“Odd-looking” income tax system unlikely to change (Report on CIOT/IFS debate)

At a joint debate hosted by the Chartered Institute of Taxation and Institute for Fiscal Studies, “Where next for income tax?”, on Monday 26 June, experts also considered how the tax has changed since its introduction, and the effects of other charges and reliefs on taxpayers.

The panelists for the debate, which was chaired by CIOT president Gary Ashford, were: 

• John Barnett – Partner at Burges Salmon and chair of the CIOT’s Technical Policy and Oversight Committee
• Fran Bennett - Associate Fellow in the Department of Social Policy and Intervention at the University of Oxford
• Nigel Mills - MP for Amber Valley
• Tom Waters - Associate Director and Head of Income, Work and Welfare at the IFS

The current income tax system

Nigel Mills, a Conservative MP and former tax adviser, said Parliament spends very little time “standing back and thinking about” tax and how it is raised, but that income tax and VAT are going to continue to be the “two big staples moving forward”, as they are stable and simple to collect.

He acknowledged there are “crazy complexities” in the income tax system, though these can occur for initially “sensible” reasons. He said it was his view that individuals should not start paying income tax until earning more than the minimum wage and that the higher rate threshold probably needed to go higher than its current level.

The IFS’s Tom Waters agreed that income tax is an “increasingly odd-looking” system, with a series of changes since 2009 making the system more complicated, creating cliff edges and providing opportunities for avoidance.

As an example, he said there is a “strong incentive” if you receive childcare support from the government to keep your income below £100,000, as someone earning £99,999.99 – essentially the same amount of income – will be treated very differently to someone earning just 1p more (the latter losing their eligibility for tax-free childcare).

Taking a more positive approach, John Barnett said “no rational tax system would have all of these humps and bumps in” but they are “not necessarily a bad thing”.

With the caveat that he “doesn’t necessarily agree” with everything he was about to suggest, he suggested that many of the current concerns over the system relate to how it is presented. He used the example of a council tax bill to show how it could be better explained, noting that a breakdown of council tax shows how much is going to different precepts including water, social care and police. “It’s not just collecting for council tax, it’s serving a number of other functions,” he explained. The same increasingly applies to income tax, he suggested. “We need to distinguish between the collection mechanism for income tax and the tax itself.”

Barnett went on to explain how an income tax statement might try to achieve this, offering a range of alternative names for credits and charges, such as a Scottish or Welsh “supplement”, “social insurance” (National Insurance) and “graduate reclaim” (student loan repayments).

The future of income tax

The panel largely agreed that while the current system of income tax is not perfect, as a big earner for the public purse it is unlikely to change much, even with a change of Government.

Mills said that he expects, in the future, the income tax system will be “much the same as it is” with “another bit of bell or whistle” every year. He saw no prospect of any Chancellor making a radical change in income tax that doesn’t collect the same amount of money or more. On how the many complexities of the system could be addressed, he added: “Hand on heart, I’ve got absolutely no idea what you could do to make this simpler.”

He added there are some big choices on taxation in general around the corner, such as replacements for taxes on petrol and diesel as more people move away from using cars with internal combustion engines. He added that young people “rather annoyingly” (for the Exchequer) don’t drink and smoke as much as in the past, which will lead to a loss of revenue and “real pressures” on how tax is raised.

Waters pointed out that while in 1991-92, just 3% of taxpayers paid higher rate tax, by 2028 this is due to be above 10%, or 14% once you incorporate higher marginal rates. He said a good income tax system should:

• Avoid high marginal rates
• Be simple and transparent - It’s hard for people to know what their marginal tax rate is
• Be decided by policymakers, not inflation

Waters added that while it’s now starting to reverse, “we have had a system which has become increasingly dependent upon top earners” and so our public finances are “very dependent” on what happens to them. He suggested removing the personal allowance withdrawal and compensating for this by introducing a lower threshold for the 45p rate.

Asked about how the demographic change of an aging population will affect tax collection, Barnett said: “Income tax is always going to be the main money raiser for the government so if the profile of people paying it is different then the rate schedules and where allowances kick in will be different.”

High Income Child Benefit Charge

The HICBC was a political counterbalance to the government’s decision to reduce the top rate of tax from 50p to 45p, said Mills. He claimed that the charge, and other measures such as the withdrawal of the personal allowance, are “actively discouraging” people from working more by introducing disincentives and, sometimes, a pay rise can be a “very bad” thing to receive.

Fran Bennett said the HICBC, like the Marriage Allowance, was introduced “largely for political reasons”, to show the better off were paying for austerity, and “is one of the things that means high marginal rates at arbitrary points”.

She added that it had made the child benefit system harder and more complicated. Until 2013, it had been a “simple, popular and well-understood” benefit, she said, that recognised the increased costs of having children.

Now, many people on high incomes choose to opt out altogether - 624,000 by August 2024 - and that has implications for loss of National Insurance credits and pension entitlements in older age.

Bennett quoted the Resolution Foundation, which said that “no rational policymaker would ever have drawn up the current system”, which can cause problems when couples with children separate and introduces an “additional tax on the better-off with children”, the number of which is increasing due to frozen tax thresholds.

Waters said a reform of child benefit should be looked at and the HICBC threshold should, as a bare minimum, be uprated.

Marriage Allowance

Bennett said the Marriage Allowance, which she called transferable tax allowance (TTA), its original name, is a “slightly odd recognition of marriage”, as it tends to benefit the higher (usually male) earner. She explained that a previous allowance was phased out by 2020 as it was agreed marriage “in itself” did not require a higher income, but it was re-introduced as a trade-off with the Liberal Democrats in the coalition government for their agenda of free school meals.

Bennett said there was “concern” at its low take-up, with 2 million couples using it in 2021/22, while also criticizing the allowance for “enhancing difference in partners’ incomes” and “rewarding” the higher earner. “We should consider why one partner isn’t earning”, she suggested, and instead address that.

“This is a small step in the wrong direction,” she continued. Instead, “keep it simple” and abolish both HICBC and TTA. Waters also discussed options for reforming marriage allowance such as making it available to all taxpayers or simply abolishing it.

Other issues

Waters criticized the lack of transparency in personal taxes, saying it is “quite common” for basic rate taxpayers to think their marginal rate is 20%, as opposed to 32% with National Insurance contributions taken into account. Barnett added: “National Insurance is income tax by any other name.”

He added that the abolition of the Office of Tax Simplification was “a shame” but it will be “great” if simplification can be embedded in tax policy making. He said the OTS produced “very good technical reports but couldn’t take the politics in to account”.

Mills said that while we want people to save for their retirement, there are “completely farcical” arrangements that encourage saving but then withdraw pensions allowances in retirement.

He added that the gig economy also presents a fairness issue as increasing numbers of people engage in “fancy tax planning”. Mills called for the term “employed” to be redefined as grey areas in this description have put “real pressure” on how income tax is collected, but there remains justification for those who are “really” self-employed to enjoy a beneficial regime.

Barnett said Labour’s estimates for how much abolishing the non-dom tax regime will bring into the public purse are based on good research but what we don’t know is what the behavioural impact of the change would be, with people potentially leaving the country.

Concluding the debate, Bennett said how we can get the political and public will to raise the money we need for public services is “absolutely critical”.

Watch the full debate.