Submission on taxation of investments to the Commission on Tax and Welfare

Chapter 14 - reforms to taxes on savings


This contains possible reforms, following on from chapter 13.



14.4. CONCLUSION

The taxation of savings in the UK is distorting, inequitable, and complex.

Reforms in recent years have not been governed by any broad strategy or direction. There remain substantial differences between the ways in which different assets are taxed. Ordinary interest-bearing accounts are harshly taxed. There is, bizarrely, more limited availability of TEE tax treatment for cash than for equities. The taxation of capital gains continues to be contested and continues to provide substantial incentives to take returns as capital gains rather than as income. The taxation of pensions has been beset by uncertainty as governments worry more about tax revenue than maintaining the integrity of the system. And the treatment of employer contributions to pensions provides a substantial tax subsidy for saving in that form.

In these circumstances, a coherent package of reform is needed. In our view, the priority should be to move towards a system that is much more neutral in its treatment of savings as a whole—neutral between consumption now and consumption in the future—and one that limits the distortions between different types of assets. Getting there is not straightforward and does not mean treating every asset the same.

To reduce opportunities for tax avoidance, it is important to align the tax rates on earned income and on investment income in excess of the normal rate of return. This would remove numerous complexities and opportunities for avoidance. It requires National Insurance contributions to be charged on returns to savings in the same way as they are charged on earnings. We have shown specifically how this might be achieved for pensions.

Aligning the tax treatments of returns to savings in the form of income and of returns in the form of capital gains is also important. This is difficult to achieve under an income tax (TTE) treatment because there is a natural benefit to be had from the ‘lock-in’ effect of capital gains tax. In addition, the current system fails to index gains for inflation, offers a substantial additional tax-free allowance for capital gains, charges capital gains tax at below standard income tax rates, offers very generous ‘entrepreneur’s relief’ to those owning their own business, and forgives CGT entirely at death.

The way we suggest achieving the desired neutral treatment is through a combination of a straightforward TEE system of taxation for ordinary bank and building society accounts, a reformed EET treatment of pensions, and the introduction of a rate-of-return allowance for holdings of shares and similar assets.

This combination of reforms would achieve a great deal more rationality in the savings tax system. The RRA system for shares would ensure that returns above the normal return, and only those returns, are taxed. These returns could be taxed at the full (income tax and National Insurance) rates applied to labour income. To ease the possible compliance burden of such a regime, we propose that equity ISAs remain in place for the vast majority of people, who have relatively small holdings of shares. In addition, those who do not choose to use the RRA would, by default, be subject to tax on the full returns.

Ordinary bank and building society accounts should just face a straightforward TEE system—saved out of taxed earnings and then no more tax applied. This is appropriate for assets on which ‘supernormal’ returns cannot be earned. Indeed, it would be inappropriate to apply an EET or RRA treatment to such assets because of the failure to tax financial services that this would imply.
 
Chapter 15 - Taxes on wealth transfers



Taxation of wealth is a topic that excites strong passions. Some view it as the most direct means of effecting redistribution and key to achieving equality of opportunity. Others see it as the unjustified confiscation of private property by the state. Given these opposing viewpoints, it is not surprising that this is an area of taxation where international practice differs dramatically. Most OECD countries have taxes on income, spending, corporate profits, and so on, with recognizably similar goals. Practice with taxes on wealth varies widely. Some countries levy taxes directly upon wealth holdings, while others only tax transfers of wealth. There are some countries that do not tax wealth at all.


In this chapter, we focus specifically on the taxation of wealth transfers. Levying a tax on the stock of wealth is not appealing. To limit avoidance and distortions to the way that wealth is held, as well as for reasons of fairness, the base for such a tax would have to be as comprehensive a measure of wealth as possible. But many forms of wealth are difficult or impractical to value, from personal effects and durable goods to future pension rights—not to mention ‘human capital’. These are very serious practical difficulties. And where attempts have been made to levy a tax on a measure of current wealth—in France, Greece, Norway, and Switzerland, for example—practical experience has not been encouraging.

There is also a persuasive economic argument against taxing the stock of wealth. A wealth tax in this form would tax not only inherited wealth but also wealth representing the individual’s accumulated savings from taxed income. Taxing the stock of accumulated savings is closely related to taxing the returns to savings, and raises many of the same issues. We have already argued in favour of exempting a ‘normal’ return to savings but taxing ‘excess’ returns. A tax on the stock of accumulated savings does the opposite of this: it is equivalent to taxing the normal return to savings but exempting excess returns. To see this, suppose that I save £100 and the normal rate of return is 5%. A tax of 20% on the normal return is equivalent to a tax of 1% on the stock of wealth: both raise £1 from me (20% of £5 or 1% of £100) irrespective of the actual return I earn on my £100. It therefore discourages me from saving, but it taxes me no more if I manage to earn extremely high returns on my savings.1 This seems exactly the wrong policy
 
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