Extent to Which Current UK Tax System Meets Generally Accepted Characteristics of a Good Tax System - Essay Example

The Extent to which the Current UK Tax System Meets the Generally Accepted Characteristics of a Good Tax System Name Course Name and Code Instructor’s Name Date Introduction Tax refers to a fee levied by a government on an income, product or activity. There are two types of tax: direct and indirect tax. Direct tax refers to a fee charged directly on corporate or personal income (Finney, 2010). On the other hand, indirect tax refers to a fee levied on the price of a good or a service. People are taxed in order to finance government expenditure (Mahr, 2007). Provision of public goods and services are often provided by the government and hence tax money is partly used to acquire such services and goods such as street cleaning and street lighting (Mirrlees, 2010). Tax is utilized by the government as revenue for spending on functions such as construction of road; for redistribution from wealthy sections to poorer sections; for re-pricing to discourage consumption of certain products or services; and for representation, that is, for accountability leaders from citizens (Adam and Browne, 2006). Tax is usually enacted by a legislation entrenched in the country’s law (Mumford, 2010). In most cases taxes are imposed in form of a percentage. There are different tax systems adopted in different countries (James, 2009). They include regressive, proportional, progressive and lump sum taxation systems (Kay, Kay, and King, 1990). Regressive tax is a tax levied so that the effective tax rate reduces as the amount upon which tax is imposed increases (Feetham, 2011). Proportional tax on the other hand refers to a fixed tax rate as the amount upon which tax is imposed increases. Progressive tax refers a tax levied so that the effective tax rate rises as the amount upon which tax is levied increase. On the other hand, a lump sum tax is the one where a fixed amount is applied irrespective of the change in the amount upon which it is being levied. Generally accepted good tax system It has been argued that no single tax structure can be used in a country to fulfil all of its requirements (Mirrlees, 2010). Thus, it has been proposed that the best tax system for a country ought to consider the economic structure of the country, its public service needs, its capacity to administer taxes and any other related factors (Finney, 2010). It has also been suggested that a country can devise a good tax policy through studying the prevailing tax systems in the world (Buettner and Fuest, 2010). It has been said that taxes serve two main purposes: to raise revenue and to create or implement social policy (Mahr, 2007). Thus a good tax or tax system has properties which are related to these two functions of tax. There are various properties of a good tax or tax system (Mumford, 2010). The first property of a good tax or tax system is that it ought to have an adequate and stable tax base. Adequate and stable tax base ensures that enough tax is generated for the purposes for which it is levied (Mumford, 2010). For, instance user fees even though fair since they are tied directly to the utilization of a certain service, they may generally fail to generate significant volume of revenue to provide the said service (James, 2009). This implies that a tax system ought to have a broad base from which adequate funds can be raised even if it is seen to be unfair in some corners. To ensure stability of tax revenue, the base from which tax is levied need to be relatively stable over time. This implies that the tax needs to be resistant to economic downturns as much as possible. Inadequate base presents a problem since it will mean that the rate of imposed tax is high in order to be able to raise the required revenue (Mahr, 2007). Such high rates are politically unpopular and often inefficient. Having adequate base implies that the base need to grow at the same rate as the demand for publicly supplied goods and services (Finney, 2010). Thus, an adequate base is able to cater for present and future needs of the population in relation to publicly supplied goods and services. Stability ensures that the base is relatively constant over time as the economy undergoes short run changes (James, 2009). Therefore, the tax system needs to be a reflection of economic growth in addition to affording government officials some degree of stability for planning and budgeting purposes (Edwards and Shevlin, 2011). Another property of a good tax or tax system is that it ought to be fair. This implies that tax burden ought to be distributed across taxpayers in such a way that is consistent with accepted norms of equity and fairness (Mahr, 2007). Fairness is viewed in two different ways although both of them are based on tax incidence. Tax incidence is the individual or group of persons who actually pay tax (Mirrlees, 2010). In most cases taxes are paid by one person such as landlord, gasoline distributor or corporation who has the capability of looking out for reimbursement from others such as renter, gasoline consumer and consumer (Finney, 2010). In this case, the tax incidence of the tax is imposed on an individual other than one who writes the check to the government. In this case the fairness of tax is judged by the incidence of a tax instead of the person who pays it. Tax incidence may also fall on the same person who pays it to the government. This includes taxes levied on income and property (Mumford, 2010). A fair tax is defined in two different ways of which one or both of them may apply. Fairness is judged based on the benefit principal and the ability to pay principal. First, fairness is defined as one where the tax burden is in accordance to the ability of an individual to