The 'Tax Simplifier' series aims to make the case for a much simpler tax code with practical recommendations for policy change. Blogs are published twice a week, on Monday and Thursday. Read David's previous blog on the principles of simplification. You can follow David on Twitter @TaxSimplifier.
HMRC costs about £4bn per year to run. The costs of tax compliance on business are hard to quantify, but were estimated by KPMG in 2006 at about £5bn per year. The cost for private individuals who pay someone to handle their tax affairs is perhaps £1bn. That’s an estimated amount of about £10bn in all.
But it may be a substantial underestimate. A report called “Taxation and Red Tape” produced in 2010 for the Institute of Economic Affairs by three authors from the Manchester Business School estimated the total costs of collecting tax to be in the region of £15-20 billion.
Then there is also what economists would call an opportunity cost.
Lots of bright people in the City and elsewhere are engaged in tax planning. Because of the increasing complexity in tax law, large transactions can now require advice from perhaps five or so tax specialists. They will all need to liaise and consult with each other, which drives up the cost to the client (this was not the case 30 years ago, when a single tax adviser could usually deal with all tax issues that might arise). But this all takes bright people away from doing something more economically productive.
And tax also leads to people doing things or not doing things for tax reasons rather than commercial reasons - this creates the “excess burden of taxation”, a cost which is increased by complexity, which was discussed in an earlier Blog.
And foreign business can only be discouraged from investment in the UK by a complicated tax system - whereas the opposite would be true if we had an effective and simple tax code.
The Tax Reform Act of 1986 in the US gives some precedent for assessing the potential impact of reform (although not necessarily on all fours with our own situation). Many tax preferences and shelters were abolished, loopholes eliminated, tax depreciation brought closer to commercial depreciation, and tax rates substantially simplified.
As a result of experience gained from this Act it has been estimated that base broadening which enables a 10% reduction in tax all rates (such as from 40% to 36%) - which would be neutral on a traditional static analysis - would actually increase tax revenues by 4%. This is because of the behavioural changes which would be induced (see “The Tax Reform Evidence from 1986” by Martin Feldstein, Harvard Professor and Chairman of the Council of Economic Advisers to President Reagan).
And it’s obvious that simplification would lead to reduced administration costs for HMRC and compliance costs for business.
So, most importantly, we are looking for tax reform to provide substantial economic benefits in terms of cost savings and economic growth. This cannot be quantified easily, but even an increase in GDP of only 1/4 % p.a. from tax reform should be achievable and would be very much worth having.
Other benefits of tax reform, and an agenda proposed for realising these benefits, are addressed in the next Blog, the last in this regular series.