Tax reform designed to create a fairer and more sustainable system must not inadvertently discourage entrepreneurship, investment and economic growth, advisers have warned following the Centre for the Analysis of Taxation’s annual “Closing the Tax Gap” conference.
Elisa Sofocli, a partner at professional services firm Blick Rothenberg, said policymakers needed to consider how taxpayers and businesses would respond to changes rather than focusing solely on the potential revenue raised.
“Attempts to equalise tax outcomes must not inadvertently discourage growth, business formation, partnership models, entrepreneurship.”
CenTax’s conference brought together tax professionals, academics, government officials, practitioners and think tanks to examine ways of addressing the UK tax gap. The organisation subsequently published a report covering discussions across its two-day event at the University of Warwick.
One of the most closely debated proposals was CenTax’s recommendation to align Capital Gains Tax rates with Income Tax rates. CenTax has previously argued that differential rates create incentives to structure remuneration as capital gains and proposed equalisation alongside an investment allowance designed to protect genuine investment.
Sofocli said the economic rationale behind reducing differences between types of income was understandable, but questioned whether the potential behavioural response had been fully captured.
“The proposal that attracted the greatest level of discussion was CenTax’s recommendation to align Capital Gains Tax (CGT) and Income Tax rates. There was academic rigour behind the analysis and the policy rational of reducing distortions between different forms of income is understandable. However, many attendees questioned whether the report fully captured how entrepreneurs, business owners and internationally mobile individuals may respond to such a change – for example, by moving their businesses, assets and themselves to a country with a less burdensome tax regime.”
CenTax’s proposed package includes an investment allowance intended to reduce the effective tax burden on investment while addressing what it regards as distortions within the existing CGT system.
Sofocli said policymakers should consider whether a simpler mechanism could encourage longer-term investment.
“CenTax recognised that any move towards higher CGT rates would need to be accompanied by an investment allowance. However, rather than introducing a more complex system of investment allowances and asset rebasing rules, policymakers should consider whether a simpler solution of phased rates linked to holding periods could better encourage long-term investment.”
She also highlighted the practical difficulties of determining the value of assets held by people moving into and out of the UK.
“There are practical challenges associated with valuing assets on arrival to the UK and again on departure. While this may be relatively straightforward for listed investments, privately owned businesses, overseas investments and other illiquid assets can be significantly more difficult to value. At a time when the UK is competing internationally for both talent and capital, there is a risk of introducing complexity that may itself become a deterrent.”
CenTax has proposed rebasing assets when people arrive in the UK and taxing gains accrued while they are UK resident, alongside measures relating to departure from the country.
Sofocli acknowledged the underlying problem identified by CenTax.
“CenTax’s proposals seek to address a genuine issue. Capital gains can sometimes represent a more favourable tax outcome than income, and individuals expecting to leave the UK may have opportunities to realise gains outside the UK tax net.”
But she warned that increasing CGT without considering international competition could affect the UK’s attractiveness to investors.
“However, if this policy was implemented as proposed, the UK could find itself with one of the highest effective rates of taxation on capital gains amongst major economies, many of which provide significant reliefs or discounts for long-term investment. Any reform needs to be considered through the lens of attracting investment as well as raising revenue.”
There was greater acceptance among conference participants of the principle of aligning taxation of investment income, Sofocli said, although she pointed to potential consequences for sectors such as buy-to-let property.
“On the proposal to align the taxation of investment income, there appeared to be greater acceptance in principle, although attendees raised understandable questions around the implications for sectors such as buy-to-let property investment. The interaction between these proposals and the suggested investment allowance will be critical and reforms should be assessed as a package rather than in isolation.”
She said there was particularly strong agreement around the need to address the tax system’s childcare cliff edge, where relatively sharp income thresholds can affect decisions about work and earnings.
“Perhaps the area where there was greatest consensus in the room was the need to address childcare cliff-edge provisions within the tax system. Sharp thresholds often drive behaviours that are contrary to growth objectives, whether that involves limiting earnings, turning down promotions or discouraging second earners from remaining in work. A more gradual approach would likely improve both fairness and economic efficiency.”
Behavioural responses were also central to discussions about extending employer National Insurance-style charges to partners and the self-employed.
“One theme that emerged repeatedly throughout the session was whether the reforms adequately account for behavioural change. That was particularly evident in discussions around extending an employer National Insurance Contribution (NIC) style charge to partners and the self-employed. There is a real difference between tackling arrangements where individuals are employees in all but name and imposing additional charges on those who are genuinely self-employed and taking entrepreneurial risk.”
Sofocli also warned that limitations in HMRC data could make it difficult to assess the true impact of reforms on internationally mobile taxpayers.
“Any analysis of those at the top of the income distribution is inevitably constrained by the data available to HMRC. In the case of internationally mobile individuals, UK taxable income may not reflect their wider global income or wealth, which is an important caveat when considering both the scale of any perceived tax advantage and the potential revenue that reforms might generate.”
The debate comes as CenTax continues to develop proposals for reforming taxation at the top of the income distribution. Its latest work argues that significant additional revenue could potentially be raised without increasing the main rates of Income Tax, National Insurance or VAT, including through reforms to CGT and investment income.
For advisers such as Blick Rothenberg, however, the central question is not simply how much additional revenue reform could generate, but whether the resulting system preserves incentives to invest, establish businesses and remain in the UK.
The tension between those objectives is likely to remain central to the debate over the Government’s next Budget.
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