pay. It has been upheld that a fair tax is one where an individual’s tax burden rises proportionally with the ability of the individual to pay in case of a flat tax or it should rise at a faster rate in case of a progressive tax (Mahr, 2007). Regressive taxes where taxes fall disproportionately on those with a lower ability to pay are often considered to be unfair in their burden (Mirrlees, 2010). A fair tax can also be defined as one where tax burden is in accordance with the benefits received. This implies that if some individuals derive more benefits from the government activities, a fair tax system is one which will call upon such individuals to pay a larger share of the tax burden (James, 2009). This is said to be the origin of property tax where property owners disproportionately benefited from various services offered by the government such as poling, sewerage, lighting and streets (James, 2009). It has been generally been accepted that fairness or equity is associated to horizontal equity and vertical equity notion (Mirrlees, 2010). Under horizontal equity notion, equals are treated equally. Thus, individuals with equal income ought to pay equivalent tax burdens under this notion. In the case of vertical equity, individuals with different welfare levels are treated differently (Finney, 2010). A vertically equitable tax system is often difficult to implement since it requires the tax implementing authority to make judgment about the appropriate way to treat people at various levels of well being (Mumford, 2010). Thus subjective judgment is required in vertical equity. Another property of a good tax system is that it ought to be efficient. Efficient tax system takes into consideration how a particular tax might impact on economic activity. Efficient taxes are said to be ones which disturb market decisions the least (Mahr, 2007). An efficient tax system is also associated with reduction of costs of administering and enforcing the tax. This reduces compliance costs which are placed on tax payers (Mirrlees, 2010). An efficient tax system is likely to receive a high degree of compliance and allows simple collection of tax. An example of inefficient tax system is the federal income tax system (Mumford, 2010). This system has been found to be extremely difficult to comply with in addition to being costly in terms of collection and monitoring by the internal revenue service (IRS) (Jorgenson and Landau, 1993). Sales and property taxes have been found to be more efficient than any other types of taxes. Transparency in the tax system is another property of a good tax system. This property requires that taxpayers be made to understand the taxation process and why and how policy changes are made (Finney, 2010). Thus a tax system needs to have a visible linkage between the taxing unit and the services provided (Jorgenson and Landau, 1993). This implies that people ought to know when and how much they and others pay. Therefore, the tax incidence needs to be clear or transparent for tax system to be good (Mahr, 2007). Transparency enables the citizens to be aware of the uses of taxes they pay. Transparency improves the democratic processes which surround taxation (James, 2009). Moreover, a good tax system is where possible is utilized in advancing a social policy (Mirrlees, 2010). Tax policy has often been used to stimulate economic development and in provision of support for activities which contribute to well being of the community (Mahr, 2007). Such kind of tax policies may involve tax abatement on certain properties, tax exemptions of non profits from property tax, exemptions from business and occupation taxes on certain business and higher business and occupation taxes on other businesses (Mumford, 2010). Analysis of the UK tax system Much of UK tax (up to two thirds of UK tax) is derived from value added tax (VAT), income tax and National insurance contribution. As mentioned above a good tax system ought to have an adequate and stable tax base (Finney, 2010). Adequate and stable tax base ensures that enough tax is generated for the purposes for which it is levied. However, UK tax system has been accused of being costly and that the revenue raised and redistributed could be attained in less costly ways (Mahr, 2007). Thus, it seems the UK tax system has a larger tax base than what it really needs. The UK tax system is relatively stable and it was able to withstand recent financial downturn. Fairness of tax system is said to be another property of a good tax system. The UK tax system has been criticized for being inequitable (Mumford, 2010). Based on the principle of tax equity, tax burden ought to be distributed across taxpayers in such a way that is consistent with accepted norms of equity and fairness. Based on the definition of fairness, tax burden needs to be in accordance to the ability of the individual to pay (Mahr, 2007). However, UK tax system has been accused of imposing very high effective rates on some low income earners, that is, it applies regression tax policies in some instances. In spite the criticism, UK tax system seems to uphold some form of equity (Finney, 2010). It has been lauded that a fair tax is one where an individual’s tax burden rises proportionally with the ability of the individual to pay in case of a flat tax or where tax rise at a faster rate in case of a progressive tax (Mirrlees, 2010). In need to comply with this principle, UK tax system levies different tax rates in accordance to the level of profit earnings (James, 2009). In addition, the differing treatments for various forms of savings seem to be based on the need to promote equality (Watson et al. 2008). However, this has been criticized for distorting the decision of people on whether to save or not and hence discouraging saving (Mumford, 