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KPMG: pandemic an opportunity to level up tax system

Author: ICAEW Insights

Published: 04 Oct 2021

Tim Sarson, head of tax policy at KPMG UK, assesses key drivers behind the top-performing tax policies over the last five decades using ICAEW’s Tax Race findings.

Much like fashion, tax policies come in and out of favour. There are those that have shone brightly then quickly waned, some that have gradually risen to prominence and others that have been staples for decades. The ICAEW Tax Race report on the jostling policy priorities of the tax system offers Tim Sarson, head of tax policy at KPMG UK, a glimpse into how the economy has evolved, but also where it might be heading.

KPMG’s glimpse into the UK’s evolving economy

Tax policy is driven by a multitude of factors, not least the political and budgetary objectives of the current government, but also how simple or costly certain policies are to collect and police. Whatever policies are selected, each one will inevitably cause distortions – impacting some groups more than others. 

We see this in income tax rules, stamp duty thresholds and environmental taxes, among many others. At the margins, the anomalies of these distortions affect economic decisions and can act as disincentives to growth.

That’s why it has historically been important for the government to take a portfolio approach to taxation – considering a bundle of diverse policies to raise revenues. A regime overly reliant on one particular policy or area can lead to greater tax avoidance and an imbalance on those impacted but also creates a regime that is hard to change.

The most appropriate analogy for this is the energy mix, which is certainly something that we all better understand these days. Reliance on one source of power puts too much pressure on that source, limits the flexibility of power generation and doesn’t spread the risk and benefits evenly. Although with energy, a key feature of grid strategy is latency – having more capacity than you need. In tax, we rarely have that luxury and must borrow instead, or take the risk and cut spending.

The evolution of tax policy

Since the starting point of ICAEW’s research in 1965, the Treasury has used a mix of policies to generate revenue – which has changed over time. 

The biggest story over the past 50 years is the rise of VAT. It started to gain real traction in the 1970s and has since grown into the second-largest source of taxation.

VAT is easy to collect and is often overlooked as a tax by the public – many consumers don’t see its impact beyond the general notion of inflation. And, as an indirect tax, it can be perceived as voluntary – you only pay it on what you buy. But, of course, it has its own distortions on the goods it does and doesn’t affect, while the registration threshold is something of a cliff edge.

Over the same period, we have also seen the relative demise of customs and excise duties. To some extent, this will have been driven by the rise of global free trade which will in turn have dampened the customs element. But the biggest share will likely be excise duties with falls in takings – possibly a reflection of changing cultural habits around smoking and the decline in North Sea production.

Similarly, the proportion of Treasury funding attributed to corporate tax receipts has fallen significantly and remains low. Developing and producer countries tend to raise a higher proportion of corporate tax revenue as they develop, but governments can find corporate taxes challenging as they are too reliant on profits and the performance of the economy. Reflecting the UK’s post-industrial development, we see a transition from corporate tax as businesses start to pay more taxes by other means – whether it is through National Insurance Contributions, VAT, Capital Gains Tax or others. 

Another feature that is clear from tax policy over the past 50 years is the answer to the age-old question of who should collect taxes. Unlike much of the rest of the world, the central government in the UK collects an increasingly large proportion of tax compared to local authorities, with the exception of devolved authorities.

Yet, with all that change, some policies have held their positions.

Throughout the timeframe of the research, you can see the persistently modest impact of estate-related taxes. However, this is one area where the conversation appears to be shifting in recent years.

The debate over wealth, land and property taxes is attracting more attention and could provide a source of relatively untapped revenue as the government looks to restore the public finances after the pandemic. Perhaps a theme to watch out for in the upcoming Budget.

The taxation of income and profits has been the true mainstay of tax policy and maintained its position as the most dominant source. As others before me have rightly surmised, the burden of taxation will always eventually fall on individuals. That is one thing that is unlikely to change.

And the next 50 years

Over decades, successive governments have introduced, tweaked and repealed parts of our tax system. This has clearly evolved into a complex series of levies and reliefs that may have made political sense to introduce at the time, but once in place have proved difficult to reform. It is an inheritance rather than a strategy.

Now there is a degree of political consensus that taxes need to rise to fund post-pandemic spending, we have an opportunity to conduct a broader conversation about the ‘what’ and the ‘how’ of taxation for the next 50 years.

The pandemic, climate change, intergenerational inequality and ‘levelling up’ are all catalysts for reform and should underpin the shape of tax policy strategy and mix for the future. Only then can we make sure that it is ‘future-proof’, and also promotes fairness and encourages the innovation and growth that we need.