The 9 most costly UK tax reliefs
Studying recent statistics from HMRC, Donald Drysdale understands why Chancellors should hesitate before making sweeping changes to tax reliefs.
Principal tax reliefs
HMRC publish a wide range of statistics covering their work – from collecting taxes to paying out tax credits and child benefit. A recent addition is their update of 20 January on tax relief statistics, which estimates the current aggregate cost of the UK’s principal tax reliefs at some £403bn a year.
While studying the breakdown of these, I noted details of the nine tax reliefs or exemptions which are considered to cost the Exchequer the most. All the figures I quote are HMRC’s estimates for 2016/17. To be fair to them, they describe some of the projected costs as particularly tentative and subject to a wide margin of error. What may also be open to question is whether these should be classified as ‘costs’.
When Chancellors do their sums and try to get the UK’s books to balance, they must be acutely aware of the price tags of existing reliefs as they look for opportunities to increase tax revenues.
1. Personal allowance
The most expensive tax relief, and possibly the most politically sensitive, is the income tax personal allowance of £11,000 for each taxpayer, projected to cost £97.4bn in 2016/17.
This estimate is admitted to be an understatement, since it excludes individuals who are not on HMRC records because their income is below the tax threshold. Given the number of pensioners with income below that threshold, this seems to indicate a significant underestimate.
But is a reality check needed here? It would be Draconian indeed if every pound of each taxpayer’s income was taxed, so it is questionable whether the personal allowance should be described as a ‘relief’ with a quantifiable ‘cost’. In a historical context, perhaps we should be thankful that today’s absence of a hearth tax or window tax is not described as a generous, costly relief.
2. National Insurance Contribution thresholds
No Class 1 NICs are due by employees on remuneration below the primary threshold of £155 a week, or by employers below the secondary threshold of £156 a week. Likewise, no Class 4 NICs are payable by the self-employed below the lower profits limit of £8,060 a year. The aggregate cost of these thresholds, collectively, is £54.44bn.
While the UK has lower payroll taxes than many other countries, any move to reduce our NIC thresholds would be unpopular with employers, and with workers who are also voters.
3. VAT zero and reduced rates
Some VAT zero-rating or reduced rating is mandatory within the EU, while other instances are under the UK’s own control. Subject to the uncertainties of behavioural changes, the standard rate VAT forgone by all such reliefs is estimated at £50.89bn.
Of the above cost, one-third (£17.55bn) relates to the zero-rating of food alone. This is not prescribed by the EU but is the result of a derogation predating the current EU minimum VAT rate of 5%.
EU proposals to review VAT rules might call into question the right of individual member states to zero-rate supplies such as food, medicines and children’s clothing. However, this is unlikely to affect the UK in view of the impending Brexit.
4. Registered pension schemes
In recent years, Chancellors have eyed pension tax reliefs as potential rich pickings. HMRC have estimated the cost of tax relief for registered pension schemes at £23.85bn. This is the hypothetical additional tax that would be payable if occupational and personal pension schemes were unregistered and employer and employee contributions were no longer tax-privileged – with employer contributions taxed as part of employee remuneration.
The costing takes account of relief on contributions paid and relief on investment income of funds, reduced by tax paid on current pension payments. However, if the £15.4bn cost of relief from NICs on employer contributions to registered pension schemes is also taken into account, the total cost of pension reliefs becomes £39.25bn.
5. Private residence exemption
With growth in house prices and in the number of transactions, the cost of the capital gains tax main residence exemption has nearly doubled since 2012/13, and is projected at £23.8bn for 2016/17. This does not equate with the tax that might be raised if the exemption were abolished, because abolition would trigger substantial behavioural changes. In particular, reluctance to relocate would severely restrict the mobility of labour.
In 2011 the Office of Tax Simplification (OTS) commented on the importance of this relief and suggested that there might be some scope for simplifying it. However, it would take a brave Chancellor to restrict it significantly.
6. VAT exemptions
Where traders make exempt supplies of goods or services, on which they are unable to charge output tax and are blocked from reclaiming input tax, the cost of standard rate VAT forgone is £22.65bn.
The EU requires certain goods and services to be exempt (for example, postal services, medical care, lending, insurance, betting), and permits member states to exempt certain other supplies (for example, land and certain financial services).
7. Inheritance tax nil rate band
The cost of inheritance tax relieved on death by the £325,000 nil rate is estimated at £22.4bn, while including the exemption of transfers on death to surviving spouses or civil partners adds only £3.95bn, increasing the total to £26.35bn.
The nil rate band was set at £325,000 on 6 April 2009 and is to remain at that level until 5 April 2021. This constrains the cost of the relief while bringing more estates into tax, causing inheritance tax to be seen as a rising burden on the middle classes.
8. Capital allowances
Capital allowances, as reduced by balancing charges, reduce projected income tax and corporation tax revenues by £22.25bn in 2016/17. This cost has fluctuated annually with variations in the annual investment allowance, high capital expenditure by North Sea oil and gas companies, and the phased reduction in the corporation tax rate.
In this instance HMRC’s costing method seems unduly narrow as it takes no account of the potential increased profitability of businesses investing in qualifying assets.
9. VAT refunds to public bodies
The ‘Section 33’ VAT refund scheme allows local authorities and certain other bodies to recover VAT incurred on non-business activities. This is extended to academies, museums and galleries under Section 33A. Central Government, Health Authorities and NHS Trusts can obtain refunds of VAT incurred on contracted-out services under Section 41(3).
The aggregate cost of these measures amounts to £17.25bn, but it is arguable whether they should be described as ‘reliefs’. After all, they simply allot responsibility for funding VAT costs among Central Government on the one hand and local authorities or similar bodies on the other.
Section 33 is controversial in Scotland, where the ability of police, fire and rescue services to recover their VAT was forfeited when the Scottish Government merged pre-existing local services into new national bodies in 2013.
HMRC’s list of principal tax reliefs reaches down as far as conditional inheritance tax exemption for heritage property, costing a mere £25m. A separate list of minor tax reliefs identifies many that cost little but are individually important to those entitled to them.
Taken together, the lists identify potential challenges for the Chancellor – seeking to balance the relative merits of shaving costs off the most expensive reliefs against abolishing those that cost comparatively little. As always, reducing or abolishing tax reliefs would create winners and losers and therefore invites political risks.
Article supplied by Taxing Words Ltd