Wrong to use tax system to ‘subsidise risk’, says IFS

Self-employment

Paul Johnson, Director, Institute for Fiscal Studies, said it was ‘pretty hard to justify’ the scale of tax difference between employed and the self-employed, especially as the only difference is in terms of maternity benefits and contributing to jobseeker’s allowance.  “That might imply a difference in National Insurance rates of up to one percentage point, but certainly no more than that”, he said. Johnson suggested it was wrong to use the tax to ‘subsidise risk’ (charging other people more tax in order to reduce the tax on another group) because the tax system helps an awful lot of people who are not taking those risks. On why unearned income is actually more favourably taxed than earned income, he said one would want to be taxing them all at the same rate but adjusting the tax base, so that you are not reducing incentives to save and invest. Johnson said that the changes to self-employment would probably fail the Treasury’s six principles of tax policy because getting rid of class 2 NICs, then the change to class 4 and the changes to dividend allowance were not done all at once.

Helen Miller, Head of Tax at the IFS, disagreed with the view of Tory MP Jacob Rees-Mogg that it might be useful is to go back to the old close companies rules, so that dividends from close companies are tracked differently to those from non‑close companies. Miller said whenever you put boundaries into the tax system and define a set of companies, you give people incentives to try to be one type or the other type.

Committee Chairman Andrew Tyrie said an enterprise culture drives economies and keeps them flexible. Rees-Mogg was concerned about the danger of having ‘nice‑to‑do baubles’ tax incentives that end up causing unintended consequences. Rees-Mogg and to a lesser extent Johnson shared a concern about forestalling if there is a long lead up to a tax change, with the balance of risk in terms of issues like dividend taxation clearly towards forestalling.

Welfare caps and spending

Rees-Mogg said caps such as the welfare cap and having a target with overseas aid, which is much more fixed than the cap for welfare leads to distortions in expenditure.  You are trying to achieve something that is based on so many moving parts that to get it absolutely right is extremely difficult and it constrains your policymaking decisions, he argued.

Carl Emmerson, Deputy Director at the IFS, said having a cap that says that, if spending goes above a certain level that you can choose in advance, we have to either rein it back below that level or explain our decision not to, could help to make policymaking better. He said: “The move to assessing it every five years, rather than every year, is a bad move and I cannot help but be a bit cynical about the fact that it will not actually get tested until after the date of the next general election, which means it cannot be breached in this Parliament.” He said the OBR’s welfare trends report still focuses on all of welfare spending, so the IFS still has a check on the whole lot despite roughly 52 per cent of welfare spending only being in the cap.

Stamp duty and probate

Johnson said that while there will be some opportunities for ‘gaming probate duty,’ the economic consequences of that will be smaller than the stamp duty changes. He accepted that the probate fee changes will create some incentives to game the estate around those levels.

Emmerson said the OBR says the ONS will decide that the spending that the Government  will do on valuing your estate is public spending and the income they get from the probate will not ‘net that off’, meaning it will in fact be a tax receipt.  His view is that the ONS will deem probate feeds to be a tax now because of its structure.

Savings (pensions and LISA)

Stephen Hammond (Conservative) suggested that there is an overall message coming from the Government, in most of the measures they are introducing at the moment, that there is a disincentive to save.

Johnson said ‘clearly’ auto‑enrolment has improved the incentives to save and the limits for ISAs have doubled since 2010, too. While a year ago the then Chancellor did not make the big changes to pensions that he consulted on to move the ‘whole thing’ to an ISA style gradually, we have moved to a savings world that is much more towards the ISA‑type savings and away from the pension‑type savings, he said.

If the lifetime allowance were done away with, it would move money towards pensions. The main group that that would help would be those currently fortunate enough to be in defined‑benefit schemes, Johnson said.

Extra money for social care

Wes Streeting said social care pressures are such that he imagine a lot of councils will put this money where it should go, which is into social care.

Johnson said if all the money that has been allocated to social care in the Budget goes on social care, that will take adult social care spending roughly back to where it was in 2010.  If all of that money goes, it is a big increase this year of seven per cent or eight per cent relative to last year, but there are three big caveats to that, he said.  First, it is not entirely clear that all of that money will have to go to social care, because as you know councils will have a degree of autonomy over exactly how that money gets spent.  Secondly, if it does all go, that is a sudden change.  Will that be spent as carefully and sensibly as it could be?  Thirdly, while there is as much money per adult as there was in 2010, there are an awful lot more older people needing social care, so the age‑adjusted or real amount available will still be less than it was in 2010.

Business rates

Streeting said the Government had made a mistake by trying to tinker with the system as they have gone along, rather than addressing the whole issue of business rates in a holistic sense, whether they are fit for purpose and the impact they are having on the success or otherwise of businesses across the UK.

Emmerson said if we want a simpler tax system, we should just apply business rates uniformly, should not go seven years without a revaluation and focus the tax more on the value of the business land, not on the property that sits on the land. Emmerson liked Tyrie’s idea to examine the possibility of using indexation followed by periodic adjustment when the indexation gets out of line, instead of more frequent complex revaluations

Miller reminded the committee that business rates relief is going to be allocated across the country according to those areas that saw the biggest increases.

Johnson said the way the appeals system works at the moment creates uncertainty, not just for businesses, but significantly for local authorities’ cash flow.  Different authorities have put different amounts of money aside to deal with appeals.

Schools budget

There are 50 schools in Helen Goodman’s constituency but she wondered if there was to be a new free school set up, where the current funding for that would come from. She added that per‑pupil funding is falling despite the population of schoolchildren increasing.

Johnson said that if you look at current spending on schools up to 2015, spending per pupil actually grew a small amount over the period 2010‑15, largely because there was a significant increase in the pupil premium. If you look at the planned period of 2015‑20, school spending is being frozen in real terms. That means a real‑terms cut of 7seven per cent or so per pupil going forward. He added that the evidence on the relationship between spending and child outcomes is not as strong as you might expect it to be. Spending on sixth forms is the bit that has really been hit very substantially over the last 20 years.

Brexit

The OBR has said that the top end of the income distribution will be disproportionately hit by the UK exiting the EU.  It is talking about salary compression at the top end of the distribution. Johnson said the IFS has looked back, and this is clearly not a ‘Brexit‑related thing’, but it is clearly the case that the earnings distribution has compressed reasonably significantly over the last five or six years. Indeed, the ‘99th percentile’ (Percentage below) has fallen relative to earnings at the middle and at the bottom. Going forward, the OBR has set out its assumptions, which look sensible to him, but the IFS has not done, and is not in a position to do its own projections of what the impact of Brexit might be on the earnings distribution.

The full session can be read here. CIOT and other tax professionals are expected to give evidence to the committee in the week commencing April 18th.

Blog by Hamant Verma