Challenges in the UK Current Tax System - Essay Example

of the current tax system-taxation of household savings An evaluation of the tax system by the economists revolves around the roles played by the taxation of savings. This is because first, the way taxation is conducted helps in the formulation of the tax base and hence what we call the comprehensive income tax; this applies in instances where savings are included to form part of the taxable income. Secondly, taxation treatment of savings helps distinguish between an individual’s lifetime and annual incomes which is employed in the equitable distribution of income and equalization of wealth across the society. Furthermore, the nature in which we tax savings can be used to explain the difference between individual taxation and corporate taxation and this is because the behavior differences between these forms of entities can clearly be stated. Still, savings realized due to taxation has an influence overall amounts of savings in the economy; in addition, how these savings are spread helps in explaining wealth distribution. This is because the amount of investments depends on the amounts of savings and by extent it is through investments that we are able to create wealth. Lastly, the manner in which taxation is done will determine an individual’s decisions on the amounts to save and the extent to which they are able to take risks while spreading their savings on assets (Angelopoulos & Malley 2010). Looking at taxation on savings in UK currently, we will take the approach of reviewing the taxation of; income tax, the NICs, and the capital gains tax. There is a complexity and unfairness on taxation of these forms of incomes; for instance, owner occupied housing, cash and shares held in ISAs savings are out of the taxation bracket. Therefore such forms of incomes are not taxed on returns as well as withdrawal. This form of treatment is not applicable in case of ISAs making the TEE treatment only available for investments in equity as opposed to savings in cash. The current system also provides a very in the taxation of pensions, here, savings is within the incomes that is subject to taxation. In addition, fund income is as well not subjected to taxation though withdrawals are taxed (Ainslie 2005). This is called the EET regime and it favors pensions since the taxation of pensions under it would consistently yield a zero as a normal return to savings. The pension saving is also subsidized since 25% of the fund can be withdrawn without being taxed if the withdrawal is in lump sum. The pension contributions by the employers are also subsidized and tax favored, as they are non-subject to employer or employee NICs either at points of contribution or withdrawal. Furthermore, the current system does not subject national insurance contributions to returns based on any of the mentioned forms of savings. Relief from the NICs is only available to the employer contributions of the pension schemes and not to any other forms of savings. This makes the other forms of savings be subjected to a treatment as specified by the TEE regime. The current situation also provides that savings can only be made from incomes that NIC have already been charged while on the other hand returns are never subjected to the NICs. The current taxation on savings also restricts individuals on what assets their accumulated savings should be allocated. Statistics from ONS shows that the wealth of households in the UK to a tune of 9 trillion pounds were held between the year 2000-2008 and among this wealth about 39% were held in pensions with an equal amounts being held in property (Akerlof 1998). This is an interesting case depicting that the UK citizens prefer taking equal risks when it comes to the sectors in which they accumulate their wealth. These choices are all based on the fact that the chosen ways of allocating savings on assets are all tax favored in the UK. The majority of the property through which the citizens allocate their savings are owner occupied housing. According to this tax system, the individuals with low levels of financial wealth are found to hold a greater proportion of their savings in other assets, which do not have tax advantage e.g on the deposits. In the current situation, it is evident that the gap between the rich and the poor is likely to even widen as the less fortunate do not derive any of the benefits that are provided by the current tax system on savings (Banks and Diamond 2010). The young without a stable income are as well negatively affected hence inequitable distribution of wealth being quite distinct. Description of the proposed recommendations The current system taxation on savings as observed is marred with a lot of complexity and inequality as to how it treats the UK citizens. The system discourages savings in so many ways with the only forms taking the advantage being the pension and property in form of owner occupied housing. The avenues for savings by the poor like the interest bearing accounts are given a very harsh treatment (Akerlof 1998). This has made savings in the UK to be inclined on the basis of how it is treated concerning taxation and not because of the available investments opportunities. Reforms on how savings are taxed are therefore mandatory to help in the promotion of neutrality towards savings for the bigger majority of the tax payers who are greatly inconvenienced. The approach fronted to spearhead this course is that which exempts normal return to savings from taxation (Banks, Blundell and Tanner 1998). The proposition above is achievable in two major ways most so concerning most of the assets prescribed. First, it can be achieved through the consumption tax implementation under which all those contributions that are directed towards savings are all made on gross taxation and tax be paid only on withdrawal. Secondly, an implementation of the rate of return approach can be adopted; where savings will be made net of taxes and then with tax they will be charged specifically on returns with returns above the normal rate (Claus 2010). In the case of the interest bearing accounts which have been sidelined for so long; and given they do not exhibit supernormal returns they can be subjected to the earnings tax under the TEE regime. This is as opposed to the current system where the interest bearing accounts are subjected to the standard income tax treatment. This standard is unfair since there is no allowance for the inflationary effects making the system to punish the taxpayer during periods of high inflation (Banks and Diamond 2010). Purpose