With the burden of government spending rising beyond 50% of national income, there has been less attention in recent months given to the growing cost of government regulation. Increased regulation reduces the underlying growth rate of the economy, reduces employment and carries a very real cost for consumers, employees and business owners. Indeed, attempts to reduce government expenditure – though both welcome and essential – may lead to greater regulatory burdens on businesses as the government slims its machines and imposes more costs on the private sector.
Unfortunately, the costs of regulation are difficult to calculate and estimates tend not to reveal how the regulatory burden disproportionately penalises small firms. However, in one area of regulation – the costs to businesses acting as unpaid tax collectors – there has been a generation of research, and a new study, published by the Institute of Economic Affairs, builds on that earlier work .
The results of this research are alarming. The UK has the longest tax code in the world – with the possible exception of India. The UK’s tax code is about five times the size of the German tax code. Furthermore, the UK is one of only three countries in the developed world where the costs of complying with tax regulation are not decreasing. Perhaps this is not surprising given that the average Finance Act in the UK today is three times its length in the 1980s. However, in 40 other developed countries, the tax system is being simplified or, at the very least, governments are harnessing new technologies to reduce costs to businesses.
Perhaps the most disturbing aspect of the costs of red tape imposed on businesses by government is how unevenly they are spread. The IEA’s authors – leading academics at Manchester Business School – estimate the total cost to businesses of paying taxes to be between £15bn and £20bn. However, relative to turnover, the cost bears 16 times more heavily on the smallest businesses than on the largest. Tax regulation – like all regulation – is an impediment to the self employed expanding to take on more staff and ultimately acts as an impediment to competition.
Can anything be done? Given the progress that other countries are making towards reducing the costs to businesses of collecting taxes, the answer has to be “yes”. Regulatory costs could probably be reduced by about £5bn just by copying best practice elsewhere. And many of the proposed actions to reduce the administrative burden of taxes also generally make good economic sense in other respects.
For example, a large number of corporation tax allowances could be abolished. These are expensive to administer and expensive to claim. They also distort investment: businesses and not politicians are the best judge of how to invest a company’s capital and the tax system should not discriminate between different forms of investment. Capital gains tax should also be axed. Sometimes the capital gains tax system is taxing income that is masquerading as capital gains. In these cases, either corporation tax or income tax should be levied using the existing tax collection systems: there is no need for an entirely different tax. Other forms of capital gain should not be taxed at all and often, in fact, capital gains tax represents double taxation.
Perhaps surprisingly, the authors recommend the scrapping of the annual Finance Act. An annual Finance Act leads to two problems. Firstly, the Chancellor of the Exchequer feels the need to pull “rabbits out of the hat” by introducing measures to grab headlines such as the ill-conceived corporation tax allowances that the authors propose should be abolished. Secondly, the Finance Act does not receive proper scrutiny in either chamber and thus ill-thought-through tax legislation goes through “on the nod”. In the future, argue the authors, the Budget should just be about setting the rates of existing taxes in order to pay for government spending. Tax legislation would pass through Parliament getting the same scrutiny as other forms of legislation.
If we had to summarise in a sentence what should be done with the UK tax system to reduce the burdens on business, it would be this: “Return to Adam Smith’s canons of taxation.” Ever since Nigel Lawson’s Chancellorship, the tax system has increasingly deviated from his two canons of “convenience” and “efficiency”. These are still the best two measuring rods by which the administrative characteristics of a tax system should be judged and the UK tax system fares poorly by both.
See also IEA publication Taxation and Red Tape