Why tax cannot be express on a postcard

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The main reason tax codes are so complex is that income is inherently a complex concept, but the truth is that we cannot do without it. When you surf for a postcard-sized tax return, it is easy to come up instead with a list of results for flat earth campaigners. There is a similarity of tone.

If only all reliefs and allowances were swept away, the tax code would be much simpler and the government’s requirements could be met from a single low rate of tax on all income. British taxpayers have just completed their annual returns and American taxpayers must soon start. But perhaps these long forms are unnecessary. If you look up “flat tax” on the internet you will discover several mock-ups of the one-page return a simplified levy would require.

Clint Eastwood is a passionate supporter of the flat tax and, untroubled by political correctness, looks forward to the day when the tax system can be administered by a little old lady with a personal computer. But the appeal of the flat tax extends beyond millionaire film stars. The latest revival of this perennial campaign is orchestrated by rightwing think-tanks such as the Heritage Foundation and the Adam Smith Institute, which believe the flat tax is responsible for the remarkable economic success of Russia and Georgia (I am not kidding).

But the notion that an advanced economy can express the requirements of a fair and robust tax system on a postcard is an impossible dream. Some complexity, as the flat taxers have argued, is attributable to the accretion of allowances and ad hoc reliefs. Members of Congress secure favours for constituents; finance ministers canvass their advisers for pieces of economic or social engineering. Every few years, these measures need to be cleared away, like the barnacles that adhere to the hull of a ship. Tax reformers in the 1980s made a good job of this, but since then the concessions and the gimmicks have been making their way back.

But the main reason tax codes are so complex is that income is inherently a complex concept. The most widely cited definition of income is that of Sir John Hicks: income is what a man can spend and expect to be as well off at the end of the period as at the beginning. You do not have to be a Nobel prize-winning economist to recognise that translating that definition into a tax code or a set of generally accepted accounting principles is going to be difficult.

Experience of tax legislation and the regulation of corporate accounts has confirmed this. I remember a debate on principles of income measurement. A revenue official and a tax practitioner, impatient with academic argument, asked: “Why can’t we just stick with the common sense definition of income?” The hundreds of pages of the tax code are the product of unsuccessful attempts to articulate the commonsense definition of income.

Income tax works relatively well when the accrual of income corresponds to the receipt of cash, as for wages and salaries or interest and dividends. Income tax does not work well when there is no such correspondence- when there are benefits in kind, when income accrues but there is no realisation, or when it is not clear where or to whom income accrues when it arises. Most of our income tax legislation, and most of the avoidance opportunities that arise from it, result from these problems.

The more thoughtful flat tax advocates understand these difficulties and urge a shift from an income base to a simpler consumption tax. They are also right to argue that elaborately graduated rate structures add little to the progressivity of a tax system but a lot to both opportunities and incentives for tax avoidance.

Tax systems around the world have evolved in line with these principles. In two decades, the number of income tax rates fell from 25 to six in the US and from 13 to two in the UK (although the British figure has since crept back up to six). Payroll taxes and sales taxes have been the main source of revenue growth.

When Hicks elaborated that definition of income, he went on to conclude that income was “a bad tool, which breaks in our hands”. His Cambridge rival, Dennis Robertson, also remarked that “the gaols and workhouses of the world are full of people who gave up as a bad job the admittedly difficult task of distinguishing capital from income”.

Both were right. We find the idea of income hard to apply, but we cannot do without it. When you surf for that postcard-sized tax return, it is easy to come up instead with a list of results for flat earth campaigners. There is a similarity of tone.

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