It’s all too complicated

Is it possible to have a simple tax system?

Since its formation in 2010, the Office of Tax Simplification (OTS) has been carrying on its ongoing project examining the reasons why tax is complex and in the last 5 years has published a number of papers on the subject.

 This month the OTS published a paper setting out the lessons it has learnt about tax complexity so far and some principles.

What is complexity and its causes?

Complexity is the opposite of simplicity and there are a number of reasons why it arises and evolves. Overall however its what makes it more difficult for people to know how much they should be paying, increases compliance costs and makes it harder for a taxpayer to take ownership of and control their tax affairs.

There are two strands to complexity. Firstly, technical causes, which are those brought about by policy and legislative flaws and inconsistencies. Then secondly, there are administrative reasons that relate to the operational process, including forms and filing procedures.

Originally the tax system was a way of raising money to fund wars and was therefore straightforward. Nowadays however, the UK’s tax system is required to deliver a trio of tasks, these being:

•  Funding government expenditure, in particular social security and healthcare;
• Satisfying particular political objectives, ie honouring government promises or plans or putting in place special rules for selected groups or causes; and
• Social policy objectives which encourage or discourage particular actions or investments.

Back in the 18th century, the Scottish philosopher and economist, Adam Smith, established four principles of a good tax system which still remain relevant today:

1. Certainty of how the tax due is determined;
2. The burden should be proportionate to the ability to pay;
3. Convenience; and
4. Efficiency of collection.

Borne out of these principles are certain aspects of particular relevance to the OTS:

Simplicity

Unless taxes are simple and capable of being understood and dealt with by the tax paying public, then uncertainty and confusion will occur. A person should be able to know the tax they are due to pay before they pay it without it being too difficult.

Stability

Constant changes to and within the tax system simply adds to complexity and in turn erodes confidence in it.

Efficiency

A simple tax system will have low unavoidable compliance costs, such as the cost of a stamp when sending correspondence via the post, and zero avoidable compliance costs, e.g not having to pay for the services of a tax adviser because the taxpayer can handle their affairs adequately by themselves.

When the OTS first spoke to small businesses about the main causes of complexity the top six categories were:

1. Change
2. Income tax/NIC interaction
3. HMRC administration
4. Capital allowances/depreciation*
5. Employment status*
6. VAT boundary issues*

*  Equally placed.

Why complexity is so bad

The OTS identify a number of negative issues surrounding complexity within the tax system.

Compliance burdens

A more complex tax system makes it more expensive for taxpayers who are also less likely to get their tax right at the first time of asking.

All roads don’t lead to Rome

Where a tax system offers choices, e.g whether to use a tax relief or not, then the taxpayer is forced in to making choice and they are less likely to make the right decision. The OTS has identified 1,156 tax reliefs . It is therefore unreasonable to expect a taxpayer to know them all and decide which is the right one(s) to select.

Psychological effects

Undoubtedly, people find tax tax stressful and this can deter them from doing it. Complexity just adds to this and can cause late returns and penalties. Forms that have too many questions, even if those questions are straightforward, all of sudden become more difficult to tackle by taxpayers who have a cut-off point at which they won’t even attempt completing a form. Research suggests complexity gives rise to less trust in the the system and reduced compliance.

HMRC’s positive strategy

HMRC is committed to creating a positive taxpayer experience but complexity defeats this object. If more taxpayers are likely to need more assistance or correction, then HMRC’s administrative costs simply go up.

Time better spent

Tax compliance and filling out forms is too time consuming for people. If they or their advisers could spend that time doing something else would it be to the detriment of the economy?

Increased tax avoidance

It could be argued that complexity contributes to tax avoidance in that complex legislation can present gaps in legislation that can be exploited.

Can complexity be a good thing?

Whilst the majority of us would consider an over complicated tax system as a bad thing, the OTS presents an argument that it could benefit the economy. The public expect the system to be fair and a more intricate system provides for a better design and targeting of reliefs. Quite subtly, complexity can aid governments in raising more tax without people fully realising what is going on.

Alas, simplicity and fairness however do not go hand in hand.

Principles for avoiding complexity

From the lessons learnt about tax complexity so far, the OTS have established four broad principles for avoiding complexity.

1.  Ensure the proposed measure meets the policy aim

• Rather than defaulting to the tax system to achieve something, could the objective be achieved more efficiently via other routes, such as grant or regulation?
• Is change really necessary?
• Balance fairness and complexity.
• Consider the impact on taxpayers and their advisers, and HMRC from the start.

2.  Focus the measure carefully

•  Consult all affected parties and stand in their shoes to see it from their point of view. Resist requests for exceptions from special interest groups that prove to be fatuous.
• Think about the knock-on effect and whether solving one problem creates an ever bigger one.
• Anti-avoidance provisions create more detailed rules and loopholes, leading to additional layers of legislation. It may be better to use broad principles or rely on improved enforcement of the existing rules.

3.  Design the measure to meet the aim

• Review administration to ascertain what forms will have to be completed and what guidance will be needed.
• Don’t make it too easy for people to sidestep a provision or gain a benefit out of it by changing something. For example the introduction of the 0% rate of corporation tax back in 2002 which encouraged small sole traders to incorporate their businesses.
• Could improving existing legislation be used rather than introducing new measures?
• Use common sense categories and definitions.
• Would it be better to draw up a general entitlement for a relief rather than a precise set of rules for every situation?
• Does it do what is says on the tin or has the new measure become too involved?

4.  Maintain the measure properly

• Keep the rules up to date.
• Ongoing assessment of the provisions to establish if they are still fit for purpose.

Is a simple tax system a pipe dream?

The OTS believes that we have now come too far to be able to have a simple tax system. Our system reflects the complexity of life and, in particular, business life. The good news is however that there is no reason why we should not be striving for a simpler tax system, particularly for those with straightforward tax affairs.

Probably the best way to achieve a simpler tax system, says the OTS, is through increased digitalisation. This is illustrated by their example of a PC:  few people know what goes on inside but good interfaces mean it can be a simple machine to use.

The great Albert Einstein once said, “Any intelligent fool can make things bigger and more complex ……It takes a touch of genius – and a lot of courage to move in the opposite direction.”

With all due respect to the OTS, who can only give advice to the government, that genius and courage appears sadly lacking.