David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: mini-budget, big changes.

With a new prime minister and chancellor of the exchequer in place, the U.K. government set out a series of new tax proposals. The September 23 presentation of the so-called "mini budget" followed through on promises Prime Minister Liz Truss made during the Conservative Party leadership contest. But the scope of the proposals led to turmoil in the currency and debt markets.

So to learn more about what was in the mini-budget and what effects it will have, we're joined by Dan Neidle, a former partner at Clifford Chance, and now the founder of Tax Policy Associates, an organization that seeks to provide advice to policy makers in the U.K. and beyond. We'll get to that interview in just a minute.

Later in the episode, we'll hear from Karl Frieden, vice president and general counsel at the Council On State Taxation about his article on sales taxation of digital business inputs.

But first, Dan, welcome to the podcast.

Dan Neidle: Hey, how you doing?

David D. Stewart: First off, could you start us out with some background of why we got a new budget proposal from the government?

Dan Neidle: Life used to be simple. There was a budget every March. The finance bill would drop on our desks a few weeks later, sometimes a few days later. It would become law in June, July. That was it. Life was simple.

Then things started to get more complicated. We had budgets in the autumn, budgets in the spring, fiscal events here, fiscal events there. Now it almost feels like around the clock, nonstop succession of mini-budgets.

That's what this was: a mini-budget and one that was prompted by the fact that we have a new leader of the Conservative Party and a new prime minister in Liz Truss.

David D. Stewart: Could you tell us a bit about the process? The Conservative Party was choosing a new leader and it seemed that tax played a role in the back and forth between the two leading candidates.

Dan Neidle: It absolutely did. We've had something of a consensus in tax for really the last 12 years or so. That when the Conservative government under David Cameron came in 2010, they pretty quickly scrapped the Labour Party's 50 pence top rate and reduced it to 45 pence. Other than that, they haven't really touched the essential progressiveness of the tax system.

They've done — under various guises — Cameron, Theresa May (Conservative Party), Boris Johnson (Conservative Party), they've done things that many people on the left do not like: Brexit chief among them. And they have changed the tax system — or failed to change the tax system — in ways that could be criticized of being insufficiently progressive.

But that aside, I think they've accepted the basic progressivity of the U.K. tax system. That however, became an issue during the leadership election. You had [Rishi] Sunak (Conservative Party) very much representing a continuation of what had gone before unsurprisingly, given he was Johnson's chancellor.

Liz Truss was taking a rather more radical approach. She was not just saying that tax cuts were a good thing in principle, which pretty much any Conservative would say at any given point, she was saying that taxes should be cut now and she didn't seem that interested in how they were funded. That was a rare bright line distinction between the two candidates, the like of which we haven't really seen in Conservative Party elections for some time.

David D. Stewart: Now, on the question of how these tax cuts are funded, what is the budget situation of the U.K. government going into this budget? Is the budget in balance, is it running a deficit? How are things progressing there?

Dan Neidle: The U.K. has been running a deficit for quite some time. I'm not an economist so I'm not going to talk to the detail on this, other than to note that as a legal matter there is no constraint on U.K. budgets. It's really down to politics and down to what the markets permit without going nuts. More in which no doubt we'll get to later.

David D. Stewart: Sure, then let's get into what was in this budget.

Dan Neidle: The budget contained some things that were expected and were not that controversial. Most significantly a massive and very expensive series of measures to help with energy bills for both businesses and individuals. I'm not going to talk about those, partly because they're not my area of expertise, partly because they were uncontroversial.

But they also contained a series of tax cuts which went from the mildly controversial to, I think fair to say, very controversial. None of them were funded by tax increases elsewhere or spending cuts elsewhere. That's very unusual because there's been a generally accepted bipartisan agreement that at least on the face of it, major tax and spending changes should be zero-sum and this wasn't.

David D. Stewart: What are the specific changes? What would you say was the most controversial change they chose?

Dan Neidle: The most controversial was eliminating the 45 pence top rate of income tax, which applies on incomes over £150,000. That was scrapped, meaning the top rate is now 40 percent, which applies broadly on incomes over about £50,000.

