Richard Wellings: How the next government can lower business costs by simplifying the tax system

Dr Richard Wellings is Deputy Editorial Director of the Institute of Economic Affairs.

Businesses are the key to a strong economic recovery, but they are being strangled by red tape. They must devote a large share of their resources to complying with regulations rather than engaging in the entrepreneurship that creates wealth. Under New Labour, the regulatory burden has increased substantially. It is extremely difficult to measure the costs of that red tape, but, in one field - the costs of tax collection - there has been serious work. There are huge and increasing costs imposed by Britain’s incomprehensible tax system.

Gordon Brown’s years of tinkering have introduced more and more complexity. The UK now has the longest tax code in Europe. A new Institute of Economic Affairs study, Taxation and Red Tape, reveals that there are 8,300 pages of primary tax legislation in Britain, compared with 1,700 in Germany and 1,300 in France. Indeed, we probably have the longest tax code in the world outside India - which is, of course, notorious for its bureaucracy. The average Finance Act since 2000 has been three times as long as the average Finance Act in the 1980s – a damning indictment of New Labour’s record.

As a result, the compliance and administration costs of taxation have now reached a staggering £15-20 billion per year – equivalent to the government’s entire transport budget. And Britain is losing ground to her competitors. The UK is one of only 3 out of the 43 most advanced economies where the costs of tax collection are not falling.

The impact on small businesses is particularly devastating. Large companies can afford to employ specialists, buy the latest software, and even set up departments devoted to tax compliance. But for small companies the burden is disproportionate. Indeed, the research estimates that the costs of tax collection as a proportion of turnover are approximately sixteen times higher for the smallest businesses than for the largest.

Fortunately a great deal can be done by an incoming government to address this injustice. Firstly, definitions and procedures should be standardised across all taxes. Secondly, the maze of special reliefs on company investment should be abolished. Thirdly, levies with high compliance costs that generate minimal revenue – a prime example is inheritance tax – should be phased out.

The authors of the IEA study have another radical idea. They suggest abolishing the annual Finance Act. There can then be then be rigorous analysis of tax laws as and when they need to be passed, rather than a rapid-fire debate over various ‘rabbits’ that the Chancellor has decided to ‘pull out of the hat’.

The next government should seriously consider embracing these proposals. Unfortunately the dire state of the public finances means that a policy of tax cuts to boost business may be impractical in the short term. By contrast, a radical programme of deregulation – including tax simplification – would be a popular and effective way of encouraging a much-needed renaissance of British enterprise.