IFS/Mirlees tax reform proposals

The creation last year of the Office of Tax Simplification signalled an important move by the coalition government to tackle the issue that has been enraging the profession for years.

To encourage the government along these lines, the Institute for Fiscal Studies and other interested parties sponsored a team of academics led by James Mirlees to carry out a review of the UK tax system. Rebecca Benneyworth and other members of AccountingWEB responded to the main Mirlees Review proposals last November.

To continue the discussions around any proposals that appear in the 2011 Budget, we're publishing a short summary of the proposals here, plus IFS commentary from its February Green Budget submission to the Treasury.

Main recommendations of the Mirrlees Review

Taxes on earnings

  • Merge income tax with employee (and ideally employer) NICs
  • End the opaque practice of tapering personal allowances and move to a transparent, coherent rate schedule
  • Introduce a single integrated benefit, getting rid of the very highest effective
  • marginal tax rates (90% and more) faced by some low earners [as is now effectively planned]
  • Strengthen work incentives for those whose youngest child is of school age and for 55- to 70-year-olds relative to others

Indirect taxes

  • Remove nearly all the current zero and reduced rates and, where possible, exemptions from VAT. Introduce a comprehensive package compensating the less well-off on average whilst maintaining work incentives.
  • Retain a destination basis for VAT while ending the zero-rating of exports
  • Introduce a tax equivalent to VAT on financial services
  • Replace council tax and stamp duty land tax on housing with a tax proportional to the current value of domestic property, to stand in place of VAT on housing

Environmental taxes

  • Introduce a consistent price on carbon emissions, through a combination of extended coverage of the EU Emissions Trading Scheme and a consistent tax on other emission sources. This would include a tax on domestic gas consumption.
  • Replace much of the current tax on petrol and diesel with a national system of congestion charging
  • Taxation of savings and wealth Take interest on bank and building society accounts out of tax altogether
  • Introduce a Rate of Return Allowance for substantial holdings of risky assets (e.g. equities held outside ISAs, unincorporated business assets, and rental property) so that only ‘excess’ returns are taxed
  • Tax capital income and capital gains above the Rate of Return Allowance at the same rate schedule as earned income (including employee and employer NICs), with reduced rates for dividends and capital gains on shares to reflect corporation tax already paid
  • Maintain and simplify the current system of pensions taxation, ending the excessively generous treatment of employer contributions and replacing the taxfree lump sum with an incentive better targeted at the behaviour we want to encourage
  • At least remove the most obvious avoidance opportunities from inheritance tax and look to introduce a comprehensive lifetime wealth transfer tax

Business taxes

  • Introduce an Allowance for Corporate Equity into the corporation tax to align treatment of debt and equity and ensure that only ‘excess’ returns to investment are taxed
  • Align tax treatment of employment, self-employment, and corporate-source income
  • Replace business rates and stamp duty land tax on business property with a land value tax for business and agricultural land, subject to confirming practical feasibility
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John Stokdyk's picture

IFS commentary

John Stokdyk | | Permalink

In addition to summarising these proposals, the IFS Green Budget in February 2011 set out its own objectives for tax reform, and contrasted its ideal with what currently exists:

Taxes on earnings

  • A progressive income tax with a transparent and coherent rate structure
  • A single integrated benefit for those with low income and/or high needs
  • A schedule of effective tax rates that reflects evidence on behavioural responses

Indirect taxes

  • A largely uniform VAT
    – with a small number of targeted exceptions on economic efficiency grounds
    – and with equivalent taxes on financial services and housing
  • No transactions taxes Stamp duties on transactions of property and of securities
  • Additional taxes on alcohol and tobacco*

Environmental taxes

  • Consistent price on carbon emissions
  • Well-targeted tax on road congestion

Taxation of savings and wealth

  • No tax on the normal return to savings
    – with some additional incentive for retirement saving
  • Standard income tax schedule applied to income from all sources after an allowance for the normal rate of return on savings
    – with lower personal tax rates on income from company shares to reflect corporation tax already paid
  • A lifetime wealth transfer tax

Business taxes

  • Single rate of corporation tax with no tax on the normal return on investment
  • Equal treatment of income derived from employment, self-employment, and running a small company
  • No tax on intermediate inputs
    – but land value tax at least for business and agricultural land

*Only in the case of alcohol and tobacco tax did Mirlees/IFS consider that the current UK tax system matched this ideal.

In its Green Budget submission (Feb 2011), the IFS put foward the follow suggestions:

Systemic tax reforms
The government should make clear where it sees the shape of the tax system in the medium term and the purpose and direction of each of the major taxes. The ways in which HM Treasury and HM Revenue and Customs work together, and the extent of parliamentary scrutiny of tax policy, should be reviewed to improve the quality of tax policymaking.

Patent Box
The proposal to reduce the corporate tax rate on the income derived from patents to 10% from April 2013 will cost over £1bn a year in lost revenue and will only benefit a handful of firms, the IFS argued. The policy is poorly targeted at promoting research, distorts the decision to invest in patentable technologies, and will add unnecessary complexity to the tax system. Much of its cost will be deadweight, accruing to activities that would have occurred in the absence of the policy. The jury is still out on whether the policy is the best way to encourage firms to retain the real activity associated with mobile intellectual property in the UK.

Environmental taxes
We should have a single, visible price of carbon for all parts of the economy in order to reduce carbon dioxide emissions as efficiently as possible. But we remain far from this ideal, and the situation will not be improved by planned changes. The government has set itself a new goal to increase the proportion of tax revenues that come from green taxes. While this is on course to be met, it should not be taken as a good guide to a government’s environmental credentials. A ‘fair fuel stabiliser’ would help stabilise household finances, but official estimates suggest that it would make the public finances more uncertain. It would also be very difficult to implement in practice.

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