With the Budget due next month, I’ve been thinking about the UK tax system. The more I looked, the clearer it became that the UK tax system treats certain taxpayers differently to others, which leads to unfairness in terms of the amount of tax paid on similar levels of income. So today I thought I’d air my thoughts on what I consider could be done to treat people more equally in terms of tax.
Fixing Britain’s Tax Inequalities: Income v Capital
Capital gains are taxed at lower rates than income in every tax band. The tax that former Chancellor Nadhim Zahawi allegedly paid late arose from a gain of £27m, on which he had to pay Capital Gains Tax (CGT) of £3.7m, amounting to around 14% of the gain.
The top rate for CGT at the time of the disposal was 20%. The discount in the effective rate was likely due to entrepreneurs’ relief, which applied a rate of 10% on gains of up to £10m in the lifetime of the taxpayer. That lifetime cap, was subsequently reduced to £1m.
There is no reliable evidence that having a lower tax rate on gains stimulates growth or employment, with over 50% of all taxable gains being received by just 5,000 individuals, mostly from the disposal of businesses.
In 1988 Chancellor Nigel Lawson aligned the tax rates that applied to income and capital gains, while at the same time introducing indexation allowance to relieve the effect of inflation on the value of assets. The recently disbanded Office of Tax Simplification suggested last year that if a similar rate alignment was reintroduced, it would pretty much eliminate the inequalities between CGT and income tax.
Fixing Britain’s Tax Inequalities: Dividends v Earnings
Income from self-employment and PAYE is taxed at higher tax rates than dividend income, which is also exempt from national insurance contributions (NIC). The favourable tax treatment of dividends, and the ease of operating through a company since the audit requirement for small companies was removed, has greatly encouraged the growth of personal service companies (PSC).
The pressure on workers to operate through a PSC also comes from firms looking to avoid employer’s NIC, the costs of pension contributions, holiday pay, sick pay and parental pay due for employees. This imbalance led to the IR35 rules enacted in 2000, which did little to solve the problem, as the underlying tax advantages of the PSC structure for both the individual and the engager remain strong.
The solution to the tangled web of employee/self-employed tax differentials has to involve the issue of employer’s NIC. But this won’t be easy as HMRC statistics show the amount of employer’s class 1 NIC paid in 2021/22 was around £90bn (12.5% of all tax collected and 40% more than the corporation tax (CT) collected in that year. But if employer’s NIC was abolished, the CT rate would have to rise from 25% to 35% to make up for the loss of NIC revenue.
Fixing Britain’s Tax Inequalities: Renters v Landlords
Landlords do not pay any NIC on their property income, unless the property is held in a limited company and the owner extracts funds as a salary. Where the individual landlord doesn’t pay sufficient NIC in a tax year, they won’t build up an entitlement to the state pension. But that may not worry many landlords who view their let properties as a pension fund, with a plan to sell up on retirement.
On disposal the increase in the value of the properties will be taxed at 18% or 28%, which is significantly lower than the tax due on regular pensions at 20%, 40% or 45%. Individuals who own their own homes also benefit from the rise in property values over time, particularly for homes located in the south of England. The CGT exemption for the taxpayer’s only or main home means that this increase in value is completely free of tax, a relief worth over £30bn per year according to HMRC statistics.
Renters by comparison will never benefit from the growth in property values and pay tax and NIC on their income at 32%, 42% or 47%, plus student loan repayments in many cases. To equalise tax treatment between homeowners and renters the CGT exemption for main homes could be restricted or removed, and the rates of CGT could be aligned with those of income tax, as previously suggested.
Fixing Britain’s Tax Inequalities: Millennials & Gen Z v Baby boomers & Gen X
I have previously blogged on the subject of the many advantages enjoyed by the older generations in my Blog on boomers’ tax breaks. Charging NIC on pension income would be a step towards equalising the tax rates between the generations, but the heavy burden of student loan repayments would also need to be addressed.
Fixing Britain’s Tax Inequalities: Non-doms V UK domiciles
Tax lawyer Dan Neidle, head of Tax Policy Associates, a non-profit which advises policymakers and journalists on tax policy, has long argued that the non-dom regime should be removed, along with excluded property trusts that provide non-doms with huge tax advantages via inheritance tax shelters.
Nadhim Zahawi’s problems arose from him attempting to obtain a tax advantage by exploiting the UK’s non-domicile rules, and I’m pleased to say, failing miserably!
Tax Accountant’s Summary
Whilst I have mentioned a number of taxes in this week’s Blog, the real elephant in the room is National Insurance, which although not called a tax, clearly is one. No-one likes paying tax, but if the liability to NIC was transparent and equitable, I suspect that even pensioners would concede that as they are the biggest recipients of the benefits arising from the money collected, perhaps they should make a contribution!