunity would, however, be open to all businesses, soit would not necessarily create unfairness as between different businesses.

• It would not be possible to disclaim depreciation in return for higherdeductions in future years, whereas capital allowances can be disclaimed.This is significant because losses can only be passed across to other groupmembers in the year in which they arise: thereafter, they are trapped withinthe loss-making company and can only be used against its own future profits. A group will therefore often disclaim capital allowances to avoid generatinglosses which would only get trapped within individual companies. It mightappear easiest to deal with this problem by allowing group relief for lossesgenerated in earlier years, but that would necessitate the introduction ofelaborate rules to protect against avoidance, comparable to the rules on pre-entry capital losses.

• The change would have redistributive effects. The current system favoursbusinesses which need to invest in plant and machinery over those whichneed to invest in buildings, and also includes special benefits for the first£50,000 a year of investment and for particular types of asset. A change to a

depreciation system would benefit some types of business and reduceallowances for others. This is the reason why recent changes to rates of



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capital allowance are significant. The reduction in the main rate on plant andmachinery from 25 per cent to 20 per cent a year, on a reducing balancebasis, reduces the difference between this rate and typical depreciation rates.On the other hand, the increase in the long-life assets rate from 6 per cent to10 per cent increases the difference, albeit on a smaller total quantity of

assets than are affected by the main rate. The recent elimination ofallowances on buildings probably increases the gap for industrial andagricultural buildings, but leaves it unchanged for other commercial buildings. A change to depreciation should however have no overall effect on thecorporation tax burden, because the tax rate should be adjusted inversely tothe change in the overall tax base.

• There would be a particularly significant redistribution of tax to the utilities,and perhaps some other industries, because they have substantial capitalassets which they maintain and do not depreciate. They do get a taxdeduction for their maintenance work, but the effect would be that unlike now,they would never get a deduction for the initial cost of their investments. Some

special transitional arrangement might be necessary, if accounting standardsprevented them from depreciating their assets. They would not necessarilysuffer in themselves, given that we envisage a significant reduction in the rateof corporation tax, but they might still suffer relative to other businesses.

• There would be transitional effects. The gaps between the accounting and taxwritten-down values of assets would need to be closed. This would involvesome temporary complexity, and might lead to unacceptable tax charges inthe short term.

• Another transitional effect would be on reported profits, as deferred taxbalances were written back. That would be a matter for financial reporting

standards authorities. It would be important to have complete clarity abouthow any legislative changes affected results, and to allow groups to writeback balances over appropriate periods of time, so that investors did notmistakenly think that fluctuations in reported results reflected any fluctuationsin the nature or profitability of business activities.

On balance, a change from capital allowances to accounts depreciation is worthconsideration, although we do not firmly recommend it. It would bring the taxableprofits of many companies very close to their accounting profits. There would stillbe differences so long as odd quirks in the tax system, such as the disallowanceof business entertaining, persisted, but the scope for error by missing out on

required adjustments would be greatly reduced.

A4.5 Adjustments to account ing profit – minor disal lowances

There are some minor disallowances in the tax system that could do with reform.

The first is the disallowance for business entertaining. While it would be difficult toremove this disallowance entirely without the risk of private entertaining becomingtax-deductible, it should be possible to amend the rule so that most smallbusinesses could ignore it. A rule that only entertaining in excess of some modestfixed amount each year had to be disallowed would be one possibility. Then abusiness which was obviously not going to spend as much as the limit on



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entertaining could simply ignore the rule, and would be excused from keepingtrack of such expenditure.

There is a disallowance for remuneration not paid within nine months of the year-end, until it is paid. This is a significant complication for businesses which pay

bonuses but withhold part of each bonus for a while in order to deter employeesfrom leaving. It is an issue not just for the City, but for small businesses, where itis common to establish the results and then decide on salary and dividendpayments to the owners. On the other hand, if the amounts were immediatelydeductible, there would be a long delay before the corresponding tax on theemployees was paid. It would be sensible to allow deduction when debited in theaccounts so long as someone, whether employer or employees, paid the tax andnational insurance likely to be due on the remuneration at the same time. (Thiswould ensure that there was no Exchequer cost.) Amounts paid on account wouldthen be set against amounts due on the remuneration when it was paid. A furtherchange, which would relieve the burden on smaller businesses, would be toincrease the nine-month period to 12 months, so that there was still time to paybonuses after the accounts were settled. There are however cases in whichdeferred remuneration does not present a problem, because accountingstandards can require the matching of debits for a bonus with the work done inthe period from its crediting until it is paid.

Payments to surrender onerous leases early are disallowed, even thoughcontinuing payments of rent would be tax-deductible. This comes under theheading of capital and income, dealt with below.

A4.6 The dist inction between capital and income

There is a traditional distinction in the UK tax system between capital andincome, often captured in the image of a tree which persists (capital) and the fruitwhich it yields (income). The distinction is, however, artificial. Most capital assetswear out, making their cost revenue expenditure which just happens to beincurred once every several years instead of being incurred every year. A widgetthat comes out of a factory incorporates not just its raw materials, but a smallportion of the value in the machine which was used to make it.

The distinction is reflected in the disallowance of capital expenditure, includingdepreciation, except to the extent that capital allowances are given, and in the

separate regime for capital gains. The distinction is, indeed, not a single rulewhich applies across the whole corporation tax system. Rather, it is a convenientsummary of a number of separate rules. This means that it could be abolishedselectively and retained in other places, if that were necessary.

It is clearly worth considering abolition of the distinction. The main advantages ofabolition would be as follows:

• The tax system would be brought into line with commercial reality, in thatsome assets last longer than others but there is no distinction between twofundamentally different types of asset. Accounts recognise the differencebetween assets the cost of which is immediately expensed, and assets thecost of which is spread over several years, but the absence of a fundamentaldifference is shown by the fact that if accounts were, for example, made up for



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five-year periods instead of annually, the cost of a number of capital assetswould move smoothly into the revenue expense class.

• All capital expenditure would come to be recognised for tax purposes,because depreciation would come to be deductible. There is a connectionwith the replacement of capital allowances by depreciation, but not an

inevitable one. It would be possible to abolish the distinction, start to makedepreciation deductible but still replace depreciation by capital allowances forsome assets.

• Capital gains would come to be treated like any other profits, making taxcomputations more straightforward. There would however be somedisadvantages to this change, covered below.

• Some non-deductible amounts, such as payments to surrender onerousleases early, would become deductible. This would be beneficial because itwould remove tax incentives to choose some transactions, when alternativeswould represent a more efficient use of resources. To take the example of

onerous leases, it is silly for a lessee to have a tax incentive to continue topay rent, and perhaps find a sub-tenant, when returning the property to thelandlord could allow it to be re-let on a lease for a term which might well lastbeyond the end of the original lease.

The main disadvantages of abolition would be as follows:

• The change in the treatment of capital gains would have redistributive effects,because indexation allowance would no longer be available. The overallburden of corporation tax should not increase on account of this, because thetax rate should be reduced in proportion, but some businesses would paymore and some would pay less.

• There would be a greater risk that profits which were realised at the level ofan individual company but which were unrealised at the level of its groupwould come to be taxed immediately. This is because capital assets would nolonger be recognised as a separate category, transferable intra-group at nogain and no loss. The best approach might be to recognise the gains involvedon business assets, such as land, but to allow rollover relief in one of theways suggested below.

• This would not, however, cater for transfers of shares, the other asset which ismost likely to show a gain, but as noted in Section A3.3, there is a case fordisregarding all gains and losses on shares made by companies, a changewhich would eliminate the problem.

• Transfer pricing would come to be extended to capital assets, and thecontrolled foreign companies regime or its successor would come to apply tocapital profits. It is however not clear that there are principled reasons whythese extensions should not be made.

• Capital losses would be merged with revenue losses, increasing theExchequer cost of loss relief (which would have a redistributive effect) andopening up new incentives for tax avoidance. Schemes to multiply capitallosses or to generate them artificially would become much more worthwhile.There would probably need to be a general anti-avoidance rule to disallow

any loss which could not be matched with a genuine economic loss sufferedby ultimate shareholders, where each pound of such genuine economic loss



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could only be matched once with a pound of loss at the corporate level. (Inorder to make tracing practical, a shareholder with a stake below a certainthreshold, even if corporate, might have to be counted as an ultimateshareholder rather than tracing indefinitely far up the tree through an ever-growing number of smaller and smaller shareholders. This would not however

apply when there was effectively a partnership or comparable arrangement –compare the action taken in 2005 against venture capital partnerships, now inTaxes Act 1988, Schedule 28AA, paragraphs 4A and 4B.) Alternatively, adisregard for tax purposes of gains and losses on shares would substantiallyreduce the opportunities for the multiplication of losses.

• The multiplication of losses which such a general anti-avoidance rule wouldbe intended to prevent is the counterpart of the multiplication of profits whichcould accidentally occur. There might therefore be a case for a rule that whereit did occur, a group could make an adjustment to avoid this. There wouldhowever be serious difficulties in devising a rule which did not allowmanipulation to make some profits escape tax altogether. Again, a disregard

of gains and losses on shares would greatly reduce the risk of themultiplication of gains.

• Rollover relief on business assets would disappear, and there would be acase for replacing it. The main asset of concern would be land. One possibilitywould be to allow a spreading of tax bills attributable to land which had beenreplaced. Another possibility, if capital allowances were to be retained, wouldbe to use the effective rollover that is given by a capital allowances pool, withthe current length of the replacement window, running to 36 months afterdisposal, being re-created by allowing expenditure to be related back by up tothree years to the extent that was necessary in order to eliminate balancingcharges. While capital allowances are not given on land, allowances could beintroduced at 0 per cent, merely in order to create a pool to which this rulecould conveniently be applied.

• There would be particular issues for property companies with having theirgains taxed as income, but to the extent that they had chosen to become realestate investment trusts (REITs), those issues would not arise. If, however, itwere to become more onerous not to be a REIT, there would be a case forreviewing the REIT regime to see whether it should be amended to removeobstacles to property companies becoming REITs.

Our conclusion is that we should not hesitate to abolish the distinction where

appropriate solutions for consequent difficulties could be devised. In particular, itwould make sense to abolish the prohibition on deducting expenditure of a capitalnature.

We should also note that if the distinction between capital and revenue werechanged for companies and for unincorporated businesses to different extents,the result could be to create a new tax reason to choose the incorporated form, orto choose the unincorporated form.

A4.7 The substant ial shareholdings exemption

The substantial shareholdings exemption exempts capital gains, and disallowscapital losses, on shareholdings of at least 10 per cent in trading companies



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which are sold by trading groups. In its current form, it has the advantage that itmakes the transfer of businesses relatively easy but the disadvantage that itsrestrictive conditions make it easy for groups to make gains exempt while makinglosses allowable. Furthermore, the restriction to sales by trading groups causesdifficulties in practice, with large and complex multinational groups being unable

to tell whether they qualify.

As noted in Section A3.3, there is a case for exempting gains on the disposal ofshares, but looking through companies sold to tax gains on assets which havebeen placed in corporate envelopes with a view to sale. That proposal wouldreplace the substantial shareholdings exemption.

A4.8 Loss reliefs

The current general pattern of loss reliefs is to allow set-off against all types of

profit, including profits of other group companies, in the year of loss, some carry-backs by one year, and much more restricted set-off, often against profits of thesame class and always only within the company which made the loss, in lateryears. By far the most significant losses by value are trading losses, to whichthese rules apply, with carry-back against all profits but carry-forward only againstprofits of the same trade, and non-trading loan relationship deficits, to whichthese rules also apply, with carry-back only against non-trading loan relationshipincome and carry-forward only against non-trading profits. There is also atemporary limited extension of trading loss carry-back, announced in November2008. It is worth considering whether the rules should be changed.

A good system of loss relief should satisfy the following criteria:

• It should give enough relief to avoid imposing very high effective tax rates oncyclical businesses.

• It should not be so generous as to allow the taxation of too small a proportionof profits made, because that would either greatly reduce revenue fromcorporation tax or require the imposition of high tax rates.

• It should not be open to extensive manipulation, in particular to themanufacture of losses which have not really been suffered at all, or (morearguably) which have not really been suffered by the person benefiting fromrelief.

• It should only allow relief for each pound of loss once.

• It should not be so restrictive as to deny effective relief for losses.

• It should give effective terminal loss relief for businesses which are closed orwhich collapse. The repayment of past taxes can be a significant source offunds for creditors.

The first criterion makes a case for preservation of the entitlement to carry lossesback 12 months, and perhaps for carry-back relief to be extended to all losses.Such relief should however continue to be restricted to relief against profits withinthe same company, not because there is not a reasonable economic case for

allowing relief elsewhere in the group, but because to do so would require rules toprevent the buying in of profit streams or the selling of potentially loss-making



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companies in anticipation of losses, comparable to the rules for pre-entry capitallosses.

The second and third criteria make a case for preventing loss-buying. Theobvious effect of allowing loss-buying would be to reduce the national tax base

down towards the total of profits minus the total of losses, which might in itself bea reasonable thing to do. It would mean that effective relief would be immediatelyobtained for all losses which were significant enough to make it worth sellingcompanies in order to have them relieved.

The consequences of not preventing loss-buying would however be more far-reaching than that potentially desirable result, because it would become muchmore worthwhile than currently to dress up non-commercial hobbies asbusinesses in order to seek relief. There are rules in place to prevent that beingdone in order to shelter personal income and the profits of family businesses fromtax, where no sale of an activity is needed in order to allow loss relief. The ruleswork by blocking relief for losses on activities not run on a commercial basis.Those rules would in theory be effective if losses on such activities were sold, butany new opportunity to sell losses would greatly increase the pressure to do soand the existing rules might become ineffective. The current rules, primarily inTaxes Act 1988, sections 768 to 768E, would therefore need to be tightened upconsiderably.

The fourth criterion would make a case for a general anti-avoidance rule, to theeffect that only the real economic loss suffered by what was effectively a singleeconomic entity (for example a group, or a company plus its owner) should beeligible for relief. Such a rule would however have to be carefully drafted so thatmost businesses, most of the time, could have confidence that it would not apply

to them. Otherwise, the administrative burden would be intolerable.

The fifth criterion would make a case for a system which included reasonablygenerous reliefs, but reliefs which were not so generous that they needed to behedged about with restrictions in order to preserve the tax base. We propose thefollowing:

• Abolition of the current division into different types of income, so that there isno need for types of profit and loss to be identified.

• Relief by carry-back for one year, within the year and by carry-forward of alllosses against all profits.

• Group relief as now, in-year only but against all profits.

• The preservation of terminal loss relief for trading losses made in the last yearof trade, by carry-back against total profits of the preceding three years.

This package would require a number of other changes, as follows:

• Losses brought forward up to the date of change would need to continue tobe restricted in use for several years, in order to control the cost of switchingto the new system. It is quite likely that capital losses brought forward up tothe date of change would have to be permanently restricted to use against

capital gains, because the amounts involved would be very large.



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A4.10 The Common Consolidated Corporate Tax Base (CCCTB)

The CCCTB is a European Union proposal for a single tax base for groups whichoperate in more than one member state. The results, computed on that basis,would then be divided between the member states concerned, and each state

would tax its share of the base at its own rate.

Some multinational groups favour the idea. It would simplify their tax compliance,and would also make commercial decisions involving operations, or potentialoperations, in more than one member state easier to take. On the other hand, itwould impose standardisation and would take the power to set tax bases awayfrom the national governments and parliaments which are directly answerable totheir own electorates. It could also be a precursor to a move to standard, or atleast minimum, tax rates.

We therefore believe that while it is worth continuing to develop the proposal, no

firm decision should be taken until a fully worked-up proposal is available.Furthermore, it would only be satisfactory to introduce the CCCTB if it werelegally impossible to move on to impose a minimum tax rate or any furtherdevelopment of the policy, either through legislation or through court decisions,without the unanimous agreement of member states.

A4.11 Special reliefs

There are a number of special reliefs in the UK tax system, for example forspending on research and development, for the purchase of energy-savingassets, for venture capital investments and for the making of films.

Such reliefs represent attempts by the Government to micro-manage theeconomy through the tax system. Attempts so to do are most unwise. The marketknows better than the Government where best to allocate resources in responseto people’s preferences. We therefore believe that it would be better to withdrawsuch reliefs, and to use the money to reduce overall tax rates.

Reliefs should not however be withdrawn in a way that would disturb existingtransactions that had been made on the strength of them, including those whichwere already under way but which had not yet reached the relief-generating point.We therefore envisage a gradual phase-out. Thus new investments might not in

general qualify, but existing ones, and those which needed to be added toexisting indivisible projects in order to carry them through to completion, shouldqualify for their current tax privileges.

