Kick-starting the debate

To flatten or not to flatten? That is the question, reckons Michelle Perry

The Treasury no longer has a choice in the matter. Flat tax is the debate of the moment in Britain and a large portion of the world. Whether the Government wants to be a part of that debate is the only matter in question for now. Authorities in industrialised and post-communist countries are not just talking about flat tax but positively embracing it.

Since 2001, many East European countries have adopted a flattened tax structure. Estonia led the way back in 1994 when the Government there introduced a flat tax on personal income. The flat tax revolution now appears to be spreading westwards.

Resistance to debate is useless. Indeed, the Government will lose face in the public’s eyes, and possibly the next election, if it fails at least to debate the issues around simplifying the UK’s over-complex tax system.

Britain’s competitiveness in Europe and the rest of the world is a growing concern. Inward investment is down and multi-nationals increasingly point to tax as a key factor when it comes to deciding where to locate operations. The UK tax authorities’ recent stance on stricter tax collection to boost dwindling revenues hasn’t exactly paved the way for smooth relations between business and government.

A prime example of how hard companies are working to remain competitive and avoid taxes is seen in the recent trend by some of the UK’s most well-known high street shops set up offshore to avoid VAT.

Chas Roy-Chowdhury, ACCA’s head of tax, says: “There’s a strong possibility that we could be put at a disadvantage in the wider global competition, if the rest of the EU members introduce low, flat taxes. We will be far less attractive to business investment if we have a complex system.”

UK officials cannot dismiss out of hand the flat tax revolution any longer. Arguments that it’s more beneficial to set up a flat tax structure in post-communist countries, such as Estonia and Poland, because they are starting from scratch hold less weight.

Greece, Germany, the Netherlands, Spain, Italy, Denmark and Canada are now all reducing their corporate tax rates and several of them are looking at flattened tax structures.

Italy became the latest European country to examine plans for a flat tax in a bid to compete with growing competition from Eastern Europe and Asia. Germany’s Angela Merkel has also suggested that a flat tax system could work in her country.

Roy-Chowdhury says: “History shows that low tax rates lead to revenue increases over time. In Ireland, reduced corporation tax led to tax take increases.”

Greece’s Finance Minister, Giorgios Alogoskoufis, has also said that from 2007 he would like to introduce a single 25% tax band for corporate and personal income.

Even the US, which last saw any kind of radical simplification in tax in 1986, is showing signs of re-examining its tax structure. President George Bush has appointed a commission to look into tax reform, although it’s unlikely to suggest a flat tax structure because of the narrow terms of reference the commission has been given.

Still, Steve Forbes, a former US presidential candidate, has published a new book advocating a flat tax and his ideas are fast gaining currency in the US.

Roy-Chowdhury says: “We think it [flat tax] deserves some serious consideration in the UK so that we can simplify the regime.”

Under a pure flat tax structure a single tax rate is applied across all personal, corporate and consumption income. All income over a personal allowance is taxed at the same rate. Tax relief and exemptions are abolished. Corporate and income tax rates are set the same, and tax is taken at source.

Proponents of flat rate tax structures say they are effective because they boost tax revenues, increase investment and encourage compliance by bringing part of the grey economy into the official economy because of a lower rate of tax. Arguably, under such a system, inefficiencies introduced by different rates of tax on different activities are removed, compliance costs fall, and the battle to stop tax avoidance eases as loopholes can be removed.

This summer George Osbourne, the UK’s shadow chancellor, kick-started the debate on flat tax for the UK after he announced he would set up a commission to look into the benefits of such a structure. The Conservative Party has pledged to build its next election campaign around a single rate of income tax, indicating a shift away from the previous three election campaigns which have all promised broad tax cuts but have all failed.

Osbourne recently told the Social Market Foundation: “We need to show that lower taxes are not an ideological obsession but the necessary part of a wider economic policy. We need to explain how lower taxes do not jeopardise economic stability or threaten public services, but are instead a vital component for enabling us to compete in the age of globalisation.”

The Conservatives’ clarion call is gaining widespread support. The Adam Smith Institute claims that evidence from Britain and other countries shows that high tax rates are counter-productive: “People strive to avoid or evade them, or move their capital or themselves overseas, or just give up work because the reward is not worth the effort. The tax system has also become hugely complicated.”

Indeed, the think tank argues that many taxes, such as capital taxes and inheritance taxes, should simply go.

The Liberal Democrats are also encouraging debate on the issue. In August, the political party put out a consultation paper which aims to help design party policy on taxation. The paper also discusses the possibility of introducing a flat tax structure.

Proposal

Howard Scott, a fellow of the Institute of Taxation and former partner of mid-tier firm BDO Stoy Hayward, has published a proposal to introduce a flat tax of 10% on all income and profits in the UK.

John Whiting, tax partner at PwC, doesn’t believe that the Labour Party will go for a flat tax structure, but he’s hoping for some simplification of the current labyrinthine tax structure.

Whiting says the proposals are “something that ought to fuel debate, even if it drives us towards focusing on simplification. That’ll be the main dividend for everyone”.

He adds that flat tax has been a success in many Eastern European countries because they have started from scratch in an environment of little compliance. “One of the theories of flat tax is that if you make it simpler then people will comply more. But in the UK we are compliant,” he says.

There are, however, concerns that a flat tax structure would benefit those on low income and high incomes, leaving those in the middle income brackets worse off.

“There’s lots of scope for debate. Anything that looks at the system is sensible. We haven’t got a perfect system,” says Whiting.

Roy-Chowdhury adds: “Unless something radical comes in to replace the existing complex system our attractiveness will be damaged.”

Radicalisation of the British tax systems at present seems unlikely. But serious debate is long overdue, as is simplification. If the Government ignores the topic now because it is a suggestion of its rivals, it does so at its peril. Public opinion is in favour of transparency and change - the Government should openly consider reform.

Michelle Perry is a freelance journalist specialising in financial and business issues.