What are the key foundations of a good tax system? This is the question asked – and answered – in a new report from ACCA, which aims to peel back the multi-faceted nature of tax systems to get to the fundamentals of state revenue-raising.
According to the report, Foundations for a Sound Tax System, this core takes the form of a tripod of simplicity, certainty and stability. Each leg provides the necessary support for making a tax system work – for government, revenue collectors and, most importantly, taxpayers.
Time for change
The importance of these fundamentals has been already recognised, but the major difference now is that tax systems face intense pressure created by the Covid-19 crisis. As report author Jason Piper, ACCA’s head of tax and business law, says: ‘Tax systems have always evolved and changed, but now there will be much more change pushed through by the extra pressures of Covid-19 on top of recent pressures caused by digitisation.’
Could this then be an opportunity to build back better, and create a tax system that taxpayers can understand and engage with, and ultimately pay the right amount of tax at the right time?
‘Even if you cannot change the big ticket items of what is taxed, or the rates at which individuals are taxed, you can at least simplify the administration,’ says Piper.
Simplicity is the first leg of the tripod. If taxpayers and their advisers face too complex a tax system and are unclear what is expected of them, this creates the potential for both mistakes and deliberate rule-breaking. Complexity in the tax system distorts the economy, diverting productive energies into non-productive administration.
As the report highlights, the advantages of simplification are clear:
- It reduces the cost of administration
- There is greater accountability through clarity and transparency
- It improves stability because the potential for unintended consequences and need for counteracting measures are both reduced.
Even if you cannot change the big ticket items of what is taxed, or rates of taxation, you can at least simplify the administration
The second leg of the tripod is certainty. If there is uncertainty in the tax system, neither governments nor taxpayers can effectively budget or plan ahead. Unfortunately, as the report observes, every tax system incorporates uncertainty to some degree, and indeed it may even be encouraged.
But the benefits of certainty are also clear:
- Policymakers can base future spending plans on a realistic assessment of tax revenue
- Taxpayers are able to choose between alternative transactions
- Where uncertainty leads to disputes, the direct and indirect costs can be considerable.
The third leg is stability. Closely related to certainty, stability focuses on whether the current answer will still be the correct one in two or 10 years’ time. This extends to the rates at which calculated values are taxed and the administrative practices surrounding that process.
According to the report: ‘Stability is essential for effective planning and efficient, sustained compliance. Individuals can budget household income more accurately, while businesses are encouraged to make investment decisions.’
Stable tax rates and a stable base are equally important. Sudden shifts in tax rates can be bad for business and consumer confidence, while changing the tax rules that affect the tax base comes with economic and compliance costs.
Benefits of stability include:
- effective planning
- efficient collection
- sustained compliance.
However, it should be noted, as the report does, that the world changes faster than government policy – the struggles over how and where digital services are taxed is an obvious example of how a tax system built yesterday can fail to cope with today’s circumstances.
Combine that with the Covid-19 pandemic – which has actually seen governments move remarkably quickly – and the pressures increase even further. Not only that, but there remain longer-term factors, such as environmental concerns, creating additional demands for change.
The struggles over how and where digital services are taxed is an obvious example of how a tax system built yesterday can fail to cope with today’s circumstances
Speed and effectiveness
The response to these changes needs to balance speed with effectiveness. Policymakers may need to accept short-term imperfections, while taking a measured approach to implementing genuine structural improvements that meet the principles of simplicity and certainty in a transparent and accountable way.
Of course, there is also the need to balance simplicity with fairness. As Piper says: ‘Tax is completely binary – you either have to pay a tax or you don’t, and changes are often not good for those taxpayers at the margins. But if people understand what it is and why they are paying it, then you can build public trust in the tax system.
‘Regardless of the policies adopted by government, the design of the tax system used to fund or implement them should be optimised to achieve a balance between simplicity, certainty and stability,’ says Piper. ‘The cumulative impact of each change should be considered not just in the context of the tax system, but of the wider environment for business and taxpayers.’