A5 Income tax on businesses

The profits of unincorporated businesses are computed using a method that iscomparable to, although not quite the same as, the method used for companies.(In particular, there are significant differences in the taxation of capital gains.)That is, one starts with the accounting profit and then makes some adjustments,

such as adding back depreciation and deducting capital allowances. The netprofit is then included in the total income of the proprietor, so that income tax can



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be charged on it. The net profit also forms the basis for a charge to class 4national insurance contributions. If the profit exceeds a given low level, flat-rateclass 2 contributions are also due.

Partnerships that are made up of individuals are treated in broadly the same way.

A tax-adjusted profit for a partnership as a whole is computed. This is thenapportioned to the partners, and each partner is treated as having his or her ownbusiness, with profits equal to his or her share of the partnership profits.

We do not see a case for changing the broad structure, of computing a profit andthen including it in total income. It is however worth reviewing the ways in whichprofits are computed, and detailed rules on their taxation, for the followingreasons:

• The current system is complex, making computations time-consuming anderror-prone. Even if computations are prepared automatically, as isincreasingly the case, items have to be assigned to particular categories

purely for tax purposes, requiring record-keeping and the exercise of judgement beyond what is required to run the business.

• We suggest changes to the way in which profits are computed for thepurposes of corporation tax in Section A4, and we need to consider whetherthe same changes should be made to the computation of profits for thepurposes of income tax.

• There have been a large number of tax-motivated incorporations in recentyears. The Government’s response to the tendency to save tax byincorporation has been to impose new legislation to try to negate the savings.Rather than piling on yet more legislation, it is worth looking at whether the

system should be changed so as to remove, or at least reduce, the incentives.

A5.1 The computat ion of prof its

The proposal here is to adopt for income tax purposes most of the changesproposed for corporation tax purposes, mainly for reasons of simplification, and toreduce any bias in favour of incorporation largely by changing the rules on thetaxation of dividends, as proposed in Section A7.

We propose the following changes to the computation of profits. Most of these

changes are in line with what is proposed for corporation tax in Section A4, andthose changes are proposed for the same reasons. There are sometimesadditional reasons for making the changes in relation to income tax, which allowus to be firmer in our recommendation that a change should be made for incometax purposes. These additional reasons are set out here. Some of the changesare specific to income tax:

• Capital allowances should be replaced by accounts depreciation (althoughthere would be a case for allowing an election for capital allowances). Thiswould allow a great many unincorporated businesses to use their accountingprofits as their taxable profits, or their accounting profits with very fewadjustments. Where the remaining adjustments (such as for business

entertaining) would have a net total of less than a certain amount, say £1,000a year, a business should be entitled to ignore all adjustments. Many



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businesses would, without computing the adjustments, be able to say withconfidence that they were below the threshold, and could therefore savethemselves work. If however the use of accounts depreciation inunincorporated businesses and of capital allowances in incorporatedbusinesses would give rise to significant tax planning opportunities for

businesses that were large enough to split themselves into incorporated andunincorporated parts, the use of accounts depreciation might have to beforbidden when a substantial part of a business was in an incorporated form.

• This change would, however, not eliminate all adjustments. Small businesseswould still need to take into account only the business part of the cost of cars,telephone lines and other assets and services which were used partly forbusiness purposes and partly for private purposes. If these adjustments werenot required, the system would allow tax deductions for straightforward privateexpenditure, rather than for legitimate business expenditure (such asbusiness entertaining) that happened to have been disallowed by tax rules todate.

• Expenses that are currently non-deductible because of the old capital/revenuedistinction, such as payments to surrender onerous leases, should come to bedeductible.

• The tax adjustment for deferred remuneration would not apply to theproprietor of an unincorporated business anyway, but it might apply toemployees. Any changes made for companies should also be made forunincorporated businesses.

• One proposal specific to income tax and to small businesses is that theyshould be allowed to operate on a cash basis, either for all transactionsexcluding loans or for all transactions excluding loans and sales andpurchases of stock in trade. The reason for proposing this is that somebusinesses will keep records entirely on a cash basis, while others will recordsales and purchases when made, leading to debtors and creditors in theiraccounts, but will not bother to adjust their year-end accounts for thedifference between opening and closing stock or for things like accruals andprepayments of rent and electricity. All of these adjustments only amount totiming differences, and if they are modest, it is pointless to put businesses tothe trouble of making them. It is likely that many businesses submit returns ona cash basis anyway, without HMRC being aware of this. If an accruals basiswere forced upon them, the result would be an increased number of errors.

• A cash basis should however be restricted to small businesses with smallamounts of work in progress. It used to be available to professional firms, butit was withdrawn because of large-scale avoidance.

There is one change which we do not think should be made for income taxpurposes, even though it might be appropriate to make it for corporation taxpurposes. Given that there is now a tax rate on capital gains which is very muchlower than the higher rate of income tax (18 per cent as against 40 per cent, witha 50 per cent rate planned), full abolition of the capital/income distinction inrespect of assets used in businesses would be very problematic. We suggest thatthe distinction should be retained in respect of disposals of assets for more than

cost. Gains on such assets would not be treated as profits on sale which fedthrough to accounts profits but would be taxed separately at 18 per cent, so far as



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they were attributable to an excess of disposal proceeds over original cost. Gainsattributable to the difference between proceeds limited to cost and written-downvalue should form part of revenue profits, because depreciation from costdownwards would have created revenue deductions. This rule should remain inplace until the top rate of income tax is reduced to something close to the rate of

capital gains tax. Even then, there would be a continuing need for rollover relief.

A sale of a business should continue to be treated as a collection of sales ofassets, with gains taxable at 18 per cent and with the benefit of entrepreneurs’relief, giving parity with the treatment of sales of stakes in companies. In order toensure that there was no need to be precise about the allocation of the sale priceand to prevent tax avoidance, there should be a rule that the price had first to beallocated to all assets that had been depreciated, up to the original values thathad been the starting-points for calculations of depreciation, and only then togoodwill. This treatment would be in exchange for getting entrepreneurs’ relief,and the rule should allow for a more generous entrepreneurs’ relief. It would nothowever be a condition of obtaining rollover relief when a business was sold andthe proceeds were re-invested in another business. There would then need to bea condition in entrepreneurs’ relief that the business being sold had been run fora few years, in order to prevent the use of rollover into an intermediate business just to make potential income tax charges disappear, followed shortly afterwardsby a disposal on which entrepreneurs’ relief was claimed.

A5.2 Loss reliefs

Trading losses can currently be carried forward against future profits, or setagainst general income in the year of loss and the preceding year. Set-off againstgeneral income is however limited to losses in trades that are run on acommercial basis (so as to exclude relief for “losses” on hobbies which purport tobe trades), and there are specific restrictions on relief against general incomewhere someone does not work much in the trade.

Loss relief against future profits from the same trade should be maintained, inorder to avoid imposing excessive tax burdens on businesses which areprofitable in the long term but which happen to be cyclical. Indeed, that is arelatively avoidance-proof relief because the trade must make a profit in order forrelief to be obtained.

The commercial case for loss relief against general income is weaker, but stillreal. Suppose that someone has a business which sometimes makes losses, butalso has income from other sources. He or she may well need to support thebusiness in its loss-making years by putting in extra money, but may find thisparticularly hard to do if tax is due on other income. Loss relief would reduce thetax burden on that other income, and would therefore allow more money to beused to support the business.

The problem is that the loss relief available against other income is not tailored tothe need of the business for additional support, nor would it be practical to tailorthe relief because it would not be practical either to formulate or to apply

universal rules for assessing such needs. The current relief is therefore ill-targeted, too generous in some cases and failing to facilitate additional support



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for a business in others (for example where the proprietor would have a low taxbill otherwise because of low income from other sources in the year). It alsoneeds substantial anti-avoidance defences.

We therefore believe that serious consideration should be given to replacing this

relief with a new relief, allowing the carry-back of losses against profits from thesame trade made in the previous three years. This would have the advantages ofproviding a cash boost, through tax refunds, to proprietors who needed to supporttheir businesses even if they did not have alternative sources of income, and ofnot needing anti-avoidance protection. On the other hand, it would not provideassistance where the business was new and did not have a history of taxableprofits. We are not in a position to say that this new relief should definitely beintroduced, but it should be considered. It should not however be added to theexisting relief against general income, because that would increase the number ofspecial reliefs in the tax system, reducing the scope for tax rate reductions, andbecause it would mean forgoing the opportunity to simplify the tax system byrepealing anti-avoidance legislation.

We do not see any need to change the current rules for the relief of capital lossesmade by individuals, whether on business assets or on any other assets, giventhat the opportunities to manufacture and sell losses are much more limited thanthey are for companies. However, one consequence of allowing accountsdepreciation would be that losses on business assets would be recognised asrevenue losses of the business, rather than as capital losses. (This is already theposition for assets on which capital allowances can be claimed, but not for otherassets.)

A5.3 Incentives to incorporate

In recent years, many small businesses have incorporated for tax reasons.

The most basic form of tax planning is to extract money in the form of dividends,benefiting from the low tax rate and lack of national insurance on dividends. Onepart of the Government’s response to this trend has been to increase the smallcompanies rate of corporation tax, a move which has an effect because dividendsare paid out of profits which have borne corporation tax. Another part of theresponse, aimed more at the use of companies to disguise employment, hasbeen legislation aimed at situations where the substance of the arrangement is

employment. Thus the personal service companies legislation treats thecompany’s income as employment income when the proprietor would, without theinterposition of the company, be treated as an employee of the ultimate client.The managed service companies legislation, which applies when the nominalproprietor does not really run the company, has the same effect regardless ofwhether there would be employment if the company were not interposed.

The approach proposed here would reduce the tax incentives to incorporate, andwould be a step on the road to abolition of the personal and managed servicecompany rules. The reduction in the incentive to incorporate would come from thefact that dividends, once taken in cash, would be taxed at normal income tax

rates, rather than at the preferential rates which currently apply. This wouldgreatly reduce the attraction of converting profits into dividends, because



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although class 4 national insurance contributions (where an activity did notamount to employment) or class 1 contributions (where it did) would be avoidedby taking dividends, the dividends would have to be paid out of profits whichwould in general have suffered corporation tax. With a 15 per cent corporation taxrate and current self-employed national insurance rates, there would indeed be a

very modest bias in favour of not incorporating where one would otherwise beself-employed, both for basic-rate taxpayers and for higher-rate taxpayers.

A5.4 Incorporat ion and d is incorporat ion reliefs

Gains on business assets can be rolled over on incorporation. We propose theintroduction of a parallel relief on disincorporation, so long as any assets that arewithdrawn from the business on disincorporation are treated as income (so as toensure that disincorporation cannot be used as a way of getting tax-free income).If depreciation were to be used in unincorporated businesses and capital

allowances in incorporated businesses, there would of course have to beadjustments to ensure that asset values did not get allowed twice, or not at all. Itwould also be appropriate to impose restrictions on the valuation of goodwill onincorporation and on disincorporation, so as to avoid creating tax avoidanceopportunities.

A5.5 National insurance

In Section A9, we propose, in the long term, reducing the burden of nationalinsurance on employment income so that it comes to equal the burden on self-employment income, with a view to the possible eventual abolition of nationalinsurance as a separate imposition. In the shorter term, we suggest ways inwhich national insurance on employment income could be simplified.

We do not see any need to make parallel short-term simplification changes toclass 4 contributions, since they are assessed annually on a profit figure that hasto be computed anyway. However, we do propose the abolition of the separateclass 2 contribution of a fixed amount per week. Its role in ensuring thatcontribution records are kept up could be replaced by a rule that a year would bea qualifying year if profits exceeded some fixed amount. Where they did not, thecontributor could choose to pay class 3 contributions instead.

We reject the proposed 1 per cent increases in national insurance rates from2011 because an increased tax on jobs is in principle bad, and is especially badwhen a recovery should be under way. In addition, the long-term goal is to reducethe burden of national insurance, and it would therefore make little sense to startby increasing it. We therefore propose the reversal of these increases, both forthe self-employed and for employees and their employers. This would alsoremove the need to increase the primary threshold, as proposed in the December2009 Pre-Budget Report.



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A6 Income tax rates and al lowances

The scale of income tax has up to now been based on a straightforward principleof increasing rates with increasing income. The top rate of 40 per cent is notideal, but it is tolerable by international standards. Changes that are to come into

effect from 2010 will, however, severely damage this structure. Not only will anunacceptably high top rate of 50 per cent be introduced. The benefit of thepersonal allowance will also be progressively withdrawn at incomes of more than£100,000. This will both generate anomalously high marginal tax rates as thebenefit of the allowance is withdrawn, and be wholly impractical to implementthrough PAYE codes. The proposal to withdraw personal allowances is alsobased on a specious claim that they are worth more to high-income people thanto low-income people. If the personal allowance is regarded not as a deductionfrom taxable income that has effect at the taxpayer’s highest marginal rate, but asa 0 per cent band that is used before the 20 per cent band and then the 40 percent band, we can see how weak the argument is.

We therefore propose the reversal of the 2010 changes. The change in relation tothe personal allowance should be reversed immediately, and then the 50 per centrate should be phased out. Beyond that, a gradual reduction in the higher rate ofincome tax would have much to recommend it. As well as improving incentives,this would reduce the difference between rates of income tax and rates of capitalgains tax. The 20 per cent basic rate of income tax is very close to the CGT rateof 18 per cent, but the 40 per cent higher rate is much greater, and this createsan artificial disparity which encourages the transformation of income into gains.

We therefore propose a reduction in the new top rate from 50 per cent to 40 percent over five years, at 2 per cent a year. Then over the following five years, the

40 per cent rate should be reduced to 35 per cent, at 1 per cent a year.Reductions in the 40 per cent rate would directly benefit skilled workers, middlemanagers and moderately senior teachers, nurses and the like.

A7 The taxat ion of savings

A7.1 Savings income and earnings

It is natural to think that income from savings should be taxed to the same extent

as income from work. That has certainly been the general approach in the UK,although tax rates sometimes differ. There used to be an investment incomesurcharge. More recently, there has been a modest difference between incometax rates on earned income and on savings income within the basic-rate band.There has also been, for many years, a more substantial difference in tax ratescaused by the application of national insurance to earnings but not to incomefrom savings.

The assumption that the general approach should be to tax earnings and savingsincome to the same extent can however be questioned. The main argument in itsfavour is that income from one source is as good to the recipient as income from

any other source. Earnings and savings income equally increase an individual’scapacity to contribute to the cost of public services. So an argument from fairness



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which concentrates on taxable capacity strongly suggests equal taxation of bothtypes of income.

There is however a different type of fairness argument, one which starts from theproposition that income should only be taxed once. Savings income arises from

capital, which will often (but not always) have been accumulated out of incomewhich was taxed when it arose. The amount of savings income is lower than itwould otherwise have been, because the capital was reduced by taxation when itarose. Such an argument would suggest that savings income should not be taxedat all.

One could debate such arguments at length, and still not reach a conclusion. Thepoint of putting them forward here is to show that we do have a choice. We do nothave to accept the assumption that earnings and savings income should be taxedto the same extent. Neither doing so, nor not doing so, can be decisively shownto be fairer than the alternative. We can turn to other considerations in our searchfor the best approach.

All of the proposals in this section relate specifically to the taxation of the incomeof individuals and trusts, not the income of companies.

A7.2 The case for encouraging savings

There is an economic case for encouraging saving. In the short term, highersaving can reduce economic growth because aggregate demand falls. In thelonger term, however, the position is different. If the current rate of saving is lowenough, additional saving and hence investment can boost output. We cannot

expect a permanent increase in the rate of economic growth, both because themarginal efficiency of capital falls as investment rises and because a high level ofinvestment requires high ongoing expenditure to keep capital goods in workingorder, but there will still be a permanent gain because the stock of capital goodswill be higher and more can be produced. This argument does not, however,apply if the level of saving is already very high. Additional investment mightsimply be a waste of resources.

The question is, will savings increase automatically so long as there is value inincreasing them, or is encouragement needed in order to achieve the optimal rateof savings? Empirical evidence suggests that all countries have saving rates

below the optimal level (J Sloman, Economics, 6th edition, 2006, page 603).There is therefore an economic case for encouraging increased saving in the UK,because that will ultimately lead to higher incomes.

There are also wider reasons why higher saving would be beneficial. With anageing population and considerable uncertainty regarding future life expectancy,it is advantageous to households to engage in precautionary saving now, in orderto provide for a future when fiscal constraints may prevent state pensionpayments from providing more than the most basic income.

Finally, there is a (non-party) political case for encouraging savings. Financial

independence encourages independence of conduct and expression. The fewerpeople who depend on taxpayers for their income, and the less the extent of



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dependence among those who do so depend, the better for the political health ofthe country.

A7.3 The tax system as a way of encouraging saving

If there is no conclusive argument for taxing earnings and savings income to thesame extent, while at the same time there is a case for encouraging saving, thenwe can consider reductions in tax on savings income.

