Tax fairness is one of Osborne’s biggest challenges

March 20, 2012

The opinions expressed here are those of the author.

The coalition government has restive backbenchers on both wings seeking to fast-track tax reforms that promote fairness and create a platform for economic growth.  These are rarely complementary agendas, so the Chancellor will have a difficult job satisfying their demands.

Despite recent downgrading of the UK’s outlook ratings, the Chancellor will be able to announce progress in the phased reduction of the fiscal deficit, and so the opportunity in the middle of the parliament presents itself, allowing Osborne to focus upon further authentic tax reforms for the remainder of this parliament. This will hopefully permit the UK to retain its AAA rating in the absence of a cataclysmic event out of his control in the European or Global economies.

Individual Taxation
The pledge that no one will pay income tax until they earn £10,000 is the central personal tax policy within the Coalition Agreement, so it can be predicted with confidence that the personal allowance will be raised again, perhaps by a further £1,000 to £9,105 for 2013/14.

The Chancellor’s dilemma is how to fund this costly pledge.  Another reduction in the threshold at which higher rate tax kicks in would be an added blow to the ‘squeezed middle’; a 40 percent tax rate applied to individuals earning less than twice average earnings is increasingly unsustainable, especially with the current proposals for the child benefit withdrawal for higher rate taxpayers.  In our view, the Chancellor must not again reduce the basic rate tax band, already much too low at its current £35,000.

The Chancellor and most Conservative backbenchers regard the 50 percent top tax rate, applied to incomes over £150,000 per annum, as economically damaging and, in particular, a disincentive for both entrepreneurs and global corporations to establish businesses in the UK. Questions continue to be raised about the level of income tax actually collected by the 50 percent rate, as it is influenced by behavioural aspects, such as possible executive relocation from the UK and the level of dividends from owner managed companies to their shareholders, which are difficult to measure.

A feasible political roadmap for the Chancellor to fast-track the abolition of the 50 percent rate might be a combination of:
•    reducing all personal tax reliefs (excluding charitable donations) to basic rate only;
•    significantly increasing the basic rate tax band;
•    introducing a further income tax band of, say, £10,000 at a 30 percent rate, and
•    introducing additional higher council tax rate bands to head off certain of his Coalition partners wish for a ‘mansion tax’.

In addition, the Chancellor should recognise the need for additional targeted measures to restrict wholly artificial stamp duty avoidance on residential property.  This would address the widespread perception of unfairness that opportunities could remain for purchasers of high value residential properties to mitigate their liability that are unavailable for more modest properties.

Business Taxation
BDO predicts that the reduction in the main rate of corporation tax may well be accelerated.  The Chancellor must be again tempted to announce a 2 percent reduction to 24 percent with effect from 1 April 2012, and a further 2 percent reduction to 22 percent from 1 April 2013.

This would enable the coalition government to be able to demonstrate its commitment to creating one of the most competitive corporate tax systems within the G20 by delivering and, indeed, exceeding its previous targets of 1 percent annual reductions until a rate of 23 percent is reached by 1 April 2014.  We would not dismiss a commitment by the Chancellor to target a flat 20 percent corporation tax rate by the end of this Parliament.

The reform of the Controlled Foreign Companies (CFC) rules is another key measure within the Treasury’s corporate tax reform package.  Measures to restrict the impact of these rules in order to encourage overseas expansion by UK-based groups will be confirmed in this Budget.  We anticipate that there could be more proposals to ease the practical implementation of the new rules, which are fiendishly complex to interpret but, fortunately, only affect a small minority of UK groups.

The Chancellor is clearly walking a political tightrope and it remains to be seen whether the Budget can placate both wings of the Coalition.  This political pressure can only add to the difficulty of fashioning authentic fiscal reforms that stimulate growth within the overarching constraints of reducing the fiscal deficit to sustainable levels. The efficacy of the actual Budget proposals will need to be set against these tight constraints.

Image — Britain’s Chancellor of the Exchequer George Osborne leaves number 11 Downing Street in London March 20, 2012.  REUTERS/Luke MacGregor

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