of providing a tax system with a neutral treatment A neutral treatment of the life-cycle savings for majority of taxpayers is much in place since the current tax regime has vastly burdened such individuals’ in the society. A discussion on saving in general is based on the fact that everyday individuals fight to create a balance between what they save and what they consume over their lifetime. This makes the study on taxation of savings a prudent matter since it is through such savings that investments are realizable (Banks, Blundellm and Tanner 1998). It is true that savings are normally quite less when individual incomes are less and the needs are more; on the other hand they save more when the incomes are high and needs are low. Other individuals normally try to create a stable consumption levels throughout their working life. The decision to save or dis-save depends on the decision on the amount to consume during a particular period. The assumption here is that the decisions on savings are made with a basis of clearly defined expectations about how the future economic events are likely to turn out (Claus 2010). For other individuals consumption smoothing is a tough choice to make with those who cannot easily access credit like the young and the poor being the most affected. This drives us to the point that explains that decisions on savings according to the traditional model are not based on the long-term view of the economic situation at hand. The other purpose is therefore to fight and get a tax system that does not levy taxes on normal returns to savings given such returns have the sole objective of compensating a delay in consumption (Tiglitz 2006). The representation of heavy taxation on people who choose to consume later and less on those who consume currently is harmful to the economy and the society as it discourages savings but current consumption. This can be handled by taxing the earnings of individuals as opposed to taxing their savings, as this will be against the sacrifice that has been made by such individual who saves today to consume tomorrow (Eccleston 2007). The assumption that everyone who has much savings is a wealthy individual does not therefore apply in such a case. The notion of the movement to the general TEE treatment of cash accounts tends to be more persuasive as opposed to being objective. This is because such forms of savings are more inclined towards the less well-off. The implementation of the reforms will act to relieve those single less well-off individuals with massive current savings. If treatments like allowance of consumption taxes EET and RRA on bank accounts, the holders of such accounts will find it easier to provide an array of services for very low return or to an extreme even zero returns (LaBrosse 2011). In RRA terms such losses would be offset elsewhere and hence the TEE regime still prevails to provide equitable taxation. The other reason is to discourage the situation where taxation restricts the manner in which I decide to save and in what aspects of the economy I should decide to save. It is true that tax policy should not decide the direction of savings that I take like in the UK system where only a few sectors like housing, pension and financial assets are favored (King 2007). My opinion on the strengths and the weaknesses of the proposals The proposals made on the aspects of taxation concerning savings are much in place and in order given the oppression that the other system has subjected the majority of the UK citizen. Under the new proposals, and individual will be able to determine the manner to conduct their savings without being subjected to specific areas with marginalized tax advantages (LaBrosse 2011). Equality will as well be achieved most so when an individual is deciding on whether to consume currently or save for the future. The tax systems will therefore have a coherent structure; structures based on defined economic principles. The propositions still hub among themselves a clear vision for an ideal system without the distortions witnessed currently. The resultant tax system would therefore be progressive, neutral, and systematic. This allows individuals to feel much relief and not oppressed. The only weakness comes when we look at the wealth that is transferred between people. The law is still silent on this and hence taxation favors those who can arrange their affairs in order to evade taxation at death. This has caused unfair taxation on some classes of assets such as business or agriculture (Tiley 2013). Under the new propositions, both individuals with lower income levels and are therefore saving for their future consumption as well as the wealthy are equal winners. The other winners are all the citizens who as a result were restricted on the areas they can save their money. This is because previously the savings were not entitled to benefits. The unfairness of high tax rates for the lifetime saver as witnessed previously is hence eliminated. This system may come with many advantages but again it has to be reinforced each time to realize the desired interaction between savings and means tested. References Angelopoulos, K, & Malley, J, 2010, Tax structure, growth, and welfare in the UK, Capstone Pub: Edinburgh. Ainslie, G, 2005, ‘Specious Reward: A Behavioral Theory of Impulsiveness and Impulse Control’, Psychological Bulletin, 82, 463–96. Akerlof, G, 1998, ‘The Economics of “Tagging” as Applied to the Optimal Income Tax, WelfarePrograms, and Manpower Planning’, American Economic Review, 68, 8–19. Banks, J, Blundell, R, and Tanner, S, 1998, ‘Is There a Retirement-Savings Puzzle?’, American Economic Review, 88, 769–88. Banks, J, and Diamond, P, 2010, ‘The Base for Direct Taxation’, in J. Mirrlees, S. Adam, T. Besley, R. Blundell, S. Bond, R. Chote, M. Gammie, P. Johnson, G. Myles, and J. Poterba (eds), Dimensions of Tax Design: The Mirrlees Review, Oxford: Oxford University Press for Institute for Fiscal Studies Claus, I, 2010, Tax reform in open economies: international and country perspectives. Edward Elgar: Cheltenham, UK. Eccleston, R, 2007, Taxing reforms: the politics of the consumption tax in Japan, the United States, Canada and Australia, Edward Elgar: Cheltenham, UK. King, M, 2007, Tax reform in the UK and US, Oxford University Press: College Station. LaBrosse, JR, 2011, Managing risk in the financial system, Edward Elgar: Cheltenham, UK. Tiglitz, J, 2006, ‘The Design of Tax Structure: Direct versus Indirect Taxation’, Journal of Public Economics, 6, 55–75 Tiley, J, 2013, Studies in the history of tax law, Hart: Oxford. Read More