The Institute of Directors argued for a new tax regime for savings in EncouragingSavings: A Better Tax Regime by Michael Templeman and Richard Baron,published in 2007. That paper was a companion piece to Capital Gains Tax andInheritance Tax, by Richard Baron (Institute of Directors, 2007), and theproposals in the two papers formed a single package. The package included acapital gains tax which tapered down to zero after ten years of ownership. Shortly

after the paper on savings was published, the Government announced majorchanges to capital gains tax, including the abolition of taper relief. While thosechanges were heavily criticised, by the Institute and by others, as representing asignificant increase in the tax burden, particularly on business owners, thecriticism reflected the 18 per cent rate of tax that was chosen and the decision towithdraw indexation allowance accrued up to 1998. There is nothing wrong inprinciple with a flat rate on capital gains, so long as the rate is low enough. Itseems unlikely that taper relief will be re-introduced. The proposals in the paperon savings therefore need to be re-considered in the context of the new capitalgains tax regime. Having said that, the proposals in relation to financialinvestments (as distinct from investment in land and buildings) still stand, and wetherefore advocate them here. The proposals would not only encourage saving.

They would also increase the competitiveness of the UK financial servicesindustry, and reduce tax compliance burdens on individuals.

A7.4 Flexibili ty , attract iveness and Exchequer cost

Savings products can be more or less flexible. Pension funds are highly inflexible:savings must be withdrawn in the form of a regular income, which must startwithin a specified age range. On the other hand, pensions enjoy the greatest levelof tax benefits, with contributions being tax-deductible and investment incomewithin the fund being tax-free. Pensions are taxable, but part of a fund, usually

about 25 per cent, can be taken as a tax-free lump sum. At the opposite extreme,individual savings accounts (ISAs) are very flexible, allowing withdrawals at anytime, but the tax benefits are minimal, particularly for basic-rate taxpayers.

The more flexible a product is, the more attractive it is likely to be. On the otherhand, excessive flexibility may lead to failure to achieve social purposes such asencouraging people to save for their old age. And the attachment of high levels oftax benefits to the most flexible products would lead to a very high Exchequercost. If, for example, all savings were tax-deductible along the lines of pensioncontributions, with no penalty for early withdrawal, there would be an immediateand huge loss of tax revenue as savings were made.



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A7.5 Non-pension savings

If we leave aside the tax-deductibility of savings made, which would have a veryhigh Exchequer cost, the main options for tax benefits are as follows:

• Gross roll-up, that is, the deferral of tax on savings income until withdrawalfrom the savings vehicle. This contrasts with the general principle of thecurrent tax system, which is to tax income as it arises. Gross roll-up enhanceslong-term returns. If tax is extracted each year during the life of an investment,the amounts extracted are no longer available to earn returns for the investor.If there is gross roll-up, the total fund at the end of the term will be higher,even after deducting tax on the entire income return at the end. Suppose forexample that someone invests £1,000 at the start of each of years 1 to 20,and that 5 per cent gross interest is added to the fund at the end of each ofyears 1 to 20. If each interest payment is added net of 20 per cent tax, thenthe value of the fund at the end of the 20 years will be £30,969. If on the otherhand all interest is taxed at 20 per cent at the end of year 20, the value of the

fund will be £31,775. The figures would of course be larger, and the differencemore significant, with a single lump-sum investment. If £20,000 were investedin a single sum and left to accumulate interest at 5 per cent a year for 20years, the final fund would be £43,822 with tax at 20 per cent each year, and£46,453 with all interest being taxed at 20 per cent at the end of the term.

• Exemption from income tax and capital gains tax for returns on investmentsput into a particular vehicle, with an overall limit on the amount which can beinvested. This would be equivalent to the current ISA scheme.

• An exemption limited by tax rate, on the following lines. There would be nomonetary limits, but income would be tax-free for all except higher-rate

taxpayers. Higher-rate taxpayers would pay some tax. This approach wouldbe particularly easy to implement for interest income, with higher-ratetaxpayers paying tax at the difference between their marginal tax rate and thebasic rate. (Thus a 40 per cent taxpayer would pay tax of 40 – 20 = 20 percent of the gross interest.)

Gross roll-up is the best option for some types of saving, in particular for thosethat are based on equities, for reasons which will be set out below. However, itseffect on returns to investments in interest-bearing investments would be limited.(The effects are more dramatic with high rates of return, but safe interest-bearinginvestments do not pay high rates.) On the other hand, the ISA approach in its

current form is complicated and primarily benefits higher-rate taxpayers. There ishowever merit in having an ISA in which both cash dividends and interest can beentirely tax-free. The general proposed change to the taxation of dividends wouldmean that ISAs would have benefits for basic-rate taxpayers. We advocate thisoption because the concreteness of a specific vehicle may itself encouragesaving. A total exemption of interest income would be costly and arguably toogenerous compared to the gross roll-up that could be offered for other types ofsaving. We therefore propose an exemption for interest limited by tax rate, forinterest that is earned outside an ISA, and simplified ISAs with a limit on theamount that each person can invest.



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A7.6 Interest

The proposal is to make interest income tax-free to the extent that it falls withinthe basic-rate income tax band, and to tax it at a reduced rate to the extent that itfalls within any higher-rate band. Interest would be treated as the top slice of

income in order to allocate it to a tax band. The reduced rate would be the excessof the relevant higher rate over the basic rate.

One specific reason for this proposal is that it particularly favours basic-ratetaxpayers, who are the people who most need encouragement to save. Tax-freeinterest, without the need to use a special vehicle such as an ISA, should haveconsiderable appeal.

The mechanics would be based on those of the current system, under whichbanks and building societies deduct 20 per cent tax on interest credited toaccounts except where account-holders have registered as non-taxpayers. The

individual is treated as having received the gross interest and as having paid taxof 20 per cent. There is only additional tax to pay to the extent that the interestfalls within the higher-rate tax band. In that case, the interest is taxable at 40 percent but account is taken of the tax already paid, so that only a further 20 per centtax is payable.

We propose that banks and building societies should not deduct any tax, whileindividuals would be taxable on interest income but would be deemed to havepaid basic-rate tax, although this would be non-repayable to non-taxpayers.(There would be no grossing-up calculation: the deemed income would be theamount received, not that amount x 100/(100 – basic rate).) Basic-rate taxpayerswould have nothing more to pay, and they would get the benefit of keeping all of

the gross interest instead of only 80 per cent of it as at present. Higher-ratetaxpayers would have a further 20 per cent to pay (given the current higher rateof 40 per cent), but they would get the benefit of keeping 80 per cent of the grossinterest instead of only 60 per cent as at present. The point of the deemedpayment of basic-rate tax is to allow the income to be incorporated in the taxcalculation so that it can be allocated to a tax band. Once it has beenincorporated into that calculation, tax can be computed on it in the ordinary wayand then, as a separate adjustment, the tax deemed to be paid can be deductedso as to give the correct final result. The calculation could be made in this waywhatever higher rate or rates existed.

An important part of the design of any scheme to encourage saving is anencouragement to build up savings, rather than to make savings one year and,without good reason, spend them the next year. The proposal would not imposeany obvious penalty for early withdrawal, but there would still be a penalty. Theproposal would offer the opportunity to receive tax-free income or, for higher-ratetaxpayers, lowly-taxed income. The larger the fund invested, the greater this tax-privileged income. There would therefore be an incentive to build up a substantialfund, rather than to save and then quickly spend. Anyone who withdrew his or herfund and spent it would need time to rebuild it and start enjoying significantamounts of tax-free or lowly-taxed income again.



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There would however have to be an exclusion from this treatment for interestreceived from a company in which the recipient had a substantial stake, in orderto prevent tax avoidance.

A7.7 Equit ies

Equities include shares in companies and units or shares in collective investmentschemes (unit trusts, OEICs and investment trusts) that invest in the shares ofcompanies. The current tax treatments of all of these forms of equity investmentare broadly the same. There is income tax on dividends at special rates, andthere is capital gains tax on disposals of investments. The alignment of taxtreatment of shares with that of investments in collective schemes is sensible,and should be preserved. Investments in collective schemes are after alleffectively investments in baskets of shares in companies. (It would however benecessary to separate out any significant percentage of a collective investment

scheme’s income which arose on bonds.)

There is one change which should be made, both for shares in companies and forinvestments in collective schemes, and that is the introduction of gross roll-up.There is a general case for this change, which can equally well be argued forshares and for investments in collective schemes, and there is an additionalargument which is specific to collective schemes.

A second area where we propose change is that of the taxation of income when itis withdrawn. The current system is a bizarre result of historical accidents.Treatment comparable to that of other income would be more appropriate.

Gross roll-up

At present, an investor in shares or in collective schemes who wishes to re-investincome in more shares or units (stock dividends or accumulation units) is taxedon the income as it arises. It is not possible to choose an increase in the size ofone’s investment and then pay tax on realisation of the investment. If, however, acompany decides not to pay dividends but to re-invest profits, the effect will be toincrease the value of shareholdings and to ensure that the only tax whichinvestors pay is capital gains tax on disposal. So a corporate decision to re-investand to build up value defers tax on the individual, but an individual cannotachieve the same effect even if he or she wants to forgo current spending in

order to build up value.

We propose changing this treatment, so that if an investor elects to takeadditional shares or units rather than a distribution of income, the amount ofincome so used should be ignored for tax purposes. On the eventual sale of theinvestment, there would be a taxable profit equal to the disposal proceeds (whichwould of course be increased by the re-investment of income) minus the originalcost. This rule on disposal would equally apply when income had been withdrawnand taxed during the period of ownership: the disposal proceeds would bereduced on account of the withdrawals of income, reducing the taxable profit, sothere would be no double taxation of amounts withdrawn and taxed.



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Rules would be needed to attribute an appropriate proportion of the cost to a part-disposal of the investment, but the current rules on the disposal of fungible assetscould be used. Shares and units bought out of income would be treated as if theywere bonus shares or units, and would be attributed to the shares or units inrespect of which they were issued.

Gross roll-up would give an incentive to build up savings, which might bedisproportionate to the actual financial benefits because it is very simple for aninvestor to leave money to roll up. This effect could be enhanced by the fact thatan investor would not need to report rolled-up income on a tax return. Therewould be a further gain in simplicity on eventual sale of the investment, becausethe cost to take into account would be simply the amount originally paid for theinvestment rather than, as currently, that amount plus re-invested income.

An argument for gross roll-up which is specific to investments in collectiveschemes is that the UK has fallen far behind other European countries as alocation for collective investment schemes, as the European Union has movedtowards allowing such schemes to be sold across borders. Given the highlydeveloped nature of the fund management industry in the UK, the UK shouldhave had a significant competitive advantage. However this has not been thecase, because in many European countries, collective investment schemes areonly competitive if they are organised on a basis which allows for gross roll-up.This is one of the reasons for the dominance in the investment industry ofcollective investment schemes based in Luxembourg and the Irish Republic,where gross roll-up is allowed.

Gains on shares are currently treated as capital gains. While the current rate ofcapital gains tax, 18 per cent, is close to the basic rate of income tax, 20 per cent,

it is very different from the higher rate, 40 per cent. Taxing rolled-up dividends ata much lower rate than dividends paid in cash, in addition to the deferral oftaxation, would be too generous. We therefore propose that gains on sharedisposals should be taxed as income to the extent that they represented deferreddividends. (That is, the whole gain or loss would be computed, deferred dividendswould be taxed as income, and the amount so taxed would be deducted from thewhole gain or added to the whole loss in order to give a net gain or loss that wassubject to capital gains tax.)

Another issue to be considered is that if the tax advantages of equities were toogreat, low-income savers might be inappropriately tempted into equities when

they would be better advised to stick to cash investments, at least for the firsttranche of their savings. However, the proposal to make all interest completelytax-free for basic-rate taxpayers should make cash investments sufficientlyattractive.

The taxation of dividend income

The current arrangement for taxing dividend is that they are not tax-deductible forthe paying company, but that in the hands of individuals they are taxable incomewith a tax credit attached. If a company pays a dividend of £900, there is a £100tax credit, giving total taxable income of £1,000. This income is then taxed at 10

per cent if it falls within the basic-rate band, giving tax to pay of £100 minus the£100 tax credit, so there is no more tax to pay. The income is taxed at 32.5 per



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cent if it falls within the higher-rate band, giving tax to pay of £325 minus the £100tax credit, so there is £225 of tax to pay. The effective tax rates on net dividendsreceived are therefore 0 per cent within the basic-rate band and 25 per centwithin the higher-rate band. Non-taxpayers cannot obtain repayment of the £100tax credit.

A move to not taxing accumulated dividends until withdrawal could sensibly bebalanced by the abolition of this special treatment. We therefore propose thatdividends be taxed like other income, with the amount of taxable income beingequal to the net dividend. It might be thought that this would lead to doubletaxation, because tax would still be imposed on companies’ profits and dividends,paid out of post-tax profits, would then be taxed again. That would be so, but wealso propose a significantly lower corporation tax rate than the current one.Furthermore, basic-rate taxpayers, who would be the ones whose tax ondividends would increase by most under this proposal, would also get the newadvantage of tax-free interest income – and most basic-rate taxpayers are likelyto have more interest income than dividend income.

The proposals would at first glance appear to threaten a considerable rise inadministrative burdens. Basic-rate taxpayers can currently ignore dividends,because their tax liabilities are covered by the tax credit. However, the ability todefer tax by re-investing dividends in shares and units should reduce the numberof basic-rate taxpayers receiving taxable dividends. The threat of large numbersof basic-rate taxpayers coming to require tax returns could also be averted byhaving companies levy a withholding tax on dividends paid to all shareholderswho had not established that they were not taxable on the dividends. Such awithholding tax could be set against corporation tax (or be repayable if there wasno corporation tax liability) for any UK corporate shareholders that accidentally

suffered it, and could provide complete satisfaction of liability for basic-ratetaxpayers, but there would be no withholding tax when the shareholder elected tore-invest his dividend in additional shares.

One difficulty is the treatment of non-resident shareholders, particularly thosewho are resident in countries where dividends and capital gains from overseasare not taxed. At present such investors in UK shares have a privileged treatmentbecause they are not taxed either on their dividends or on their capital gains. Thistreatment would continue except that if they took payment of dividends thenwithholding tax would be applied, although it could not apply if they were tocorporate shareholders within the European Union with holdings of at least 10 per

cent unless the Parent-Subsidiary Directive were repealed. It would clearly beimpossible to apply withholding tax where shares which had just been acquiredwere sold through the market. One possibility would be to allow non-residents tohave dividends re-invested in shares which could only be traded after the expiryof a fixed period, say two years, but this is an area where further work would berequired to avoid creating distortions, as well as to ensure compliance withEuropean law.



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A7.8 ISAs

As noted above, there is merit in having a concretely identified investment vehiclein order to encourage saving. We propose to retain and improve the ISA, asfollows:

• There would be a limit on the annual investment, which could initially be thesame as the limit of £10,200 that was announced in the 2009 Budget. All ofthe amount could be invested in equities, in bonds, or in a mixture of the twoin any proportions, removing the current restrictions. Re-invested income onISA investments would, as currently, not eat into this limit.

• All dividends, including cash dividends, would be tax-free, as currently.

• All interest would be tax-free, as currently.

This would allow higher-rate taxpayers to derive some benefit not otherwiseavailable to them, but the benefit would be restricted by the investment limit.

An additional possibility, which would be worth investigation depending on theextent of the need to incentivise savings, would be to encourage the moves thatare currently being made by some employers to introduce ISAs for theiremployees. If an employer contributes to an ISA, the amount contributed issubject to income tax and national insurance contributions, just like salary. Itmight be worth allowing employers’ contributions to be free of employers’ nationalinsurance, up to a modest limit of the order of £50 a month, and conditional ontheir only being given this benefit so long as they did not exceed the amountspaid in by employees. There would be a danger of abuse, with payments intoISAs substituting for salary, but if the limits were modest, the benefit of

encouraging savings might well outweigh the cost of the loss of employers’contributions.

A7.9 The Enterpr ise Investment Scheme

The Enterprise Investment Scheme gives a tax saving of 20 per cent of the costof the investment, exemption from capital gains tax on disposal and theopportunity to set any loss on disposal against income.

While this scheme has benefited those who have invested under it, it distorts the

allocation of investment. It also allows lacklustre companies to attract capital(Study of the impact of Enterprise Investment Scheme (EIS) and Venture CapitalTrusts (VCT) on company performance: HMRC Research Report 44. Institute ofEmployment Studies, University of Sussex, 2008, page 43). Given that wepropose changes to the tax regime for equity investment generally which wouldallow extensive deferral of tax, we propose that the Enterprise InvestmentScheme be phased out. All investments made before the date of abolition of thescheme would retain their tax privileges, but no later investments would benefit.Several months’ notice of this change should be given, despite the fact that doingso would encourage a rush of investment, because it takes a while to plan andarrange a share issue, and the tax system on the basis of which commitments

are made should not be changed without warning.



