Is tax so complex that it needs its own office aimed at simplification? Miranda Stewart interviews Jeremy Sherwood, Director of the United Kingdom Office of Tax Simplification.
What do you do at the Office of Tax Simplification?
The UK Office of Tax Simplification was set up in 2010 in HM Treasury with the task of providing independent advice to the Chancellor on tax simplification. The Chancellor is the political minister with responsibility for tax – equivalent to Australia’s Treasurer.
We carry out reviews into specific areas of the tax system, gathering evidence of where it is most complicated and make recommendations to the Chancellor.
How do you decide what to tackle? Do you focus on tax law, administration or policy design?
We generate the ideas for the projects ourselves, by examining the tax system and assessing where it is most complex. Early on, we decided that our goal is to deliver the biggest simplification to the greatest number of people, so we try to focus on areas of the tax system that will make the biggest difference. We draw up a shortlist and present that to Ministers in government and agree with them the subjects to tackle in the next year or two.
We are able to make policy recommendations that would involve changing the law. When we start a project we do it with an open mind. That is a really important principle. As we talk to people, our ideas start to crystallize as to where we think the most impact can be made.
When we started out, we thought that we would most likely make recommendations aimed at changing policy and legislation. But in practice, we have found that we can often make the biggest difference by changing relatively simple processes at the coalface between the taxpayer and HMRC, the UK revenue authority.
How do you investigate complexity?
We build a mixed team of civil servants and external experts. The civil servants bring to the role project management and their policy expertise and political awareness. The private sector people bring their tax expertise and practical commercial experience. Typically we will have 50 to 70 meetings around the country, often organised by firms of accountants or their clients, or by business representatives or charities.
We try to balance that anecdotal evidence with internal data and statistics that we gather with help from the HMRC analytical team. We look at sources such as call centre statistics, e.g. where are the greatest number of calls coming from? What are the errors people make most frequently? We also design and conduct customer surveys and sometimes ask universities or market research organisations to carry out research projects for us.
Can you give us an example of a successful project completed and implemented?
One good example is our small business review, the first review we did in 2010. The main recommendation we made was to allow small businesses to draw up their accounts on a cash basis.
In our investigation, we found that, although by law in the UK businesses had to draw up their accounts on an accruals basis, 75 per cent of people did not understand it and were getting it wrong, which was a surprise to us. They thought that they were doing it right, but they were actually getting it wrong. HMRC did not know that such large numbers were getting it wrong. It depends on the type of business, but we also found, talking to small firms and small accountants, that the cost of maintaining records and professional fees for drawing up accounts for the accruals basis often amounted to more than the tax paid by the business.
Our recommendation was for the government to provide a cash basis for small businesses as a default option, implementing a behavioural insight that a default rule would be more effective. The government decided to provide a choice for businesses to opt into the cash basis, up to turnover of £77,000 which was the threshold for VAT in the UK.
We were not sure how successful this optional rule would be. Accountants were telling us that people would not take up the option. However, we were very pleased to see that in 2014/15, about 1 million tax returns were submitted using the cash basis, so the demand is really high, out of about 5 million small businesses.
Another recent project of the Office was on improving the competitiveness of the UK tax system.
Prime Minister David Cameron was very keen on improving the ranking of the UK in the World Bank’s Doing Business survey. He set all agencies the goal of getting the UK into the top five.
There are three elements to the Doing Business index on tax, where the UK is ranked 15 this year (previously 16) – we are ranked 6 overall. The tax elements are: the tax rate, the amount of time it takes to prepare a tax return and the number of payments that a business needs to make. Australia is not doing so well and is currently ranked 42 on paying taxes (although 13 overall).
We focused on trying to improve the time it takes to prepare a tax return. We spoke to the tax managers and heads of tax of major corporations in the UK and small and medium enterprises as well. We got through nearly all of the FTSE 100 tax departments. We also collaborated with the Manchester Business School in setting tax students the task of analyse tax systems from countries around the world, in terms of strengths and weaknesses and this helped us build a comparative picture of the UK tax system.
We made 50 recommendations in our report of December 2014. The main recommendation was to align more closely tax profits with accounting profits. We estimated that there were 81 adjustments to be made to accounting profit, to come up with the tax profit. That took a lot of time of the tax departments in these companies.
The government has said they will implement 49 of our recommendations. The one that was too difficult related to HMRC’s customer service model. A lot of businesses were very complimentary about the model for large businesses, where the taxpayer has a single officer who is responsible for co-ordinating their tax affairs. We wanted HMRC to extend that model to medium sized companies but they said that they just did not have the resources to do that.
There is a lot of emphasis on cutting red tape at the moment in Australia. Does a goal of deregulation fit with tax simplification?
In my experience, there is an overlap between deregulation and simplifying tax. But tax is quite different to other areas of regulation, not least because people don’t like paying tax! You need to have a certain level of regulation to encourage people to pay tax who don’t want to.
The principle that we like to apply is that you should not let the small minority of people who are not complying with their tax obligations dictate the way that you design the tax system for the vast majority of people who do comply. There may be a link between simplification and compliance with the tax law, suggested by the OECD and indicated in some research in the US (see, e.g. Nugent 2013; although c.f. Forest and Sheffrin 2002 ) .
Simplification would definitely improve the high level of errors that you get when people try to comply with the tax system – unintentional errors. But I think it would also – anecdotally – improve peoples’ behaviour in complying with the tax system.
You have been developing a complexity index for tax. What is the biggest cause of tax complexity?
The biggest cause that people have told us, in the meetings that we have had with businesses and taxpayers over five years, is change. Just as people are getting used to the system, it gets changed and they have to learn a new set of rules, new legislation, new references and new processes.
Another cause is that politicians use the tax system to target other objectives, such as economic or social objectives. For example, incentives to encourage research and development, or to encourage innovation, or enterprise. Our feeling over the course of these reviews has been that, while some of those objectives on their own might be valid, when they are all put together, you end up with a very complicated system. We think it is much less efficient to use the tax system to target these behaviours than to use something such as targeted grants, or loans, which are better focused on the people who you want to encourage.
Change is inevitable, as the business world changes and as politicians want to implement their policies. But we would like them to minimise changes to what is absolutely necessary.
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