2010). Even though a good tax system ought to efficient, the UK tax system has been criticized for being expensive and inefficient. Although, efficient tax system takes into consideration how a particular tax might impact on economic activity, the UK system imposes corporation tax which has been criticized for discouraging investment that is financed through equity and favours debt (Mahr, 2007). In addition, the levying of different tax rates in accordance to the level of profit has been criticized for attracting profitable firms to invest in the country (Finney, 2010). Thus the tax system adopted in UK seems to disturb market decisions more and hence goes contrary to the principle of efficiency in tax system (James, 2009). Even though an efficient tax system is associated with reduction of costs of administering and enforcing the tax, the UK system is said to be very costly (Mumford, 2010). The levying of two separate taxes on earnings, that is, national insurance and income tax, complicates the tax system unnecessarily (Mahr, 2007). The system is said to have a complex array of welfare benefits which are difficult for tax payers to understand. Furthermore, UK tax system has not integrated personal taxes with personal taxes. All these policies have been criticized for creating complexity in the UK tax system and creating opportunities for tax avoidance and thus low compliance rates (Mumford, 2010). In addition, the tax system of UK is criticized for its stamp duty which is said to be among the most inefficient and damaging of all taxes (James, 2009). In addition, the zero rating of VAT on several goods and services has also received criticism for being expensive and inefficient because they are not helping people who earn lower income. The complexity of the UK tax system makes it to be less transparent as required under the generally accepted good tax system (Mahr, 2007). The complexity of UK system makes it difficult for taxpayers to understand the taxation process and why and how policy changes are made (Finney, 2010). For instance the benefits system in the UK system is said to be overly complex and does not provide incentives for people to find work. The treatments of income tax and national insurance have been accused of adding complexity to the system and making it more opaque. It has been heralded that, a good tax system is where possible is utilized in advancing a social policy. Tax policy has often been used to stimulate economic development and in provision of support for activities which contribute to well being of the community (Mumford, 2010). The funds raised through taxation in UK are utilized in the provision of public services such as health, education and social security (Finney, 2010). This is in line with property of good tax system to advance a social policy (Ogilvie, 2007). However, the system provides tax exemptions that could spur investment and creation of jobs for economic growth of the country. Conclusion Tax refers to a fee levied by a government on an income, product or activity. There are two types of tax: direct and indirect tax. Tax is utilized by the government as revenue for spending on functions such as construction of road; for redistribution from wealthy sections to poorer sections; for re-pricing to discourage consumption of certain products or services; and for representation, that is, for accountability leaders from citizens. Properties of a good tax system are based on its ability to raise revenue and to create or implement social policy. Thus a good tax system has adequate and stable tax base, is fair to all tax payers, is efficient, is transparent and is utilized in advancing a social policy. Based on these properties UK tax system falls far behind being a good tax system. It has been said to be highly inefficient, complex, and unfair. This implies that there is need for the restructuring of the system in order to qualify to be a good tax system. The system has been accused of discouraging investment, savings and economic growth. Some quarters have stated that the complexity of the system makes it possible for tax evasion. Reference Adam, S. and Browne, J. 2006. A survey of the UK tax system. (IFS Briefing Notes BN09). Institute for Fiscal Studies: London, UK. Buettner, T., and Fuest, C. 2010. The role of the corporate income tax as an automatic stabilizer. International Tax and Public Finance, vol. 17, no. 6, pp. 686-698 Edwards, A., and Shevlin, T. 2011. The value of a flow-through entity in an integrated corporate tax system. Journal of Financial Economics, vol. 101, no. 2, pp. 473-491 Feetham, N. 2011. Tax Arbitrage: The Trawling of the International Tax System. London: Spiramus Press Ltd. Finney, M. 2010. Wealth Management Planning: The UK Tax Principles. London: John Wiley and Sons James, M. 2009. The UK tax system: an introduction, 2nd Ed. London: Spiramus Press Ltd Jorgenson, D., and Landau, R. 1993. Tax reform and the cost of capital: an international comparison. Liverpool: Brookings Institution Press. Kay, J., Kay, A., and King, M. 1990. The British tax system, 5th Ed. Oxford: Oxford University Press Mahr, B. 2007. Comparison of US, UK and German Corporate Income Tax Systems with Respect to Dividend Relief. London: GRIN Verlag. Mirrlees, J. 2010. Dimensions of Tax Design: The Mirrlees Review. Oxford: Oxford University Press. Mumford, A. 2010. Tax Policy, Women and the Law: UK and Comparative Perspectives. Cambridge: Cambridge University Press. Ogilvie, J. 2007. CIMA Official Learning System Management Accounting Financial Strategy, 4th Ed. London: Butterworth-Heinemann Watson, J., Sauter, R., Bahaj, B., James, P., Myers, L., and Wing, R. 2008. Domestic micro-generation: Economic, regulatory and policy issues for the UK. Energy Policy, vol. 36, no. 8, pp. 3095-3106 Read More