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A7.10 Insurance products

One of the main areas in which the taxation of savings gives rise to considerabledistortions is the way in which life assurance products are taxed. The originaltreatment was that anyone taking out a life assurance policy received tax relief on

the premiums, although at a rate that was far less than the basic rate. (This reliefwas withdrawn in 1984.) Proceeds of a policy were free of all taxation, althoughtax paid by the insurance company reduced the amount that any policy produced.However in 1972 this treatment was changed and it became possible, in certaincircumstances, to levy higher-rate tax on the proceeds of such policies. The ideawas that where the policy was approved by the Inland Revenue as giving realprotection, it should remain tax-free in the hands of the policyholder provided itwas held for least four years. One of the criteria that the Revenue used inapproving such policies was that they were capable of lasting for ten years. Therewas a charge at the difference between the higher rate and the basic rate inrespect of the proceeds of unapproved policies, and also on approved policies

cashed in within four years. There was also what was intended as a de minimisprovision under which any amounts withdrawn from a policy that in any one yearamounted to less than 5 per cent of the capital invested were treated asrepayments of capital and were not taxed.

The only taxation levied on approved policies held for more than four years is inthe hands of the insurance company. The taxation of insurance companies iscomplex but to simplify considerably, a mutual company is taxed on itspolicyholders’ profits at 20 per cent. Where the company has shareholders and isnot organised on a mutual basis, it is necessary to separate out the profitsattributable to the shareholders, which are taxed at the normal corporation taxrate.

This method of taxation gives rise to two different kinds of problem. The firstarises out of the fact that levying taxation on the profits of the company works asan effective method of taxation where the policy is taken out with a companybased in the UK and subject to UK corporation tax or with a foreign companywhich operates in the UK through a branch or agency. However, in 1993 theEuropean Union introduced the Insurance Directive, under which companiesincorporated in the European Union were able to sell insurance policies acrossborders, without the need to establish a branch or agency in the country wherethe policyholder lived.

The second problem with the existing basis is that many policyholders pay taxthrough the company on their capital gains but would not have any liability onsuch gains if they received them directly, because of the capital gains tax annualexempt amount. A tax arrangement which penalises those with few gains outsidethe policy and favours wealthy higher-rate taxpayers is hard to defend.

Changing the current taxation treatment would have its own problems. Existingpolicies have already borne tax and many possible reforms would either lead tounfairness to existing policyholders or, alternatively, mean that there was anadvantage in cancelling existing policies and replacing them with ones taxed on anew basis. Such a change would only benefit those who sold policies and

charged commissions, which are largely taken at the start of the policy term.



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A further factor which ought to be considered is that in recent years the traditionalwith-profits endowment policy has fallen out of favour, largely because fallinginterest rates have meant that profits have fallen well below what was predictedwhen many of them were taken out. The traditional with-profits endowment policycan still have a part to play because it provides funds to meet family needs when

they are at their greatest, that is, when a policyholder dies unexpectedly. Butmost advisers would now suggest that the best way of meeting those needswould be to take out a term insurance policy and to use the difference betweenthe comparatively low rate for term insurance and the amount charged for a with-profits endowment policy to save in other vehicles. The objective of any reform ofthe taxation of insurance policies, and also the taxation of savings, ought to be toprovide a level playing field so that a long-term life policy becomes a respectableway to make savings while at the same time removing any bias induced by thetax system.

The first reform required is to the de minimis provision which allows 5 per cent ofcapital to be withdrawn each year tax-free. When this was introduced in 1972,nobody would have imagined that it would be used to market a series ofinsurance bonds which offered people tax-free income at a rate in excess of thegross amount of interest offered even by the highest-rate deposit accounts.

The first step necessary to produce a level playing field is to abolish, or greatlyreduce, the ability to take amounts of capital repayment tax-free. The de minimisamount should be reduced to 0.5 per cent to prevent what must be seen as amajor abuse of a sensible form of taxation.

A more fundamental question is whether there is a case for encouraging lifeassurance policies with a savings element at all. There are two arguments for

such encouragement. The first is that there is a case for this kind of long-termsaving for misfortune as a supplement to pensions, which are for retirement.There is a case for encouraging people not to touch their nest egg for misfortuneand with-profits policies discourage early withdrawal by offering poor surrendervalues. The second argument is that the with-profits funds of life companies areimportant in the provision of annuities which are the companion to private savingfor retirement through defined-contribution pension arrangements. They offersome balancing of risk, with the main risk in life assurance being high mortalityand the main risk in annuity provision being low mortality – although the relevantcohorts of people only overlap, and are by no means an exact match. With thegrowth in defined-contribution pension arrangements, the demand for annuities

will continue to increase. If with-profits policies and other savings in the form oflife funds continue to decline, the ability of life companies to provide competitiveannuity rates will continue to fall.

The essential feature of our proposal for life policies is to allow income andcapital gains to roll up tax-free in the company and then tax all withdrawals overthe de minimis amount at full capital gains tax rates. This would allow stagedwithdrawals by those who had available capital gains tax annual exemptamounts. (The amount of the annual exempt amount would be an importantfactor in deciding whether this treatment was too generous, given that a policycan easily be surrendered in stages of a size tailored to use annual exempt

amounts. It might be appropriate to limit its availability to withdrawals frompolicies which would be qualifying policies under current rules, broadly policies



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which run for at least ten years and have reasonably level premia. But theavailability of the annual exempt amount should not be seen as re-instating thecurrent 5 per cent allowance, because the amount would be limited to a fixedcash amount each year.) As we have seen, one of the ways in which lower-income policyholders are disadvantaged by the present system is that their

capital gains are taxed in the company even if they have unused annual exemptamounts.

The ideal would be to allow this treatment for all qualifying policies. Existingpolicies would be valued at the date the revised scheme was introduced, and theexisting treatment would be applied on maturity to the gain accrued up to thevaluation point. As indicated earlier, it would be important to manage anytransition in a way that not only avoided preserving existing unjustified privileges,but also ensured that there was no incentive to cancel existing policies and buynew ones.

We propose for insurance policies that:

• the current de minimis withdrawal free of all taxes at 5 per cent be reduced to0.5 per cent;

• all income and capital gains belonging to policyholders be free of all taxes inthe company’s hands;

• the existing income tax charge on withdrawals within four years of the start ofa policy should remain;

• all subsequent withdrawals in excess of 0.5 per cent be taxed as partdisposals and charged to capital gains tax;

• companies would provide calculations of gains to enable policyholders tomake the appropriate returns.

A7.11 Pensions

Under the current regime, pension contributions are tax-deductible. They are notdeductible for national insurance purposes, but no national insurance is chargedon employers’ contributions. Investment income within the fund is not taxable. 25per cent of a fund may be taken as a tax-free lump sum, and the rest is withdrawnas an annuity which is taxable income. (This is only a rough outline. There are

some complications.)

Tax reliefs for pension contributions exist in order to encourage people to providefor their old age, given that the state pension can only provide a very modestincome. They do however have an Exchequer cost of about £28.4bn, minus£9.5bn tax on pensions, giving a net cost of £18.9bn (figures for 2008-09, takenfrom HMRC table 7.9, updated September 2009; there is also £8.2bn of nationalinsurance not charged on employers’ contributions).

It is important not to deter saving for retirement. One sure way to deter saving isto change the system repeatedly. We therefore propose keeping the system

broadly as it is in the short term, pending a full review of the whole of privatepension provision that would take account of all factors, not just tax, as proposed



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in Section 4.3 of Roadmap for Retirement Reform 2009 by Malcolm Small(Institute of Directors, 2009). There are however a couple of changes that wouldmake pension saving more attractive and that should certainly be considered.

The rules for the tax-free lump sum could usefully be changed in order to

encourage longer working lives and thereby reduce the ratio of pensioners tothose in work. The maximum lump sum might for example increase from 25 percent of the fund if a pension were drawn at or before the state pension age, by 5per cent a year for each year’s delay after that age, up to a maximum of 50 percent of the fund if a pension were drawn five or more years after the statepension age.

The requirement to buy an annuity, which is the greatest inflexibility of pensionsaving, appears to be a major deterrent to pension saving. One should thereforeconsider abolition of the requirement to buy an annuity, although there would stillneed to be some control over the use of pension funds to ensure that theysustained pensioners throughout their retirement. The minimum control would beto require that any lump sum in excess of the 25 per cent to 50 per cent limitwould be taxable: there would be a risk of higher-rate tax if large amounts werewithdrawn in a single year. This control would however probably be too weak.Something on the lines of the current income draw-down rules, but simplified sothat people could understand what was allowed, would be needed.

Another reform would be to phase out stamp duty reserve tax and stamp duty ontransfers of securities, a change which would boost the value of pension funds. As set out in Section A10.5, this would be a desirable reform for other reasonstoo.

Finally, the Government has put in place an extraordinarily complicated andunworkable temporary regime to limit tax relief on pension contributions for high-income individuals, to be followed from 2011 by a permanent regime thatthreatens to be equally complicated. It would be far simpler to work within theexisting framework, preserving the well-established and highly practical principleof relief at the marginal tax rate of the contributor and limiting contributions tosomething of the order of £50,000 a year instead of the current £245,000. Giventhe distribution of size of contribution by income, the effect would be similar towhat the Government has proposed, both in terms of individuals affected and interms of overall Exchequer effect. This is therefore what we propose.

A7.12 Trusts

Trusts that are not collective investment vehicles or charitable trusts need to besubject to income tax and capital gains tax, just like individuals. There are,however, special difficulties in setting the rates and allowances. In order toprevent the use of trusts in tax deferral and avoidance, it is tempting to imposetax at the highest rates applicable to individuals, with no allowances. On the otherhand, trusts are used for many reasons other than tax avoidance, and placingassets in trusts rather than directly in the hands of beneficiaries who may only beliable for tax at the basic rate would place the beneficiaries at a disadvantage.



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Gains, losses and the annual exempt amount

We propose re-structuring the annual exempt amount, an exemption which existsto avoid the need for computations when the amounts of tax at stake are small,rather than to benefit those of small means, who are far more likely to have

income than capital gains anyway. The current annual exempt amount is gains of£10,100 a year. This high level was up to 2008 justified by the fact thatcomputations were often complex and required significant historical research. Ithas continued under the 2008 regime in recognition of the fact that this newregime raises significantly more tax than its predecessor. It would have addedinsult to injury to reduce the annual exempt amount. However, in the context ofan overall package which will include significant tax reductions, it is reasonable toconsider changes to the amount and to the way in which it works. A largeexemption which does not exist to help the poor must be examined to seewhether changes to it would help to fund tax reductions elsewhere.

Re-structuring of the annual exempt amount is proposed because currently, it isfor an amount of gains. This requires a taxpayer to gather data and docomputations in order to determine whether or not the gains are covered by theexemption. A computation which only required the deduction of purchase pricefrom sale proceeds might not appear to be arduous, but a taxpayer might wellhave to gather information on incidental costs of acquisition and disposal, mighthave to identify enhancement expenditure and consider whether it was eligible forrelief (not all enhancement expenditure qualifies), and might have to considerwhether any specific reliefs were available.

An exemption that was based on proceeds would be much more straightforwardto operate, and that would facilitate the introduction of a lower exemption. We

propose that if the proceeds of capital assets sold in a given tax year (beforededucting incidental costs of disposal) did not exceed a lower limit, all gains andlosses would be disregarded. If proceeds equalled or exceeded an upper limit, allgains and losses would be taken into account. For proceeds between these twofigures, a full computation would be done but the proportion of the total gainsminus total losses to take into account would be (proceeds – lower limit)/(upperlimit – lower limit). This method is proposed because it would be simpler thanallowing a deduction from the proceeds of selected disposals, but would stillavoid a cliff-edge when proceeds only slightly exceeded the lower limit. Modestlimits, of the order of £5,000 and £10,000, might be used.

The procedure each year would then be as follows:

• Add up the proceeds of all disposals. If they do not exceed the lower limit forthe exemption, do no calculations. Otherwise, continue with the followingsteps.

• Compute each gain and each loss, and work out the total gains and totallosses.

• Set the losses against the gains to give a net gain or loss.

• Apply the new exemption, so that the net gain or loss is taken in full ifproceeds equal or exceed the upper limit, and is multiplied by (proceeds –

lower limit)/(upper limit – lower limit) if proceeds are between the lower andthe upper limits.



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• If the result is a net gain, use losses brought forward (which will already havebeen subject to the exemption computation when they were made) to coverthat gain, then either tax any balance of gain or carry forward any balance oflosses.

• If the result is a net loss, add that to the net losses brought forward, and carrythe total forward.

The effective reduction in the annual exempt amount should also reduce theinfluence of the tax system on behaviour. A desire to use, but not exceed, theannual exempt amount appears to be a significant influence on investorbehaviour (Evaluation of the Changes to Capital Gains Tax Since 1998, HMRCResearch Report No. 26, Ipsos MORI Social Research Institute, December 2006,page 2).

Fungible assets

Fungible assets are identical assets, such as shares of the same class in thesame company. If someone buys 100 ordinary shares in a company, then buys200 more ordinary shares in the same company, then sells 50 shares, a matchingrule is needed to determine whether the shares sold came out of the firstpurchase or out of the second. Once the purchase has been chosen, a cost canbe established.

The current rule is last in, first out. In the above example, the 50 shares would betreated as coming out of the later purchase of 200 shares. We propose tomaintain this rule.

CGT as a replacement for IHT

CGT does not currently apply on death. The heirs acquire assets as if they hadbought them at the time of death, for their market values at that time, but thegains that accrued during the deceased's lifetime are never taxed.

If IHT were to be abolished, this exemption from CGT would be anomalous. Wepropose that it be removed, so that when someone died they would be deemed todispose of all of their assets, for their market values. This could be done while stillleaving the tax system much more favourable to savings than it currently is. Anytax charge would be on gains made, not on the total amount saved. Incidentally,

this would greatly reduce a significant problem with IHT, the fact that it imposeslarge tax bills that must be paid in cash when the estate's assets may not be at allliquid.

Investments in businesses and in farms would not necessarily be deterred. Suchassets are usually exempt from IHT. There would be no such blanket exemptionfrom CGT, but the relief which allowed a gain on a gift of business assets,including farms, to be deferred would apply (see below).

CGT reliefs and exemptions

There are several reliefs and exemptions in the CGT system. Many of them arethere for good reasons which would make it sensible to continue them. It wouldhowever be necessary to consider carefully which of them should apply on death.



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Entrepreneurs’ relief was introduced in 2008. It gives an effective 10 per centrate, and an effective multiplication of the annual exemption by 1.8, in relation todisposals of qualifying assets. Broadly this means businesses, whether or notincorporated, in which the person making the disposal has at least a 5 per cent

stake. The relief is available for gains up to a lifetime total of £1m. As the point ofthe relief is to encourage serial entrepreneurs, and as the relief for a gift ofbusiness assets would apply, the relief should not be given on death.

The relief which ensures that no gain and no loss arises on a transfer betweenspouses or between civil partners should continue to apply, because couples arelikely to accumulate wealth in common to provide for both parties. This reliefshould also apply on death. It would be wrong to take part of that accumulatedwealth in taxation merely because it happened to be in the hands of the first partyto die.

The exemption for charitable gifts should continue to apply, in order to encouragesuch gifts. It should also be made fully available on death. If someone inheritedan asset and wanted to pass it on to a charity or to the spouse or civil partner ofthe deceased, the will could be deemed to be varied so that the asset was treatedas passing directly from the deceased to the new recipient, making the relevantexemption available. There is a parallel provision for deeds of variation in thecurrent IHT rules.

The relief for gifts of business assets given by Taxation of Chargeable Gains Act1992, section 165, should apply so as to allow businesses to be transferredintact, preserving jobs and the productive potential of existing businesses. Thisrelief allows the gain that would otherwise arise on a gift to be deferred until a

subsequent disposal. Transfers of intact businesses are as important on death asduring life, so the relief should apply on death. The relief should also be availablefor farms, so that there would be an effective replacement for IHT agriculturalproperty relief.

The exemptions for wasting chattels and for low-value chattels should apply inorder to take out of charge a great many trivial disposals, most of which areprobably not even recognised by taxpayers as possible sources of CGT charges.The low-value exemption is for chattels disposed of for up to £6,000, with areduced exemption for chattels sold for up to £15,000. Cars should continue to beexempt, because withdrawal of the exemption would lead to a substantial rise in

the number of transactions which had to be reported and because cars areusually sold at a loss anyway.

The exemption for a gain on a taxpayer's only or main residence should applyduring life, otherwise it would become impossible for people to move house, andlabour mobility would suffer. Furthermore, it would not be possible to limit theexemption to job-related moves.

The residence exemption should not apply in full on death. Instead, gains thataccrue in the seven years before death should become chargeable on death. Iffor example a house was bought ten years before death and was still held at

death, it should be treated as sold at death for its then market value, but only 7/10



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of the gain should be taxable. If a house was bought ten years before death butsold two years before death, 5/8 of the gain should be taxable.

