“The Centre for Policy Studies has labelled the treasury's new 50% tax rate as ‘unfair, complex, inefficient and damaging'” telegraph.co.uk June 2009
“In view of the furore over the expenses of Members of Parliament, the question must be raised as to whether such a high rate is necessary.”
Taxation has played a huge role in many of the countries since it was first introduce thousands years ago and still is an important role in modern society today. What is tax? Tax is a levy imposed by government or other tax raising body, on income, expenditure or capital assets to raise revenue for which a taxpayer receives nothing specific in return. Taxes are used to achieve government objectives such as managing the economy, regulating and developing society and providing public services. This essay will discuss the difference between tax avoidance and evasion and the principles of a good taxation system in relation to the two statements above.
Tax evasion is the general term for efforts to evade paying taxes by individuals, trusts, firms and other entities by illegal means. Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax liability. This usually includes things like under declaring income, profits or gains, overstating deductions, failing to declare incomes that are taxable or smuggling goods into the country without paying import tax etc. Therefore, tax evasion is illegal and is a crime in most countries and is punishable by fines or imprisonment. Switzerland is one notable exception where tax fraud i.e. forging documents is considered a crime and tax evasion i.e. under declaring assets is not.
On the other hand, tax avoidance is legal and involves arranging your activities to your advantage to minimise your tax liabilities by means that are within the law. Availing yourself of legitimate tax concessions is legal and acceptable i.e. saving your income in an ISA instead of a building society account without being subject to pay tax. This is one of the simple ways individuals avoid paying taxes, but there are sophisticated ways to avoid tax by using elaborate schemes devised by tax advisors or planning experts who find loopholes in the legislation and exploit them. The term tax mitigation is a synonym for tax avoidance and has also been used in the tax regulations of some jurisdictions to distinguish tax avoidance by legislators. In an attempt to crackdown on tax avoidance The Finance Act 2004 was introduced which is updated annually, so now those who sell tax avoidance schemes and those who use them such as accountants and solicitors have to disclose them to HMRC in a bid to tackle it.
Over the years there has been a change in the attitudes of the courts of what constitutes tax avoidance. Judicial doctrines, relying on tax legislation, this is now being evolved by using underlying issues in cases and not just the legal nature to prevent tax avoidance involving circular, self-cancelling transactions in Ramsay v IRC (1981), or where steps with no commercial purpose other than the avoidance of tax are inserted into a transaction in Furniss v Dawson (1984).
Even until now UK still face the problem with tax avoidance because no one exactly knows where the boundaries lie between acceptable and unacceptable tax avoidance and is difficult to determine. In UK, the authorities use the term tax mitigation to refer to acceptable tax planning and minimising tax liabilities in ways expressly endorsed by Parliament. As set out above, on this view tax avoidance break the spirit of the law while following the letter and is therefore thought by some to be unacceptable, although not criminal in the way that evasion is.
Referring to the first statement if the treasury increase the rate of tax up to 50% this will influence majority of taxpayers to use tax avoidance to a greater degree, as they will not be able to save as much and businesses will find ways to reduce their liabilities. Mike Hennessy, chief executive of Isle of Man Chamber of Commerce, said, "I think the island has to be careful in terms of making sure that any taxes that are introduced do not kill the excellent business opportunities that we have pursued . . . and have been fundamental to our strategy." Regarding this statement some people might implement tax avoidance to a higher degree or even consider to move abroad to do business where there are lower taxes, this will lead to migrating talents that can be detrimental to the economy and add more pressure especially in recession. The situation will become complex as more and more businesses will find ways to adopt sophisticated schemes to avoid tax and therefore changes or improvements will be made to the legislation that will consequently cause more loopholes. This will lead to being inefficient as it will be costly and time consuming as tax expert try to plug loopholes in the legislation.
