Osborne caught in a tangle over tax


A YEAR on and coalition relations are distinctly less rosy than they were in the rose garden last May. But despite recent tensions the coalition has already made plenty of progress in reshaping Britain: radical reforms to welfare, education, and healthcare have all been initiated.

From an accountant’s perspective though, one of the areas where the government has made the biggest impact since 11 May 2010 has been the UK tax system.

As was to be expected, the changes have been a mixed bag.

While individual taxpayers have been clobbered by the chancellor as he seeks to patch up battered public finances, businesses have benefited from a number of tax cuts.

Perhaps most importantly of all though, the government is struggling to get to grips with the “spaghetti bowl” – Osborne’s words – that is the UK’s tax system.

From the individual taxpayer’s perspective, it has been a busy year. VAT and national insurance contributions are up, while more people have been brought into higher tax bands to pay for a rise in the personal allowance for the worst off. For the wealthiest, capital gains taxes have gone up and the 50 per cent tax band remains.

The swiftly rising personal allowance is a bold move from the government and will certainly go some way to balance out other tax rises for the worst off.

The impact of these changes is relatively easily understood. Taxes go up, take home pay goes down. However, there have been two changes that are less obvious to most taxpayers, but which will still have a big impact on personal finances.

The first of these is a change to pensions. From April 2011, annual pension contributions have been capped to £50,000 or equivalent, with punitive tax charges on anything over (lifetime contributions have been capped too). At first glance, this doesn’t seem so important: surely no one puts away more than £50,000 in a year?

Ideally, everyone would begin saving for their pension in their twenties. But twenty-somethings have other things to spend their money on. By their thirties, future pensioners have kids and a mortgage, likewise forty-somethings. Pensions might take a back seat.

By the time people get to their fifties, house bought, kids gone, earning a decent wage, with retirement around the corner, it’s time to start really investing in that pension. This is where – for some workers, but not necessarily only the wealthiest – the £50,000 cap could bite.

When you think about pension-boosting tools like buying extra years of qualifying service for a final salary scheme, it’s easy to see how contributions could breach £50,000. You can invest more of course, and the taxman will thank you for it.

Seemingly innocuous change number two is the gradual switch from the Retail Price Index (RPI) to the Consumer Price Index (CPI) for indexing all direct taxes. Switching to CPI, which excludes housing costs, and is consistently lower than RPI, means tax band thresholds will rise more slowly in future. This worsens fiscal drag: people will pay more tax on a lower wage than they otherwise would have done.

Business, by comparison, has fared better. National insurance went up for employees but not for employers. Capital gains tax for individual investors is up, but the coalition has continued Labour’s policy of offering generous reliefs for entrepreneurs. For small businesses, business rates rises – linked to last year’s inflation – have been wisely deferred to take into account current economic woes and last year’s high inflation.

The government has also taken a mature approach to small business finance by beginning to rein in the liquidity made available by the successful time-to-pay scheme; businesses would otherwise become reliant on an unsustainable source of finance.

Planned big cuts in corporation tax are a positive signal, although the radical changes to the taxation of multinational groups are more interesting; some companies could pay as little as 5.75 per cent in the UK under new plans. Expect squabbles over the following question: who pays more tax in the UK, the company here because of the low tax rate or the one not here because of a high rate?

Where the government is coming unstuck though is with Osborne’s bowl of spaghetti. Despite promising to deal with an over-complicated tax system, the chancellor is still churning away with the pasta-making machine.

The positive, first: the Office of Tax Simplification (OTS) is a legacy project that will bear fruit over time and is the independent assessor of the tax system that this country needs. The OTS has recommended 64 reliefs to be simplified or abolished; the government has lined up 43 for change of some kind.

However, on top of these proposed abolitions, there has been a further 200 or so tax changes announced in the last 12 months. The sheer number of these changes creates a burden for businesses and taxpayers as they try to understand and comply with them.

Having two budgets doesn’t help, and we have new parties in government. However, compare this to 1997 and 1998 when the same thing happened. 2010 and 2011 saw roughly 100 and 110 changes announced respectively; 1997 and 1998, 40 and 90.

The difference in the number of changes shows how complicated the tax system became between 1997 and 2010; there are now so many levers to pull just to keep the system working.

Incidentally, over half of the changes announced in the 2010 budget (the figure for 1997 was 25 per cent) were originally announced by the previous government. This doesn’t let the coalition off the hook though, as there was an element of choice; some changes, such as the rise in employers’ national insurance, didn’t make it.

It isn’t all bad: government is now committed to simplification and the OTS will have an impact. Hopefully, some of the changes announced now mean fewer changes announced later. But if the government really wants to get a grip on the tax system and make it simpler and more manageable for all kinds of taxpayers, then it needs to heed some traditional parental advice: stop picking at it, you’ll only make it worse.