The reason for this approach is that if the exemption applied in full, there wouldbe a strong incentive to invest in private housing with good short-term growth

potential late in life. This would skew investment decisions, in a way that the taxsystem should ideally not do. This may seem to be a surprising proposal, giventhat the main reason for the increase in the proportion of estates liable to IHT hasbeen the rise in house prices, which has meant that even a modest house in anexpensive region can absorb the whole of the IHT nil rate band. But the gain thatwould be taxable on a given house would be much more modest than the entirevalue of the house. The tax on such a gain would not often be so much of aburden as to require the sale of the house.

The provisions on re-organisations of share capital and on the conversion ofsecurities should broadly remain in place, because they merely ensure continuitywithout a CGT charge when there has been no effective disposal by the investor.The question of whether to apply these provisions on death would not arise,because it is an action by the investee that occasions their application.

The provisions on small part disposals, allowing deductions from acquisition cost,should continue to apply because they allow pointless computations to beavoided and they do not lead to the permanent exemption of gains.

The payment of CGT on death

The payment of IHT on an estate at death can currently present significantdifficulties, because it must be paid before the executors can obtain probate and

have access to the estate's assets. The same rule might be applied to thepayment of CGT on deemed disposals on death, but that would be undesirable. Ifit were applied, there should certainly be a rule that probate should be granted inrespect of assets that would not give rise to chargeable gains, for examplesterling, without first requiring the payment of tax on other assets. The remainingassets would be adequate security for the tax, because the gain on an assetcould not exceed its value and the tax would only be a fraction of the gain.

A8.2 IHT

We propose simply to abolish IHT, in respect of all transfers after a given datewhich would otherwise have been chargeable transfers, and all potentiallyexempt transfers which would otherwise have become chargeable after that date.This would mean the loss of a significant amount of tax revenue in one go. Therewould however be the counter-veiling CGT charge on death, which would beintroduced for all deaths from the abolition of IHT onwards.

The case against IHT

IHT should be abolished because it discourages saving, at a time when it there isan urgent need to save more.



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IHT discourages the accumulation of wealth which is retained until later in life,because of the increasing risk that the wealth will be charged to IHT when it is stillheld at death. Many people, including those who have pursued ordinary workingcareers and have accumulated modest wealth, now run the risk that IHT will becharged on their estates simply because of rising house prices. This is

particularly unfortunate because it is later in life, after retirement, that personalwealth is most needed in order to avoid becoming dependent on other taxpayers.With increasing longevity, people need to retain increased assets to cover the riskthat they may need substantial funds to support themselves. In addition, lifeexpectancies are now such that it is not uncommon for people to retire at thesame time as they need to start supporting their aged parents. This time may alsobe close to the time when they have to help their children through universityand/or to get a foot on the property ladder. The person who wishes to keephimself or herself independent of other taxpayers, to look after parents and togive children a good start in adult life must save hard. Such a person is thenexposed to the risk of dying while in possession of resources which will lead to asubstantial IHT burden. There is then a payment into public funds when all thathe or she wanted to do was to avoid making withdrawals from public funds. IHTdeters thrift and independence, virtues which need to be encouraged as the statefinds that increasing life expectancies force it to withdraw from comprehensiveprovision for all.

The fact that IHT taxes all wealth means that it is a significant brake on theaccumulation of private wealth. Some of the wealth that is accumulated in onegeneration is lost and has to be accumulated again in the next generation, simplyin order to stand still. Wealth is prevented from snowballing. But if private sectorwealth is allowed to cascade down the generations then everyone, includingthose who find employment in the private sector without owning significant wealth

themselves, will benefit. The public sector will also benefit, because economicgrowth will lead to an increased tax base, making it easier to raise funds forpublic services. The importance of taxing income and gains, and taxing themonce only, rather than taxing total wealth, is a good reason for not replacing IHTwith a donee-based tax under which legacies received would be taxed as if theywere income or capital gains. Such a tax would still apply to wealth rather than toincome or gains, and it would still tax amounts that had already been taxed.

A replacement charge to CGT on death would not have these adverse effects, ornot to anywhere near the same extent, because it would only apply to increasesin value in the hands of the deceased, not to the total value of assets.

Even if the redistribution of wealth were to be a policy objective, IHT would be avery bad way of achieving that objective. If someone is sufficiently wealthy that heis certain not to need what he intends to leave to his heirs to support himself inold age, he can give it away well in advance of death. On the other hand, ifsomeone's wealth is primarily locked up in her house and her pension, shecannot avoid a significant part of her estate going in IHT. In other words thepresent incidence of the tax is extremely uneven. It falls proportionately verylightly on very large estates, and proportionately much more heavily on moremodest estates.



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The effects of changes along these lines would be to turn employees’ nationalinsurance into a supplementary income tax rate on employment income, makingfull integration with the PAYE system possible. (The single adjustment forpension contributions would be easy enough to incorporate.) There would becases when adjustments after the end of the year were necessary, but these

would be cases in which adjustments to income tax after the end of the yearwould be necessary anyway.

Only employment income would be considered for the purposes of determiningrates of national insurance. That is, if one were to look at national insurance as asupplementary income tax, there would effectively be a rule that employmentincome should be treated as the bottom slice of income. This would need to betaken into account when coding out investment income or tax underpayments oroverpayments for previous years. That is, coding adjustments would need to bereduced in order to avoid effectively imposing national insurance on investmentincome or on tax underpayments, or giving bonuses on overpayments, whichwould then increase the sizes of adjustments after the year-end. But this problemshould be manageable. Such coding adjustments mostly affect people who needadjustments after the year-end anyway, and any further adjustments could bemade then, so that any increase in the frequency of adjustments should bemodest.

The treatment of national insurance as an extra tax on total income from allemployments would remove the need to apply rules on maximum totalcontributions for a year to people who only had employments. There wouldhowever be a need for a rule on the allocation of the band in which fullcontributions (11 per cent or 8 per cent) were charged, where someone hadincome both from employment and from self-employment.

Employers’ contributions could be turned into a payroll tax. This would be a fixedpercentage of an amount that was computed by taking the total of all salaries thatwere paid in a month and deducting a fixed amount for each employee. Theemployer would also have to pay, once a year, the same fixed percentage of allthe amounts that were reported on P11Ds and subject to income tax. The point ofthe deduction of a fixed amount per employee is to preserve the existing bias inthe system in favour of a large number of relatively low-paid employees ratherthan a small number of relatively high-paid employees, because to do otherwisewould penalise many small businesses and businesses with substantialworkforces. Using the total of PAYE codes to compute the deduction would not

be satisfactory because that would discriminate against employers of people insubsidiary jobs (the benefit of a code normally being allocated to their main job),and against employers of people with substantial coding adjustments. Given theneed to have a fixed deduction, and the scope for the same person to work formore than one employer and therefore generate more than one deduction, itwould still be necessary to have some rules to determine when jobs for two ormore related employers should be treated as a single job.

National insurance – the contributory principle

If changes to national insurance are to be considered, the contributory principle

must also be considered. Broadly, this ties entitlement to the state retirementpension, to jobseekers’ allowance and to some other benefits to having earnings



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that give rise to national insurance contributions. (Sometimes earnings can leadto entitlement even if no contributions are actually due.) If national insurancewere to change its form, entitlements to benefits might also change, and therecould be significant consequences for the cost of paying the benefits.

There need not, however, be any great change in this area. The rule could bethat a year would be a qualifying one so long as earnings that were liable tonational insurance exceeded the lower earnings limit. This would represent somechange, because it would allow someone with two low-paid jobs, each yieldingless than the lower limit but together yielding more than that limit, to accruequalifying years. The effect should not, however, be that great. Any such changeto the rule on qualifying years would also cover the proposed abolition of class 2contributions. Income from self-employment would simply be added to incomefrom employment for the purposes of the test.

Al lowable expenses

The current rule on the deductibility of expenses is extraordinarily strict.Expenses may only be deducted if they are incurred wholly, exclusively andnecessarily in the performance of duties of the employment, apart from a fewspecific allowances that are enshrined in statute. Court cases have emphasisedhow strict this test is. In particular, an expense has to be such that each andevery holder of the employment would have to incur it (Ricketts v Colquehoun 1925). If an employer re-imburses an expense that does not meet this stringenttest, the employee is taxable on the amount. The self-employed have a morerelaxed test: expenses need only be incurred wholly and exclusively for thepurposes of the trade.

With the rise of remote working, we can expect an increasing number of disputesabout allowable expenses, and, less visibly but still economically damaging, anincreasing number of checks having to be made on expenses to ensurecompliance with the very strict rule for employees.

If the rule for the employed were brought into line with the rule for the self-employed, possibly with some statutory exclusions to cover large items, such astravel between home and work, less checking would be needed because the rulefor the self-employed is close in its effect to the commonsense test of whether anitem is a business expense. It is not clear that this change need be madeimmediately, but this is a key area to keep under review.

A9.2 Tax rates on income f rom employment and from sel f-employment

Eliminating the substantial difference between the tax burdens on employmentand on self-employment would mean reducing the national insurance burden onemployment until it was no higher than that on self-employment, perhapsadjusted to reflect the fair value of benefits that are only available to theemployed. (The alternative of increasing the burden on self-employment wouldrepresent a large and wholly unacceptable tax increase.) Although there is nomedium-term prospect of large reductions in national insurance rates, there are

reasons for having a long-term goal of making such reductions. Doing so wouldhave a number of advantages:



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• It would substantially reduce the tax burden on the use of productiveresources, giving a real boost to the economy.

• Businesses that hired the services of individuals who might be treated asemployees or as self-employed would not be exposed to the tax risk thatcurrently attaches to mis-classifying workers. (There might be a much smallerrisk connected with the taxation of benefits in kind, but even that risk could beeliminated by making other, much more modest, changes.)

• The personal service company and managed service company legislationcould be repealed. In addition, national insurance categorisation regulationsthat deem certain types of work to be liable for employment-level contributionscould be abolished.

• It would make a merger of income tax and national insurance feasible. Thatwould hold out the prospect of a significant simplification of the tax system.

If the burden of national insurance on employment were reduced to the level at

which it currently falls on self-employment, this would mean reducing the mainemployee rate by 3 per cent, and abolishing the 12.8 per cent employercontributions. Alternatively, employee contributions could be reduced by moreand employer contributions by less. That would have different distributionaleffects but the same overall Exchequer cost.

Such a change would clearly only be feasible in the long term. But the effectwould be greatly to reduce the total revenue from national insurance, from itspresent level of about 70 per cent of income tax revenue (HMRC table 1.2,updated May 2009) to under 30 per cent of income tax revenue. It would then bemuch more feasible than currently to merge income tax and national insurance,

by abolishing the latter and increasing the rates of the former. It is not possible tosay now that this would be the right thing to do. It would shift some of the burdenof taxation from income from labour onto income from capital. But it wouldcertainly be worth considering. If the proposed reforms in Section A7 to reducethe tax burden on income from capital were introduced, the overall package mightbe acceptable to the providers of capital. It is particularly worth noting that theremoval of employers’ contributions would itself be of benefit to capital, in that itwould reduce the cost of having a workforce and thereby increase returns tocapital, particularly capital that was invested in employment-intensive businesses.

A10 Indirect and local taxes

The UK has a large number of indirect taxes which fall on the value oftransactions, or on the quantity or value of goods, rather than falling on profits.These taxes contribute a large proportion of total revenue. Estimated receipts for2009-10 include £64bn from VAT, £27bn from fuel duties, £9bn from alcoholduties, £8bn from tobacco duties and £5bn from stamp duties (HMRC table 1.2,updated May 2009).

The long-term role of every tax should be questioned. But the scope for radicalchanges in these taxes is limited in the shorter term, partly because of the need

for revenue and partly because the most significant one, VAT, is heavilygoverned by European law. There are also social arguments for some of thetaxes, the merits of which fall outside the scope of this report.



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The discussion in this chapter is therefore limited to the merits of changing therates of some taxes, and to some detailed policy changes.

A10.1 VAT

VAT is a creature of European directives. Many policy changes would need theagreement of all 27 member states. But VAT rates are under the control ofindividual member states, and changes should be considered.

The standard rate of VAT

The UK’s rate is 15 per cent until the end of 2009, when it will revert to 17.5 percent. This is comparatively low. France uses 19.6 per cent, Germany 19 per cent,Italy 20 per cent and Denmark and Sweden 25 per cent. Changes to the UK

standard rate would have significant effects on revenues, about £4.3bn perpercentage point (HMRC table 1.6, updated May 2009).

The general thrust of this report is that tax burdens should come down, in theinterests of improved economic performance. But there is also an economic casefor switching tax from taxes on income and profits to taxes on consumption,moving the burden away from the supply side. VAT increases may therefore beused to fund reductions in other taxes.

The main objection in the past to increases in VAT has been the effect on theretail prices index and costs that are linked to it, such as pensions and benefits.But if the way in which total tax revenue were raised was merely re-arranged,

with a VAT increase being matched by reductions in other taxes, it would bereasonable to strip VAT changes out of the index that was used to computeincreases in state pensions, public sector pensions and benefits, becausepensioners and benefit claimants would benefit from corresponding reductions inother taxes, either directly or because the costs of businesses from which theybought goods and services would be reduced. Such an approach should nothowever be adopted for investments, such as index-linked gilts and nationalsavings certificates, because investors made specific contracts under which theywould benefit from increases in the retail prices index. The same might be said ofprivate sector pension schemes that incorporated index-linking.

In the light of these considerations, and the difficult fiscal circumstances that arelikely to persist for several years, we recommend increasing the standard rate ofVAT to 20 per cent in order to help to fund the other measures. The overallpackage would still involve a substantial tax reduction.

The zero and reduced rates of VAT

The UK applies a zero rate to food, children’s clothing, public transport andnewspapers, amongst other things. There is also a rate of 5 per cent on fuel andpower for domestic use. The zero rates have been largely unchanged since theintroduction of VAT in 1973. They still reflect the wish of the Government at the

time to preserve the exemptions that had existed in purchase tax.



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At least some of the zero rates were justifiable on social grounds in 1973, but withincreases in the standard of living, it is not at all clear that they are still justified. Ifthe desire is to help people on low incomes and their families, benefits would be abetter-targeted way of doing so. A large deadweight cost attaches to givinggeneral zero rates. There is also the problem that the existence of zero rates can

give rise to absurd legal arguments about what does or does not qualify, as forexample with Jaffa cakes and with hot takeaway food: cases on the latter are stillcoming before tribunals, 25 years after zero-rating was withdrawn from hot, butnot cold, takeaways.

Abolition of some of the zero rates could yield substantial tax revenue, althoughthis should of course be used to fund tax reductions elsewhere, rather thanincreasing the total tax burden. Estimated costs of zero rating include £12bn forfood, £5.6bn for domestic construction, £2.8bn for passenger transport, £1.5bnfor books, newspapers and magazines and £1.2bn for children’s clothing (HMRCtable 1.5, updated April 2009). This is not to say that all zero rates should beabolished. There would be significant knock-on effects, for example on theconstruction industry and on the choices that people would make between publicand private transport. But the zero rates should certainly be examined to seewhich ones were still justified, and which ones were not.

The reduced rate of 5 per cent for fuel and power for domestic use should also beexamined. The estimated cost to the Exchequer is £3.5bn (HMRC table 1.5,updated April 2009). Given that the Government seeks to cut emissions, oneshould at least consider abolishing this reduced rate in order to tilt the balance infavour of improved home insulation. Again, increased revenue should be used toreduce other taxes.

Exemptions from VAT

Exemptions are different from zero rates. As with zero rates, VAT is not chargedon an exempt supply. But a trader who makes zero-rated supplies can reclaimthe VAT that he has suffered on purchases, whereas a trader who makes exemptsupplies cannot do that. So the VAT burden on an exempt supply is the VAT onwhatever needs to be bought in order to make the supply.

Exemptions, like zero rates, can be a significant source of litigation. Forexemptions, this is partly because they are defined in a European directive andthen implemented in domestic law, and there is scope to debate whether

domestic law correctly implements the directive. In particular, the exemption forfinancial services has led to litigation in the context of outsourcing by banks andthe management of investment funds. It is unfortunate for a tax to be so prone tolitigation, because it makes the tax uncertain in its operation. The exemption forfinancial services is also the most significant in terms of Exchequer cost, at£4.4bn a year (HMRC table 1.5, updated April 2009).

There is, however, an obstacle to removal of the financial services exemption,even if one were to assume that its removal would be desirable. This is thatdespite much thought over many years, no-one has yet come up with a workableway of charging VAT on financial services. VAT would, for example, have to be

charged on interest and on foreign exchange transactions. And changes to anyexemption would require the agreement of all 27 member states. We therefore



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recommend the continued study of exemptions, and in particular of the financialservices exemption, but do not propose specific changes. We also accept thatinsurance premium tax should continue as a surrogate for VAT, so long asinsurance remains exempt from VAT.

