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Business Services  •  Business Tax  •  government  •  IHT  •  Personal tax  •  Personal Taxation  •  Probate and Inheritance Tax  •  Taxation

The Fairness of the Tax System

By Lesley Stalker on 26 September, 2009

If ever there was a policy designed to score quick political points it’s the Lib Dem’s suggestion that people with a property over £1m should pay an extra tax of 0.5%. And if there was a move that is more demoralising to tens of thousands of hard working small business owners, I’d be surprised. However, the proposals do raise an interesting question as to the fairness of the tax system and especially the discrepancy between capital and income tax rates, writes Lesley Stalker.

The £1m house price tag sounds high but let’s put this into perspective. Imagine it’s 1999 and your business is up and running; in fact it’s not doing too badly, so that decision to set up on your own is feeling a little more sensible. The family is growing and you need a bigger house so you take the plunge and move to a nice one for 600K. It’s a stretch but you’re no stranger to hard work. There’s no extra money coming in and for the next ten years you pay the mortgage, the bills, living expenses (which have risen exponentially) whilst sucking up an ever-increasing tax burden. Then the economy falls on its sword due to financial mismanagement at the very top end and the country finds itself in a recession. You work even harder to make ends meet, but you’re still managing – just. At least that house you bought ten years ago has done quite well notwithstanding the dip in the property market. Staggeringly it’s now worth over a million pounds….which means…ah…

The tax would affect around 250,000 people who would pay an average of £5,000 a year – i.e. 0.5% x £1m?). It would, though, raise £1.1bn and that is unquestionably money that is needed because of the levels of government spending fuelled partly by economic gloom.

Total government spending in 2007/08 was £620bn, an increase of 7% on the previous year. That’s 44% of the national income. On top of this the UK has an eye-watering national debt of £804.8 billion to pay off (not helped by its £85.5 billion injection to the banks last year)

Big cuts in departmental spending would hit the poorest which is why all the parties have come up with tax increases to mitigate the blow of spending cuts.

But the point is, are those tax rises aimed at the right people? The mansion tax is a case in point. Although clearly it will be hitting those who have ‘old money’ and huge houses, there is the real danger that it will ensnare a separate layer of the hard working middle classes who simply can’t afford to pay a few thousand more quid to the taxman each year.

The Lib Dem’s plans also represent a shift from taxing income to taxing assets which have not been sold. They also suggest raising money by reducing the annual exemption from capital gains tax from £10,000 to £2,000 and by levying national insurance on company ‘benefits in kind’ and scrapping pensions tax relief for higher earners.
These measures, the Lib Dems say, would allow it to raise the income tax threshold to £10,000 thereby helping the poorest, but is the current tax system fair on the hardest working?
Alongside his levy on those in big houses, Lib Dem deputy leader Vince Cable suggested closing what he called tax loopholes enjoyed by the ‘relatively wealthy.’ One, he said, is the disparity between income and capital gains tax rates. Payment in shares which appreciate in value generate a capital gain taxable at 18% instead of the 40%, (and by next year 50%), on income over £150,000.

But it this situation fair? An entrepreneur has usually taken all the risk and deferred his payment for a number of years. On top of this shares are a very valid way to motivate staff without a high initial cost and suggesting this is a loophole could be very damaging for businesses in the long term.

If political parties argue that their measures help the hardworking poor, what about the hardworking others? If it’s a question of hard work, where does that put someone who buys a second property to make some money compared to someone who relies on a bonus? The property ‘developer’ gets taxed at 18% whereas the lump sum bonus earner gets hammered at 40%. But who has worked the hardest?

And should people selling businesses get preferential tax treatment when the economy is in such a mess? There are very few incentives for someone who wants to keep working and keeping earning an income (and in doing so, keep working to help build up the economy). What is good in the long term for the economy as a whole is bad for the individual from a tax perspective.

In this respect, perhaps we should return to the old system of indexation relief? We have come to expect capital should be taxed at a lower rate partly because of government incentives but should this practice continue?
Indexation relief for CGT (which was designed to exempt gains which arose through the effects of inflation and was a fair system) has been abolished and replaced with measures that encourage taxpayers to aim for a 10% tax rate, and entrepreneur’s relief (not available to all) which allows the first 1 million received from the sale of a business to incur a 10% rather than an 18% tax rate.

There are no easy answers to these problems, but it is definitely time to look closely at the infrastructure of the tax system as opposed to short-term money making ideas that are detrimental to those who really can get the economy back on its feet.

Lesley Stalker is Head of Tax at Robert James Partnership and a specialist in small business tax issues.

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