Regarding the second statement MPs uses taxpayer's money to cover their expenses that are unnecessary and then decide to increase tax to cover the excessive government expenditure, is morally wrong. Many people accuse MPs of trying to maximise the amount of money they can legitimately claim within the rules. The Telegraph reported that between 2004 and 2006 Andrew Brown received over £6,500 for cleaning services at the prime minister's private flat. Gordon Brown said the system did not work and had to change: "MPs have to live in two places. But we need a system that is better than the one we have. "
Adam smith who is one of the economists that considered the principles of how to create an effective tax system that was published in his book “The wealth of nations” in 1766. Now in modern terms it was re-stated to equity, certainty, convenience and efficiency, which will be discussed in detailed below.
Equity is where tax should be fair to everyone and levied according to individual's ability to pay. If equity is unfair then people will not pay up and the whole system will grind to a halt, i.e. when community charge (poll tax) introduced by Margaret Thatcher as a primary local tax. VAT on domestic fuel was also seen to be unfair as elderly, unemployed people spent higher amount of their incomes on heating compared to others i.e. regressive tax. There is often atrade-offto be made betweenequityandefficiency i.e. a cut in the marginal rate of tax for higher earners might be justified on the grounds that it encourages greater work effort and higher labour productivity. However Governments must be careful not to increase tax too high as proposed at 50%, as it will have a negative effect on the economy.
To measure the fairness of the tax system you have the concept of horizontal and vertical equity. Horizontal equity is where taxpayers with equal taxable capacity bear the same tax burden and vertical equity is whoever need are greater bear less tax.
Moreover certainty is another feature of a good tax system. Certainty is where a person needs to be informed about who will pay tax, when will they have to pay and how much they have to pay. Taxes that are certain will be preferred to those that are uncertain. The HMRC code of practice states all the information and advice needed on taxes.
Another principle of a good tax system is convenience. The tax system will become more convenient when people pay their taxes at source (PAYE) rather than a lump sum. The system not just includes administration costs but also compliance costs incurred by taxpayers to consider. The more complex the tax system, the greater the costs for the government to administer it and the greater the compliance costs for taxpayers to determine their tax liability and report it.
Efficiency has two aspects economic efficiency and administrative efficiency. Firstly economic efficiency is when the system is efficient and does not distort the decisions of the people. In this case how it affects people's behaviour i.e. a pensioner invest in a pension fund and obtains tax relief instead of investing in a property that is subject to tax.
Secondly administrative efficiency relates to administration of taxes where government tries to keep the cost to a minimum, which allows them more expenditure to achieve desirable economic efficiency.
In conclusion the system has to be drastically improved or changed as stated by PM Gordon Brown and be much simpler to enable for the system to be effective and efficient. The introduction of the 50% tax rate will be damaging to the economy as it will change people's behaviour on making decisions and influence them to leave the country to do business elsewhere. Finally MPs should keep their expenses to a minimum and not to abuse the system and then rely on taxpayers to cover the costs by increasing the tax rate.
Bibliography
Books
Clube, J., Conley, A., Gordon, K., Gravestock, P., Ward, J. (2008/2009) Tolley's taxwise I. London: LexisNexis Tolley.
James, S. and Nobes, C. (2008/2009) The economics of taxation. 8th ed., Birmingham: Fiscal Publications.
Melville, A. (2009) Taxation: Finance Act 2008. 14th ed,. Harlow: Financial Times Prentice Hall.
Lymer, A.and Oats, L. (2008/2009) Taxation: Policy and Practice. 15th ed., Birmingham: Fiscal Publications.
Lymer, A.and Oats, L. (2009/2010) Taxation: Policy and Practice. 16th ed., Birmingham: Fiscal Publications.
Newspaper article - Internet copy
Bounds, A., and Groom, B. (2009) ‘Isle of Man bridles at tax clawback.' Financial Times.[Online] 21st October. [Accessed on 7th November 2009]
Houlder, V. (2009) ‘Tax reform expected to stem exodus.' Financial Times. [online] 7th August. [Accessed on 6th November 2009]
Webpage
Politics. (2009) Cabinet expenses under scrutiny. [Online] [Accessed on 7th November 2009]
Journal Article
Richards, G. (2009) ‘Countering Tax Avoidance in the UK: Which Way Forward?' British Tax Review,pp.325-327.