Other policy changes

When VAT was introduced in 1973, it was promised to be a simple tax. Businesspeople who have to deal with its intricacies no longer see it that way. But it isparticularly important to make VAT as straightforward as possible to administer,because it tends to be administered by business people themselves rather thanby their professional advisers. Business people need to get involved becauseVAT applies to each transaction, with returns being made regularly throughoutthe year. If a business does not get VAT right as it goes along, help after theevent from professional advisers is likely to come too late to pick up all of thepieces.

It is therefore essential to be constantly on the look-out for irritants in the system,and for small policy changes that would reduce burdens. This is indeed whatHMRC do, with regular consultations with practitioners and frequentimprovements to guidance. But when a change in the law would be needed, theneed to comply with the precise terms of European directives can be a handicap. As and when directives are revised, it would be helpful if they could be phrasedso as to impose standardisation only where it is needed for the functioning of theSingle Market, allowing maximum flexibility on other points.

One particular reform would be useful. VAT normally becomes due once aninvoice has been issued. If, for example, a business has a VAT accounting period

that runs from January to March, and it makes a sale in March, the VAT is due onthe payment date for the quarter, 7 May for electronic payment, even though thecustomer may not pay until June. In order to address the potential cash-flowproblem, businesses with turnover of up to £1.35m can choose the cashaccounting scheme, under which VAT is only due once the customer has paid thebusiness (and correspondingly, VAT on a purchase can only be reclaimed oncethe business has paid its supplier). Up to now, the UK and the few other memberstates with cash accounting schemes have had to negotiate them individually. Adraft directive that was published in January 2009 would give general permissionto introduce such schemes, with turnover limits of up to €2m (COM(2009) 21final, pages 14-15). But a significantly higher turnover limit could help a

substantial number of businesses. We therefore believe that before the directiveis enacted, the turnover limit should be changed to at least €4m, with a provisionto increase this limit easily as circumstances require.

A10.2 Alcohol duty, tobacco duty and bett ing and gaming duties

These taxes exist partly for social policy reasons, and the validity of thosereasons is outside the scope of this report. The one point we would make is thatthe taxes do have significant impacts on the industries concerned, and thatgovernments should be mindful of this when considering changes. The fact that

the taxes may reduce behaviour that might be regarded as undesirable does not



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justify using the taxes as a convenient source of cash whenever more funds areneeded.

A10.3 Environmental taxes

Environmental taxes are constantly on the policy agenda. There is a real dangerthat they will come to be an excessive burden. While we do not have specificpolicy proposals in this area, it is important to respect four key principles forenvironmental taxation:

• Increases in revenue raised from environmental taxes should be matched byreductions in the revenue raised from other taxes. Environmental taxes mustnot become a tool to increase the size of the overall tax burden.

• Taxes should apply equally to businesses and to private consumers, and theamounts due should appear on bills or tickets sent to private consumers. This

will ensure that consumers are fully aware of the burdens that are beingimposed in the name of the environment.

• Environmental taxes should be simple in design and straightforward in theirapplication. They must also be introduced with ample warning, and withadvance publication of detailed guidance on what needs to be done.

• Environmental taxes should be designed to do their job properly. The level ofa tax should match the cost of the environmental damage. The onus must beon the Government to demonstrate the scale of the relevant costs. A fullappraisal should be conducted to ensure that a new tax or a tax change willnot cause the offending behaviour simply to relocate to another country and

continue to do the same (or possibly more) environmental damage.

Not all current environmental taxes respect these principles. The climate changelevy does not apply to fuel and power for domestic use. The link between levelsof vehicle excise duty, hydrocarbon oil duties and the environmental and roadrepair burdens that are imposed by traffic is unclear. Air passenger duty hasbecome excessive in relation to environmental damage. And the levels of landfilltax and, to a lesser extent, the aggregates levy have increased in such a way thatone must doubt that they are closely geared to environmental costs.

A10.4 Customs dut ies

Customs duties are imposed at the European Union level, on imports to theEuropean Union as a whole. Here we only make the general point that it makeseconomic sense to reduce customs duties and to encourage free trade.

A10.5 Stamp duty reserve tax and stamp duty

Stamp duty reserve tax is a 0.5 per cent tax on the value of each sale of sharesor of certain other securities. There is also a 1.5 per cent tax on value when ashare or other security enters a clearance system, but then transfers when it is

within the clearance system are not subject to the 0.5 per cent tax. Sometimesthe charge is replaced by an equivalent charge to stamp duty.



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In the medium term, the tax should be abolished. The City of London remains amajor earner for the UK, and anything that clogs up markets in securities is to bedeplored. There are several arguments for abolition:

• The duty reduces the likely return from holding shares and thus increases thecost of raising capital for UK firms. The burden is indirect, in that it arises

when newly-issued shares are sold rather than when they are issued, but it isstill there. Subscribers for shares will take into account the fact that the costwill in due course be incurred.

• Only the UK among its main rivals as a centre for financial transactions has alevy of this kind. Abolition would give a clear boost to the City of London. It istrue that many companies based abroad choose to be listed in Londonanyway, because of the benefits to their share prices, but as other financialcentres become more and more competitive, every little advantage helps.

• A further problem that duty causes for the UK as a financial centre is thecharge on the creation of units in unit trusts. This is one of the reasons the UK

is not a major base for cross-border mutual funds. The 2009 abolition of UKtax on cross-border dividends removes the other major disadvantagecompared to competitors such as Luxembourg. In a recent consultation theyield of stamp duty reserve tax on unit trusts was estimated at £40m, which isinsignificant compared to the commercial damage. The government took theview that the charge had to continue to prevent private unit trusts being usedby companies as a way to avoid stamp duty on dealing in their shares. Abolition of the duty would remove this problem.

• Sophisticated investors who expect to deal frequently in components of theirportfolios can invest in shares through other instruments, such as contractsfor differences, which do not attract duty, a possibility that arises becausemarket makers can deal without paying duty. Hedge funds, for example, usethis method. Given that contracts for differences can be created by foreigncounterparties, as well as UK counterparties, there is not much the UKauthorities can do about this. But it is an undesirable trend because it createsmajor risks for investors if their counterparties overextend themselves or if theauthorities interfere with a particular type of market activity, as with the ban onshort selling of shares in financial firms that applied in the autumn of 2008. Itcannot be logical to continue with a tax that can be so easily avoided in a waythat adds greatly to the risks in the financial system.

• At a time when returns on investments held by pension funds are low, a tax

on dealings, however small, increases pension fund deficits and thereforebusiness costs. Many pension funds are unwilling or unable to use contractsfor differences, due to investment restrictions in their trust deeds, and the dutyis an important element in their cost of operating equity portfolios. Even if theirholdings are only changed once a year, the cost of the duty will be likely toexceed their annual investment management fees.

A10.6 Stamp duty land tax

Stamp duty land tax applies to sales of land and buildings. It is a very convenient

tax for governments to levy, because although the sum charged on any onetransaction is large, it is a small proportion of the total amount involved in the



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transaction. The revenue from the tax also rises with the price of land andbuildings. While gains on commercial property are taxed, most gains onresidential property are not subject to capital gains tax, and stamp duty land taxcould be seen as a very approximate substitute for the taxation of those gains.The tax is also a substantial source of revenue. In 2007-08 it yielded £10bn, of

which £6.7bn came from transactions in residential property and £3.3bn fromtransactions in non-residential property (HMRC table 15.4, updated September2009). It should however be noted that the yield for 2008-09 was lower at £4.8bn,of which £3bn came from transactions in residential property and £1.8bn fromtransactions in non-residential property (HMRC table 15.4, updated September2009).

The tax cannot be regarded as a very high priority for abolition, although like alltaxes that are not limited to addressing externalities, its imposition will in itself doeconomic harm. But its structure should be reformed. There is currently a slabscale. Using the rates that will apply from 1 January 2010, there is no duty if theconsideration is up to £125,000 (residential property) or £150,000 (non-residentialproperty). But if the consideration exceeds the threshold by even £1, duty of 1 percent is payable on the entire consideration. Similarly, if the consideration lies inthe band from £250,001 to £500,000, duty of 3 per cent is payable on the entireconsideration, and above £500,000, 4 per cent is payable. Thus the differencebetween duty on a house that is sold for £250,001 and one that is sold for£250,000 is £7,500 - £2,500 = £5,000. Not only is this an utterly irrationalstructure. It clogs up the market for properties with values that are around thethresholds, with buyers very keen to get reductions to just below the thresholdswhile sellers are reluctant to give reductions because they do not see anyadvantage accruing to them.

We therefore propose a move to a slice scale, under which the first £x ofconsideration would be charged at 0 per cent, the next £y at 1 per cent (orperhaps at 2 per cent), and so on. Then a small increase in consideration couldonly lead to a small increase in duty. The bands and rates could be set toproduce revenue-neutrality or a reduction in revenue, as desired. It is not possibleto say in advance precisely what rates would be appropriate, because muchwould depend on the state of the housing market. And the duty on sometransactions would be higher than it would be under the current scale. But giventhat transactions in relation to any one property are only occasional, it should beeasier to handle the problem of winners and losers than it normally is when taxscales change.

A10.7 Local taxation

Politicians who are elected locally make decisions on spending, both on the totalamount to be spent and on how it should be spent. Ideally, those who decide howto spend public money should be responsible for raising the same amount ofmoney, so that they must answer to their electorates for all of the taxation that isrequired in order to fund the spending. Then voters appreciate directly that thereis no free lunch to be had. They must pay for whatever public spending theywant.



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Current local government finance arrangements are very far from that ideal.Roughly three quarters of the amount that is spent by local authorities is paid forout of national taxation (including business rates, which are a national tax thathappens to be collected locally). This makes national politicians answerable forthe tax burden that corresponds to local spending decisions. This mismatch

reflects the wide disparities in wealth between different local authorities. If areasonably substantial range of service provision is to be delegated to them,allowing local as opposed to national democratic influence on that provision, thenthe total amount of spending that is delegated is inevitably beyond the means ofsome local authorities. They could not fund it all by levying taxes on theirresidents and businesses.

One long-term option would be to re-allocate services from local to nationalprovision, but that would have significant implications for responsiveness to localneeds, and it should not be done merely to solve a tax problem. Another optionwould be to expand local taxation powers from council tax by allowing localauthorities to set levels of business rates, but that would tempt some localauthorities to impose high rates, knowing that no votes were immediately at stakebut damaging their local private sector economies. Finally, one could amend thefunding arrangements so that while the level of rates did not vary nationally, thefunding that was available to a local authority was more directly geared to thenumber and size of businesses that it managed to attract. This last option wouldamount to an expansion of the Local Authority Business Growth IncentiveScheme.

Another, overlapping, set of issues relates to the structures of the taxes that exist.Council tax is imposed on property values, and is unrelated to incomes. Ittherefore needs to be supplemented by council tax benefit, which helps low-

income people but in the process leaves many of them not liable to pay counciltax at all. That is bad because it gives them a direct incentive to vote for high-spending councils. They will reap the benefits without directly suffering any cost.Local income taxes have therefore been suggested, but they would have thedisadvantages of administrative complexity and of leading to even highermarginal tax rates than currently exist on higher incomes.

Given the difficulty of finding reforms that would command general assent, we donot propose large-scale reforms to local taxation in this report. We would howeverlike to emphasise the importance of not making changes that would increase thetotal tax burden. Specifically, it is important to ensure that the burden of business

rates does not increase. Rates are a fixed cost that must be paid regardless ofprofits, so it is particularly important that their level be kept under control. At themoment, there is a good control, which is that the total burden must not increasefaster than the retail prices index. This control is not perfect: the five-yearlyrevaluations can lead to substantial winners and losers within the well-controlledtotal burden. And it is being breached with the introduction of business ratesupplements, some of which will pay for useful infrastructure but others of whichmay be used to finance wasteful projects. But it is still, overall, one of the bestcontrols on tax burdens that we have. It is therefore essential to keep it in place.



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Annex B

Costings and implementation

In this annex we set out a specific proposal, cost it and propose a scheme ofimplementation. The proposal is not the only one that would reflect the contentsof Annex A. Any government that was minded to adopt our approach would haveplenty of room to make a range of detailed choices. But it is important todemonstrate that our approach is practical, as well as being attractive in theory. And the way to do that is to give an example of how it could be put into effect,starting from where the UK is now.

Only the changes that we definitely propose should be made are covered here. In Annex A, we suggest a range of other changes for consideration. But since theyare not firm proposals, we have not incorporated them in our costing or our

scheme of implementation.

References to tables in the form “T1.2, May 2009” are to tables that are publishedby HM Revenue & Customs and to the date of the edition used. These tables areavailable at http://www.hmrc.gov.uk/thelibrary/national-statistics.htm.

B1 The proposal and costings

The baseline

As set out in Section A1, the baseline is the tax system as it will be under currentplans, because these plans have been factored into revenue projections. Ittherefore includes the planned increases in national insurance, the plannedincrease in the small companies rate to 22 per cent, the planned 50 per centincome tax rate and the planned withdrawal of personal allowances at high levelsof income.

The costs of specific income tax proposals are, however, computed on the basisof tax rates of 20 per cent and 40 per cent, because the cost of reducing theincome tax rate is computed separately. This implies a moderate amount ofdouble-counting, given that the cost of reducing the higher rate from 40 per cent

to 35 per cent is also computed separately, but that errs on the safe side. Thereis also a modest under-statement of the cost of specific proposals in early yearswhen the highest tax rate would still be over 40 per cent, compensated by over-statements in later years, but the effect should be small because the onlymeasures that would be affected and that would take effect within the first fiveyears would be the proposed change to the rules for ISAs, and the proposal toallow unincorporated businesses to disregard small adjustments to profits.

Reduce the main and small companies corporation tax rates to 15 per cent

The main rate is currently 28 per cent. The small companies rate is 21 per cent,but this is projected to rise to 22 per cent from 1 April 2011, a rise that is factoredinto Government projections, so we have taken 22 per cent as the starting point.The cost is hard to specify precisely, because the revenue from corporation tax



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fluctuates considerably depending on the state of the economy. But a reasonablefigure for annual revenue is £45bn (T1.2, May 2009). This gives an upper boundon the Exchequer cost of £45bn x (28 – 15)/28 = £21bn.

The actual cost would not be as high as this, because reductions in the main rate

from 28 per cent to 22 per cent would have no effect on the revenue fromcharging the small companies rate, and would also reduce the marginal relief thatwas given when profits were between £300,000 and £1.5m. The data that wouldbe needed to make a full calculation are not published, but some idea of the sizeof the effect can be gleaned from the fact that the small companies rate and themarginal relief reduce corporation tax revenue by about £4bn a year (T11.2, May2009). On this basis, £21bn could not be an over-estimate by more than £4bn. Itis reasonably cautious to take £20bn as our cost.

Two points are worth noting about the figures in T11.2, May 2009. The first is thatthe table excludes overseas, life assurance and North Sea companies, but thedifference made by them to the effects of the small companies rate and ofmarginal relief would be very small. The second is that the table includes largefigures for double taxation relief. This relief will not apply to overseas dividendsthat benefit from the dividend exemption which was introduced in 2009, but theeffect on corporation tax revenues will be small because the dividends willcorrespondingly no longer be included in taxable profits, and because doubletaxation relief has historically covered most of the tax on those dividends.

Do not tax gains or allow losses on shares held by companies

In order to cost this, we need to consider the tax paid on gains by companiesother than life assurance companies. The cost of the proposed changes to the

taxation of life assurance will be considered separately below.

The cost is difficult to estimate because figures for companies’ capital gains arenot published. Only figures for “trading income” and for “other income and gains”are given (in T11.2 and T11.5). But capital gains have long been known to formonly a small proportion of taxable profits, largely because of the ready availabilityof capital losses to set against the gains. And the substantial shareholdingsexemption, which already exempts gains on majority shareholdings in tradingcompanies that are held by trading groups, reduces tax revenue by only £260m ayear (T1.5, April 2009). Given that most commercial businesses will not have anyreason to hold shares other than shares in subsidiaries or in companies that carry

on joint ventures, it would not be plausible to think of the total revenue at stake asbeing more than £2bn. It may well be considerably less. (The fact that the figureis comparatively small means that it is not worth reducing the estimate givenabove for the cost of reducing the corporation tax rate to take account of thedouble-counting that is involved in accounting for loss of revenue on gains. Thedouble-counting implies a modest error on the safe side, over-estimating theExchequer cost of the proposals that are set out in this paper.)

Al low deduct ions for capi tal items currently ent irely disal lowed

The cost cannot be estimated accurately without a survey of tax computations,

but it should be small.



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Al low a cash basis for small unincorporated businesses

The cost should be negligible.

