Why it is misleading to count the ‘cost’ of key tax reliefs

The Commons public accounts committee (PAC) has formally announced its inquiry into tax reliefs and their administration, and as the PAC prepares to question Treasury and HMRC officials on 7 April it is worth bearing in mind that HMRC considers a key element of last week’s National Audit Office report, on which the inquiry is based, to be “misleading”. And while I haven’t yet read the whole report I agree, because many reliefs are there to define the tax base. Their value is not money that government could collect without abolishing many important, long-established and widely accepted tax reliefs, exemptions and allowances.

In March 2011 the Office of Tax Simplification published its Review of tax reliefs. The OTS found 1,042 reliefs, allowances and exemptions and selected 155 for detailed scrutiny. That OTS report, focusing on the 155 reliefs, recommended the abolition of 47 reliefs on the basis that they were:

“either time expired, there is no ongoing policy rationale, the value is negligible, or the benefit is outweighed by the administrative burden”

Last week’s NAO report ran to 60 pages. It noted that since the OTS report “Parliament has abolished 48 reliefs but has introduced 134 new reliefs”. The NAO also found that:

  • the value of reliefs in relation to tax revenue and public spending has increased – but the increase is “mainly explained by increases in the income tax personal allowance, the thresholds for national insurance contributions, and the standard rate of VAT (because as the standard rate of VAT rises, so does the value of VAT reliefs)”;
  • the value of “tax expenditures” [such as EIS reliefs and the income tax exemption for ISAs] has increased in real terms from £91bn to £101bn;
  • HMRC “has not systematically categorised tax reliefs according to the function they perform”, and “a lack of relevant data means that HMRC does not know the cost of many reliefs”.

“Tax expenditures” is just one of six classifications drawn up by HMRC in order to identify the different objectives of reliefs – see figure 1 on page 5 of the NAO report.

The first category, for example, is “reliefs to correctly measure income or profits” (eg. reliefs for losses, to ensure that only the net profits after deducting any losses are taxed over the life of a business, and capital allowances for investment in equipment). The third category includes personal allowances. As the NAO noted, in paragraph 5 on page 7:

“Some reliefs simply help define the tax base, such as the first three categories in Figure 1, and could not be otherwise collected.”

Yet the NAO goes on to show (in figure 3 on page 9) “the total cost of tax reliefs compared to GDP in order to give a broad indication of the scale of the tax reliefs landscape”.

I’m not surprised that HMRC has objected to this. The NAO added, at HMRC’s request (see paragraph 6):

“HMRC disagrees with the inclusion in figure 3, paragraph 15 and paragraph 1.12 of the total of the costs of the separate tax reliefs. As the report itself explains at paragraph 5, HMRC does not publish this figure, because it does not represent an amount of money which might be obtained by government – due, for example, to interactions between the reliefs. It is therefore misleading to refer to the figure.”

This does not invalidate the PAC’s inquiry, however, so long as it focuses on monitoring and evaluation of tax reliefs rather than the underlying tax policy.

On this aspect the NAO said:

“Monitoring arrangements for reliefs vary across HMRC, and few evaluations are commissioned. Monitoring and evaluation are important to understand the extent to which a tax relief is misused. For a tax expenditure [a relief “designed to deliver specific policy objectives by providing behavioural incentives to achieve economic and social objectives”], it is also necessary to understand the behavioural consequences of the relief and whether it is meeting its social or economic objectives. There is also limited monitoring of changes in the cost of particular reliefs.

The PAC’s announcement said:

“All tax systems include tax reliefs. Reliefs can help maintain the competitiveness of the tax system and governments can use tax reliefs as a mechanism to redistribute wealth, support economic growth and influence behaviour. Tax reliefs may also be used for practical purposes such as establishing the correct income and profit for tax purposes and making the tax system simpler to use. HMRC and the Treasury share oversight of tax reliefs.  The Treasury is responsible for strategic tax policy design and HMRC for delivering and maintain policy and the administration of the tax system. This inquiry will examine the variety of tax reliefs used in the UK and how they are administered.”

That sounds sensible, in fact it sounds like something that the House of Lords economic affairs committee might have said. But PAC chairman Margaret Hodge, in a statement published hours earlier, was more forthright:

“There are at least 1,128 tax reliefs – those with similar aims to spending programmes are worth over £100bn each year – and the number continues to grow. Despite good intentions, every one of these reliefs is an opportunity for abuse or fraud. 6 of the 19 types of tax avoidance schemes that HMRC specifically warns people not to use exploit tax reliefs. It is shocking that HMRC knows this and yet there is still no systematic evaluation or monitoring of whether reliefs are working as intended.”

See also Tax reliefs under scrutiny as Hodge defies critics (Tax Journal).