Changes to companies’ loss reliefs

Any change to the rules on relief for losses has three effects, two transitional andone permanent. The first transitional effect arises from the fact that lossesbrought forward from before the time of the change become either easier orharder to relieve quickly. The second transitional effect arises from the fact thatnew losses carried forward may on average be relieved faster or more slowlythan before the change. This shows up in a change in the stock of losses. Thus iflosses used to take four years on average to relieve but following a change takethree years, the stock of losses that are awaiting relief must as part of thetransition diminish by one year’s worth of losses carried forward. The permanenteffect arises from the fact that some losses never get relieved. If it becomeseasier or harder to obtain relief for losses, the amounts that go permanentlyunrelieved will decrease or increase, and that will decrease or increase taxrevenue.

Not only would the transitional effects be one-off. They could be spread quitethinly if required, for example by imposing restrictions on the use of losses in theearly years. We therefore concentrate on the permanent cost here, although wealso make allowance for the transitional cost when setting out the implementationplan.

By far the most significant losses are trading losses and non-trading loanrelationship deficits. The changes that are proposed in this paper would give rise

to three significant effects on tax revenue, as follows:

• Non-trading loan relationship deficits could be carried back against theprevious year’s profits of all types, instead of only against non-trading loanrelationship income.

• Non-trading loan relationship deficits could be carried forward against futureyears’ profits of all types, instead of only against non-trading profits.

• Trading losses could be carried forward against future years’ profits of alltypes, instead of only against profits from the same trade.

The effects of these changes need to be priced on the basis of a corporation taxrate of 15 per cent, given that the cost of reducing the rate to that level, on thebasis of the current tax base, has already been taken into account above.Data to allow a proper estimate of the permanent cost are not available. ButT11.2, May 2009, indicates that if we leave to one side North Sea oil businessesand life assurance businesses (for which figures are not given), the total lossrelief obtained each year is of the order of £20bn. This suggests that losses ofapproximately the same amount are generated in any one year. We then need toestimate the proportion of losses generated that go permanently unrelieved. Dataare not available, because loss relief claims are not made for such losses, butanecdotally, the proportion would appear to be under 10 per cent. Some of thesewould not come to be relieved under the proposals set out here, but others wouldcome to be relieved. We can guess that half of the unrelieved losses might come



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to be relieved. That would give a total annual tax cost of £20bn x 10 per cent x0.5 x 15 per cent = £75m.

As the published statistics do not allow us to cost the effects on North Sea oilbusinesses and on life assurance businesses, and as these types of business

already have special regimes which segregate different items in ways that do notapply across the corporation tax system, we do not propose extending this reformto those types of business. It may be that this reform, or some similar reform,should be made for North Sea oil businesses or for life assurance, but that wouldbe for further consideration at the time. And under our plans, life assurancecompanies would only continue to be taxed on the shareholders’ portions ofprofits.

The abolition of special reliefs

Special reliefs for research and development, for the purchase of energy-savingassets, for venture capital investments and for the making of films should beabolished to simplify the tax base and to remove distortions.

To the extent that the corporation tax base would be broadened, the effect shouldbe measured at the proposed new tax rate of 15 per cent rather than the currentrates of 28 per cent and 22 per cent, because the cost of the proposed ratereduction is based on the corporation tax base as already reduced by the effect ofthese reliefs. Expanding the base by removing the reliefs will therefore increasetax revenue by the expansion multiplied by the proposed rate. As most relief thatis against taxable profits will currently be given at 28 per cent, a reasonablemeasure of the effect will be the current cost x 15/28. This gives the followingresults.

T1.5, April 2009, gives costs for corporation tax purposes of £580m for researchand development tax credits and £95m for enhanced capital allowances forenergy-saving technology. (An unknown part of the latter figure is for income taxrelief, but treating it all as corporation tax relief will err on the safe side in costing.)These two together give additional corporation tax revenue of £675m x 15/28 =£362m.

Table B.1, April 2009, note 10, gives the cost of film tax relief as £110m. This isthe amount that is spent on directly payable tax credits, at fixed rates of 25 percent or 20 per cent. This cost is unaffected by the rate of corporation tax, and the

amount is currently regarded as public spending rather than as a reduction in taxrevenue, so the full potential saving of £110m should be taken into account.

T1.5, April 2009, gives an income tax cost for venture capital trusts and theEnterprise Investment Scheme of £60m + £130m = £190m. Changes incorporation tax rates would not affect this figure.

The total additional tax revenue under this heading, available to help to fund taxreductions, is therefore £362m + £110m + £190m = £562m.



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Tax dividends received by non-companies at full income tax rates with notax credit, but do not tax stock dividends

Basic-rate taxpayers currently pay no tax on dividends, while higher-ratetaxpayers pay 25 per cent of net dividends received. The additional revenue from

moving to full income tax rates and not taxing stock dividends should therefore be(0.4 – 0.25) x net cash dividends that would be paid to higher-rate taxpayers +0.2 x net cash dividends that would be paid to basic-rate taxpayers – 0.25 xdividends currently paid to higher-rate taxpayers that would cease to be taxablebecause not taken in cash. The dividend figures to use are hard to estimate,because there would be substantial behavioural effects. Taxpayers might wellcome to prefer stock dividends because they would allow the deferral of tax untildisposal of the shares. On the other hand, some would rather have the certaintyof cash, or would need cash. (The sale of a small proportion of a shareholding inorder to yield the full cash dividend with immediate tax on just a small proportionof it would not be a popular option because of transaction costs.) And companies,benefiting from a reduced corporation tax rate, might pay higher dividends thanhitherto.

The best we can do here is to calculate the order of magnitude of the amountsthat would be involved, and to consider whether they might significantly upsetcostings. T3.7, December 2008, gives investment income for 2006-07, by rangeof total income. There is an income range to exclude those whose income is toolow to pay tax, and we can reasonably take half of the dividend income of thosewho have total income between £30,000 and £50,000 as being taxed at thehigher rate. (The total income at which higher-rate tax would start to apply was, in2006-07, £38,335, but some of the dividend income of some higher-ratetaxpayers would be taxable at the basic rate.) On that basis, £11.4bn of dividend

income would be attributed to basic-rate taxpayers and £30.1bn to higher-ratetaxpayers. These figures are for income that is taxable under current rules, sothey must be multiplied by 0.9 to give net dividend figures of £10.3bn and£27.1bn. If there were no behavioural effects, the potential effect on tax revenueswould be an increase of 10.3 x 0.2 + 27.1 x 0.15 = £6.1bn. Clearly there would bebehavioural effects, and some reduction in tax revenue from higher-ratetaxpayers switching from cash dividends to stock dividends. But the magnitude ofthe tax yield assuming no behavioural effect shows that we can at least discountthe risk of a tax loss from this change.

Deduct accounts depreciation in computing the profits of unincorporated

businesses

This change would have two opposing effects on tax revenues. It would slow therate at which the cost of assets that currently qualify for capital allowances wouldbe deducted from taxable profits, increasing the tax base in the short term (andpermanently if total spending on such assets grew). But it would also acceleraterelief for the cost of other capital assets, which is currently given only when theyare sold. It would permanently increase the value of relief for those assets wherethey were sold for less than cost, because relief would be in the form of adeduction from income rather than in the form of a capital loss.

Unfortunately, the data that would be needed to compute the sizes of theseeffects are not publicly available. The fact that there would be effects in opposite



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directions should reduce the net effect, but it could still be substantial. We havenot attempted to cost this proposal. There are however grounds to think that theeffect on tax revenues would be positive. The reduction in the rate of capitalallowances on general plant and machinery from 25 per cent to 20 per cent thatwas announced in 2007 was expected to bring in far more revenue than was

expected to be lost from increasing the rate of allowances on long-life assets from6 per cent to 10 per cent. (The figures for 2009-10 were +£2,270m and -£380mrespectively, as shown in Budget 2007, table A1, lines 2 and 3, page 208. Thefigures for the proposal here would be much smaller, because the 2007 changeapplied to incorporated businesses as well as to unincorporated businesses.) Ifthe effect on tax revenues were expected to be a substantial increase, this couldbe used to fund reductions in other business taxes.

Al low unincorporated businesses to ignore prof it adjustments that wouldhave a net total of less than £1,000

The data that would be needed to compute the impact on tax revenues are notpublicly available. We can however compute an upper limit to the cost. T3.9,December 2008, shows that in 2006-07 there were five million individuals withincome from unincorporated businesses, and that only about 600,000 of themhad income from those sources that would suggest that they were higher-ratetaxpayers. (More might be higher-rate taxpayers, because of income from othersources, but there is no reason to suppose that a substantial number would be.)So even if every business decreased its taxable profits by a full £1,000, themaximum loss of revenue, taking both income tax and national insurance intoaccount, would be 4.4m x 1,000 x 0.28 + 0.6m x 1,000 x 0.41 = £1.5bn. This is ofcourse likely to be a large over-estimate, because most businesses would beunlikely to find £1,000 of currently disallowed expenditure to claim. But we have

used a cost of £1.5bn in order to err on the safe side.

Introduce a disincorporation relief

Disincorporations that would lead to significant tax charges are currently stronglydeterred by the lack of a relief, so it is unlikely that any significant amount of taxthat is collected on such transactions would be lost on the introduction of a relief.

Any loss of tax would come from businesses and their proprietors paying less taxunder the income tax regime than they would under the corporation tax regime.Given that the businesses most likely to disincorporate would be those that paid

the small companies rate of corporation tax, which is only just above the basicrate of income tax and would fall to below the basic rate under our proposals, thisshould not happen on any large scale and the cost should be low.

Abol ish c lass 2 national insurance cont ributions

National Insurance Fund Account 2007-08, page 13, note 2, gives revenue of£290m. In addition, Northern Ireland National Insurance Fund Account 2007-08,page 14, note 2, gives revenue of £6m. The cost might be a little higher than in2007-08, but it would clearly be close to £300m.



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Reverse the 1 per cent increases in national insurance rates that areplanned fo r 2011

The annual yield from the initial proposal to increase national insurance rates by0.5 per cent is expected to be £5bn (Budget 2009, table A2, lines j to n, page

154). The annual yield for the further 0.5 per cent increase, net of the increase inthe primary threshold, is expected to be £3.2bn (Pre-Budget Report 2009, tableB4, page 173). The total cost of reversing all of these changes would therefore be£8.2bn.

Reverse the withdrawal of the personal allowance

The long-term annual yield from withdrawal of the personal allowance is expectedto be £1.5bn (Budget 2009, table A1, footnote 2, page 153).

Reduce the 50 per cent income tax rate to 40 per cent in steps of 2 per centa year, and then reduce the 40 per cent rate to 35 per cent in s teps of 1 percent a year

The long-term annual yield from the introduction of the new 50 per cent rate isexpected to be £2.4bn (Budget 2009, table A1, footnote 3, page 153). We cantherefore cost the reduction to 40 per cent at £0.48bn per 2 per cent reduction.

T1.6, May 2009, gives the cost of a 1 per cent reduction in the 40 per cent rate ofincome tax as £910m in 2009-10 and £1,400m in 2010-11. The differencepresumably reflects the effect of withdrawing the personal allowance for highearners. Given that under our proposals, this effect will have been reversed, it islikely to be appropriate to use a figure of £1bn for each percentage point.

Tax interest received by individuals only if it falls within the higher-rateband, and only at the excess of the higher rate over the basic rate

The tax lost, at current tax rates of 20 per cent and 40 per cent, would be 20 percent of all interest income that was subject to income tax. (The rate to apply incomputing the cost would be 20 – 0 = 20 per cent for basic-rate taxpayers, and40 – 20 = 20 per cent for higher-rate taxpayers.) There would then be a smalladjustment for interest that was currently taxed at 10 per cent.

T3.7, December 2008, gives interest income for 2006-07 of about £17bn, very

little of which would not have been subject to income tax. That would give a taxcost of £3.4bn. The amount should perhaps be adjusted upwards slightly forhigher incomes, but on the other hand it would fluctuate considerably with theinterest rates that were available to private savers.

Al low the whole of the ISA lim it to be used for shares, in terest-bearinginvestments or any combination of the two

The cost would be the effect of people choosing to move money currently not intax-free interest-bearing investments within ISAs into such interest-bearinginvestments, to the extent that they could not already do so because they were

already up to the limit on such investments (£5,100 from 2010).



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T1.5, April 2009, gives the 2007-08 cost of ISA relief as £2bn, much of which willrelate to interest rather than dividends because only higher-rate taxpayers savetax on dividends by holding shares in ISAs. That figure reflected an overall ISAlimit of £7,200 rather than the new £10,200. The increase in the limit that wasannounced in the 2009 Budget was expected to have an Exchequer cost of £60m

a year after two years (Budget 2009, page 152, table A1, line 17). The fact thatthe increase in the cost was proportionately far less than the increase in the limitsuggests that many ISA users are not currently at the limit, or at least cannot beexpected to take full advantage of any increase. This is borne out by T9.4, July2009, which shows that in 2008-09 the average cash subscription was £2,480,rather less than the maximum of £3,600. We may therefore take it that the cost ofthe proposed change would be rather less than £100m, but we use this figure inthe overall costings so as to err on the safe side.

Changes to the taxation of insurance policies

The main proposed change is to replace the 20 per cent tax charge within lifeassurance companies on the policyholders’ share of profits with an 18 per centcapital gains tax charge on policyholders, giving policyholders the benefit ofavailable capital gains tax annual exempt amounts. Those exemptions would bein the proceeds-based form that is described in Section A8.1.

The reduction in the rate on policyholders’ profits is costed at £740m in 2007-08and £160m in 2008-09 (T1.5, April 2009). The 2008-09 figure is abnormally low,reflecting the economic downturn. So if we take the 2007-08 figure, it wouldsuggest corporation tax currently collected on these profits of £740m x 20/8 =£1.85bn.

The extent to which such a loss of revenue would be counter-acted by chargeson policyholders is unclear. Even if we fixed thresholds for the re-designed capitalgains tax annual exempt amount, everything would depend on the sizes ofpolicies, and on the extent of any behavioural change that led people to makewithdrawals each year in order to use up every year’s annual exempt amount.

We also cannot assume that the reduction of the de minimis withdrawalallowance from 5 per cent to 0.5 per cent of capital would yield significantamounts of tax.

We must therefore conclude that the total tax cost of the package could well

exceed £1bn a year, and that it could rise to £1.5bn or more. This reform istherefore likely to be a fairly low-priority reform.

Change the CGT annual exempt amount to a tapered proceeds-basedexemption using l imits of £5,000 and £10,000

The current annual exempt amount, which covers the first £10,000 of gains in ayear, is estimated to cost about £3.5bn a year. (This is the 2007-08 figure in T1.5, April 2009. The 2008-09 figure is only half of this, but it is abnormally lowbecause of the economic downturn. Changes to the CGT regime from April 2008onwards would affect the cost, but not hugely, because the anticipated overall

effect of those changes was to increase the yield from CGT by 15 per cent to 20per cent.)



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The proposed new form of exemption would exempt fewer gains, because gainsof over £10,000 cannot be realised unless proceeds are over £10,000. Thechange would therefore increase tax revenues. The likely increase is howeverhard to estimate, partly because data are limited and partly because there wouldbe some influence on taxpayer behaviour. Specifically, data on disposals, such

as those given in T14.4 and T14.6, reflect information that is reported on taxreturns. If gross gains fall below the annual exempt amount and proceeds belowfour times that amount, the gains need not be reported at all. This means that alarge proportion of the gains that the proposal would bring into charge are notreflected in the data at all. We can therefore recognise that there would be anincrease in tax revenue, but we cannot quantify it.

Introduce CGT on death

T1.5, April 2009, estimates that the current exemption for gains on death reducedtax revenue by £550m in 2007-08 and by £260m in 2008-09, a year in whichgains were probably abnormally low. The approach to exemptions on death thatis proposed here would affect the cost, but probably not hugely. We canreasonably score a yield from this proposal of £300m, but this figure must beregarded as subject to a wide margin of error. At least we can be confident thatthere would be no decrease in tax revenue from this change.

Abol ish IHT

Inheritance tax yielded £3.5bn in 2006-07 and £3.8bn in 2007-08, and it isexpected to yield £2.8bn in 2008-09 and £2.3bn in 2009-10 (T1.2, May 2009). Wemay reasonably estimate the loss of revenue from its abolition at £3.5bn a year.

Replace the proposed restriction on relief for pension contributions with amuch lower contributions limit

The new limit could be chosen so as to be revenue-neutral. Estimates vary, butthere is an industry consensus that a limit on annual contributions of somethinglike £50,000 would be reasonable.

Al ign the base for national insurance wi th that for income tax onemployment income, except for pension contribut ions

The one large difference between the bases that would be eliminated would be

that which results from the current treatment of benefits in kind. The increase inrevenue that would come from extending employees’ national insurance tobenefits in kind can be estimated from the revenue that is shown in the Fund Accounts for employers’ contributions, both Class 1A and Class 1B, on thosebenefits. This totals about £1bn a year (National Insurance Fund Account 2007-08, page 13, note 2, and Northern Ireland National Insurance Fund Account2007-08, page 14, note 2) This figure should then be multiplied by 98.7/77.2 toadjust for the NHS allocation of £21.5bn which leaves net revenue of £77.2bn.The result of this calculation is to increase the figure to £1.28bn

The portion of this that would reflect benefits in kind that fell within the band

between the primary threshold and the upper earnings limit then needs to bemultiplied by 11/12.8, and the portion that would reflect benefits that fell above



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the upper earnings limit by 1/12.8, in order to allow for the difference betweenemployee and employer contribution rates.

T4.2 for 2006-07 suggests that approximately 5,650/8,515 = 0.66 of benefitswould fall above the upper earnings limit, taking the earnings band that starts at

£40,000 as starting at the upper earnings limit. (The current upper earnings limitis higher, but income levels generally would need to be updated and thecorrection would probably be small. Any error is also likely to understate the extrarevenue that would be available from this source, because it is likely toexaggerate the benefits on which only 1 per cent contributions would be due.)

The expected extra revenue is therefore £1.28bn x (0.66 x 1/12.8 + 0.34 x11/12.8) = £440m. This figure is small enough that there would be little point inmaking the change purely for the sake of revenue. But it would also facilitate thetaxation of benefits through the payroll, an approach that is currently beingdeveloped to replace the long-standing P11D procedure.

Transform employers’ national insurance into a payroll tax

This is an administrative simplification that could be made in the short term, andthat would become redundant if employers’ contributions were to be abolished.That is, it would be the new payroll tax rather than employers’ contributions thatwas in the end abolished.

The change could be made on a revenue-neutral basis. It would just be a matterof selecting the correct rate or rates of tax. Then the costings given below for theabolition of employers’ national insurance would still apply.

In order to preserve the current bias in favour of a large number of jobs onmodest salaries rather than a few jobs on high salaries, there should be a zerorate band for each employer which equalled the number of employees multipliedby what is currently the primary threshold, or by something close to that figure,then a charge of a certain percentage of the balance of the payroll. If thepercentage were set at 12.8 per cent, the current employers’ contribution rate,there would be some fall in revenue because the allowance would be given in fulleven in respect of part-time employees who were not earning as much as thecurrent primary threshold, and then effectively transferred to set against the payof other employees. But the percentage could be increased slightly tocompensate for this.

Reduce the national insurance burden on employment to equal that on self-employment

This is a long-term goal, on account of the very high Exchequer cost. It should beconsidered after the ten-year plan for the other reforms, set out in Section B2,has been implemented.

Different sources give different figures for revenue from national insurance. T1.2,May 2009, gives revenue of £100bn in 2007-08, £97bn in 2008-09 and £98bn in2009-10. But the Fund Accounts state that the total revenue from employer and

employee contributions in 2007-08 was £72.5bn + £1.5bn = £74bn (NationalInsurance Fund Account 2007-08, page 13, note 2, and Northern Ireland National



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Insurance Fund Account 2007-08, page 14, note 2). The difference is mainlyexplained by the allocation of money to the National Health Service before payingthe balance into the fund. One additional thing that the notes to the Fund Accounts show is that all but about £2bn of contributions are derived from incomeon employment.

The division of the total into employer and employee costs is not published, butwe can use the Exchequer costs of 1 per cent reductions in the main rates, asgiven in T1.6, May 2009. For employee contributions, the 2009-10 cost is£3.75bn, while for employer contributions it is about £4.8bn. These costs wouldimply total revenue of £3.75bn x 11 + £4.8bn x 12.8 = £103bn. The costs in T1.6may therefore be slight over-estimates, but not greatly so.

On this basis, the Exchequer cost of reducing the main employee rate by 3 percent would be about £11bn a year (T1.6, May 2009). The Exchequer cost ofabolishing employer contributions would be about £61bn a year. Adjustments tothe estimates should be made for the effects on the base of the other nationalinsurance changes that are proposed here, but those adjustments would be smallin relation to the overall costs, and there is little point in estimating them so farahead of the implementation of significant reductions in national insurance.

Relax the rule on deductible expenses for employees

The precise effect of this change on tax revenues would depend on the degree ofrelaxation and on the details of the expenses currently incurred. It is not possibleto put a figure on the effect in advance. Even the detailed data from tax returnswould not help, because the items that would make a difference to tax revenueare not currently claimed on tax returns. It is however unlikely that the cost would

be very great, given that there are already special regimes to allow items liketraining costs and travel expenses which might be disallowed under the generalrules for employees’ expenses.

Increase the standard rate of VAT to 20 per cent

A change to the standard rate would have significant effects on revenues, about£4.3bn per percentage point (T1.6, May 2009). An increase from 17.5 per cent to20 per cent should therefore yield revenue of about £10.75bn a year.

Abol ish stamp duty reserve tax and stamp duty on t ransfers of secur it ies

The revenue from these taxes is up to £4bn a year, although the estimate for2008-09 is lower at £3.2bn (T15.1, September 2009).

Change stamp duty land tax f rom a slab scale to a slice scale

This could be done on a revenue-neutral basis by choosing appropriate bandsand rates.



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B2 Implementation

In this section, we set out an order of implementation of the proposals over a ten-year period (two full Parliaments), with overall costings. The current fiscalposition, and uncertainty about the timing and extent of the recovery, mean that

we should not be over-ambitious about the rate of progress. But thecompetitiveness of the UK corporate tax system is such a pressing issue thatcorporation tax rates need to start coming down soon. And some changes thatwould have little effect on tax revenues could be made within the first few years,with the constraints being time to do the detailed policy development work andspace in finance bills, rather than the fiscal position.

There is nothing sacrosanct about this particular implementation plan. Therewould be several possible ways to implement the proposals. The point of settingout a specific plan is to demonstrate that it would be practical to implement theproposals.

In preparing this plan, we have borne in mind the need to give immediate help inorder to protect jobs and investment. That is why we start with corporation taxreductions and with reversing the national insurance increases. Because theamounts involved in relation to national insurance are very substantial, and thedeficit is currently so large, we propose increasing the rate of VAT at the start. Asingle increase would be much less troublesome to retailers than a stagedincrease. While prices would be increased, take-home pay would be increasedthrough reversing the national insurance increases, and low-income familieswould be protected to some extent by the fact that food is zero-rated and thatdomestic fuel is charged at a reduced rate.

Reverse the 1 per cent increases in national insurance rates that areplanned for 2011, at the beginning of year 1

The annual cost would be £8.2bn.

Reverse the withdrawal of the personal allowance, at the beginning of year1

The annual cost would be £1.5bn.

Reduce the 50 per cent income tax rate to 40 per cent in steps of 2 per cent

a year, starting at the beginning of year 1, and the 40 per cent rate to 35 percent in s teps of 1 per cent a year, starting at the beginning of year 6

The annual cost of the reduction to 40 per cent would be £0.48bn per 2 per centreduction.

The annual cost of the reduction from 40 per cent to 35 per cent would be £1bnper 1 per cent reduction.

Increase the VAT rate to 20 per cent at the beginning of year 1

The increase in revenue would be £10.75bn.



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Reduce the main and small companies corporation tax rates by 1 per cent ayear fo r seven years, then the main rate by 2 per cent a year for three years,starting at the beginning of year 1

This proposal would meet the urgent need to restore the UK’s competitiveness by

working towards a corporation tax rate of 15 per cent. Reductions in the firstseven years would bring the small companies rate down to 15 per cent and themain rate down to 21 per cent. Then reductions in the following three years wouldbring the main rate down to 15 per cent.

The total cost, estimated above at £20bn, would be spread over the period. Sincethe vast majority of the revenue from corporation tax is paid at the main rate, wecan spread this across the 13 per cent reduction in the main rate, giving £1.54bnper percentage point. This would be the cost for each of the first seven years,with £3.07bn in years 8 and 9, and £3.08bn in year 10 (the two £0.01bnadjustments eliminate the rounding error).

Replace the proposed restriction on relief for pension contributions with amuch lower contributions limit, starting at the beginning of year 1

A suitable choice of limit would make this a revenue-neutral change. It would re-instate the basic principle, and the simplicity, of relief for contributions at thetaxpayer’s marginal rate.

Abol ish special rel iefs, s tar ting at the beginning of year 2

The additional revenue is estimated in Section B1 at £562m, on the basis of acorporation tax rate of 15 per cent. At current corporation tax rates, it would be

£675m + £110m + £190m = £975m, reducing by £675m/28 = £24.1m a year foryears 1 to 7, then £48.2m for years 8 to 10. The summary of fiscal effects belowtherefore takes credit for £926.8m in year 2, and thereafter an amount which fallsby £24.2m for each of years 3 to 7, then £48.1m for each of years 8 to 10(£48.1m is used rather than £48.2m to eliminate the rounding error).

Change stamp duty land tax from a slab scale to a slice scale, starting atthe beginning of year 3

This should be a straightforward and revenue-neutral change, but ample warningshould be given so as not to affect property transactions that were already being

negotiated. The timing might also be affected by predictions of the state of theproperty market and of the short-term effects of the change.

Al low the whole of the ISA lim it to be used fo r shares, in terest-bearinginvestments or any combination of the two, starting at the beginning of year3

The cost would be under £100m, but we have used £100m in the costing.



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the terms of an option to continue to claim capital allowances would also beimportant.

Al ign the base for national insurance wi th that for income tax onemployment income, except for pension contributions, starting at the

beginning of year 6

The effect might be to increase revenue by £440m a year.

Transform employers’ national insurance into a payroll tax, starting at thebeginning of year 6

This change could be made on a revenue-neutral basis.

Relax the rule on deductible expenses for employees, starting at thebeginning of year 6

The cost should be very small, although research would be needed in order tosubstantiate this impression.

Tax interest received by individuals only if it falls within the higher-rateband, and only at the excess of the higher rate over the basic rate, startingat the beginning of year 7

The cost may be estimated at £3.5bn.

Amend the ru les fo r rel iev ing companies’ losses, start ing at the beginningof year 7

The proposals were costed in Section B1 at £75m a year of permanent cost, solong as the corporation tax rate was 15 per cent. There would also be transitionalcosts, which could, as explained, be spread thinly. We propose implementation inthe seventh year, when the corporation tax rate would be 21 per cent, giving apermanent cost of £75m x 21/15 = £105m a year at first, diminishing over thefollowing three years to £75m as the corporation tax rate fell. There would also bethe transitional cost, which could be limited to £295m a year to give a total cost of£400m a year. As the permanent cost fell, restrictions could be relaxed so thatthe transitional cost rose, keeping the total cost at £400m a year until thetransitional period ended.

Abol ish stamp duty reserve tax and stamp duty on transfers of secur it ies,starting at the beginning of year 8

The lost revenue might be £4bn a year.

Abol ish IHT and introduce CGT on death, start ing at the beginning of year 9

The combined effect of these proposals may be estimated as a tax loss of £3.2bna year.



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Tax dividends received by non-companies at full income tax rates with notax credit, but do not tax stock div idends, starting at the beginning of year10

This is a major reform which would introduce an unacceptable level of double

taxation if it were made with a corporation tax rate of 28 per cent. We thereforepropose introducing it in the tenth year, once the corporation tax rate has fallen to15 per cent. As noted in Section B1, there is no reason to suppose that therewould be a significant loss of tax revenue. It must however be acknowledged thatthere is significant uncertainty about the effects, because the behaviour ofinvestors would change.

Make changes to the taxation of insurance policies, starting at thebeginning of year 10

The cost might be up to £1.5bn a year.

B3 The overall impact on revenue

A s tat ic basis

Making these changes, at the times given, and assuming no dynamic effects,gives the following overall reductions in revenue. The second column shows thereduction in revenue each year as compared to the immediately preceding year.The third column shows the total reduction in revenue, that is, the differencebetween the revenue without any of the changes (before year 1) and the revenuein the year in question. In common with the convention in tables in the

Government’s Budget documentation, reductions in overall tax revenue areshown as negative numbers.

Table B3.1: Effects on tax revenues on a static basis

Year Incremental change in revenue asagainst preceding year (£bn)

Total change in revenue asagainst before year 1 (£bn)

1 -1.0 -1.02 -1.1 -2.13 -2.1 -4.24 -4.0 -8.25 -3.9 -12.1

6 -2.1 -14.27 -6.5 -20.78 -8.1 -28.89 -7.3 -36.110 -5.6 -41.7

All figures have been computed without adjustments for inflation or for economicgrowth. Both effects would increase both the total tax take and the effect on it ofthe measures that are proposed here. And given that a range of taxes, computedon different bases, is involved, it cannot be assumed that the effects would beuniform. But the task here is to show that there is a feasible implementation plan.

Figures that based on the current size of the economy and on current prices canbe compared with the current tax take in order to test for feasibility.



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Given that these reductions are substantial, and that there is an urgent need toput in place a credible plan for the reduction of the deficit, it would not be sensibleto commit now either to the precise distribution of measures over the years, or toa year in which the programme should start. It would be more appropriate toregard the schedule given here as indicative. Once the plan for deficit reduction is

clear, the schedule should be reviewed. It would, however, be important tocommit to a schedule at the start of the period of implementation, in order to buildconfidence.

It should also be noted that the revenue from some taxes, especially corporationtax, fluctuates considerably from one year to the next. Thus there would beconsiderable fluctuations in tax revenue that were independent of the effects ofour proposals, as there are now.

Al lowing for dynamic effects

Plenty of economic studies have shown that reduced tax rates are good foreconomic growth. References to some of the studies are given in Chapter 1. It istherefore reasonable to suppose that a programme of tax reductions will itselfincrease yields from some taxes, helping to finance the programme.

We will only consider dynamic effects in relation to corporation tax, since this isthe tax that is most obviously likely to benefit from such effects. Other taxes maybenefit too, but if we exclude them, that reduces the risk of over-stating theoverall dynamic effect.

The tables below show what the figures would be in the overall costings tableabove, assuming (i) a 25 per cent dynamic effect spread over five years and (ii) a

50 per cent dynamic effect spread over five years.

There are two separate pairs of tables, to illustrate two ways of computingdynamic effects. But the message of both pairs of tables is the same: dynamiceffects make a significant difference to overall costings. Our programme of taxreductions is perfectly affordable.

Dynamic effects computed as taxable profit increases

Under the first method, it is taken that if there is a y per cent dynamic effect, theny per cent of the reduction in profits subject to corporation tax is restored by

increases in those profits.

That increase is spread over a five year period, starting in the year after the yearin which the reduction takes effect. Thus in the first year in which there is adynamic effect, the increase in revenue would, if the tax rate were unchanging,be y/5. In the second year, it would be 2y/5, in the third year it would be 3y/5 andin the fourth year it would be 4y/5. In the fifth and subsequent years, it would bey. These increases are then scaled down for the planned falls in corporation taxrates.



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Table B3.2: Effects on tax revenues assuming a 25 per cent dynamic effect ontaxable profits

Year Incremental change in revenueas against preceding year (£bn)


1 -1.0 -1.02 -1.0 -2.03 -2.0 -4.04 -3.8 -7.85 -3.6 -11.46 -1.8 -13.27 -6.1 -19.38 -7.8 -27.19 -6.9 -34.010 -5.2 -39.2

Table B3.3: Effects on tax revenues assuming a 50 per cent dynamic effect ontaxable profits



1 -1.0 -1.02 -0.9 -1.93 -1.8 -3.74 -3.7 -7.45 -3.3 -10.76 -1.4 -12.17 -5.8 -17.98 -7.5 -25.49 -6.6 -32.0

10 -4.8 -36.8 Dynamic effects computed as tax revenue increases

Under the second method, it is taken that if there is a y per cent dynamic effect,then y per cent of the reduction in tax revenues is restored by increases in thoserevenues. Thus there is no separate adjustment for falling tax rates.

That increase is spread over a five year period, starting in the year after the yearin which the reduction takes effect. Thus in the first year in which there is adynamic effect, the increase in revenue is y/5. In the second year, it is 2y/5, in the

third year it is 3y/5 and in the fourth year it is 4y/5. In the fifth and subsequentyears, it is y.



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Table B3.4: Effects on tax revenues assuming a 25 per cent dynamic effect ontax revenues



1 -1.0 -1.02 -1.0 -2.03 -2.0 -4.04 -3.8 -7.85 -3.5 -11.36 -1.7 -13.07 -6.1 -19.18 -7.7 -26.89 -6.9 -33.710 -5.1 -38.8

Table B3.5: Effects on tax revenues assuming a 50 per cent dynamic effect ontax revenues



1 -1.0 -1.02 -0.9 -1.93 -1.8 -3.74 -3.6 -7.35 -3.2 -10.56 -1.4 -11.97 -5.7 -17.68 -7.3 -24.99 -6.4 -31.3

10 -4.6 -35.9



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tax makingtheukcompetitive 2009

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