Now that was hugely controversial, mainly for its symbolic power. The actual economic cost of that was relatively small according to the Treasurer's projections, costs about £2 billion a year to scrap that rate. Which in the context of a U.K. budget of something like a billion all in, that's not very much money.

David D. Stewart: This was the rate that at one point was 50 pence under the Labour government.

Dan Neidle: Correct, it was very briefly 50 pence. For most of the Labour government from '97 to 2010, they accepted and didn't change the top rate was 40 pence.

Then just at the very end when Gordon Brown (Labour Party) knew he was in dire danger of losing an election, he increased, or rather created a new top rate. First of 45 pence and then before it was even introduced, increased it to 50 pence. This was widely seen as triangulation to create difficulty for the Conservatives.

So it was 50 pence for about 18 months. Then the Conservatives in 2012 brought it down to 45 pence, where it's stayed ever since.

David D. Stewart: Now I see there were some other measures aside from tax rates in this mini-budget, like abolishing the Office of Tax Simplification. What is the reason for that?

Dan Neidle: The stated reason was that the government wanted deeply to improve the simplification of tax, which is a counterintuitive thing to say. They said that they would be embedding the virtues of tax simplification throughout HMRC (Her Majesty's Revenue and Customs) and the Treasury.

It's probably reasonable to say that HMRC should pay more attention to simplification on new measures, but it's not really realistic to expect them to be looking back, taking a holistic view of the tax system and thinking about simplification for existing measures. That's what the Office of Tax Simplification did and I think most professionals mourn the fact it's going.

David D. Stewart: Was that office fairly effective in its work?

Dan Neidle: Opinions differ. It produced some fantastic pieces of analysis, which were very useful to me and other people working in this space. It made some useful changes.

It's probably fair to say it wasn't able to make any really consequential changes. The reason for that is simple: most tax complexity is ultimately down to policy decisions. And those policy decisions are usually driven by politics. Changing those is hard.

If you want to be harsh on the Office of Tax Simplification, it failed to do anything significant because it wasn't a political body and possibly that's why it's being abolished. I'm really not sure.

David D. Stewart: Are they doing anything concrete to embed this notion of tax simplification in or is it more of an aspirational statement that they're making?

Dan Neidle: I haven't seen anything concrete. It's a great question.

We should probably talk about some of the other tax cuts. One of them was reversing a national insurance increase from last year. National insurance broadly equivalent to social security. That was essentially a 2.5 percent increase of tax and wages. That's being repealed and that costs something like £18 billion a year. Now we're getting into serious money.

Then there was another significant change which goes to corporation tax. Now, corporation tax has had a complicated history in the last 20 years. Twenty years ago, corporate tax was normally 33 percent, then it fell to 30 percent, then it began something of a precipitous decline all the way to where it is now; 19 percent. Lots of people would talk about a race to the bottom in corporate tax if they didn't like it or talk about a wonderful corporate tax cutting agenda if they did like it.

The problem with both of those positions is they're wrong. Everyone hearing this can't see me move my finger, but the rate of tax did go down like this, he said dropping his finger precipitously. But the effective rate of tax corporates pay, looking at the total tax paid by corporates, divided by the total corporate profit in the economy, that just wobbled along, not doing very much. The total revenue raised by corporate tax as a portion of GDP (Gross Domestic Product) also wobbled along, not doing very much.

How could this be? No great mystery. The rate went down, the tax base expanded. Really, corporate tax is a story of the dog that didn't bark. Not much has really happened to it, big picture. But that 19 percent rate has a lot of symbolic power.

One of the last decisions on tax of the Johnson government was to say that given the fiscal difficulties the country's in — and I think this was even before the energy crisis, this was just looking at the effects of the pandemic — that 19 percent rate should go up to 25 percent. They set that and they created a special allowance in the meantime to avoid people deferring expenditure to get more of a benefit from a higher rate and we were all set to a 25 percent rate.

But in the mini-budget, that was scrapped and that loses about £18 billion a year in revenue.

David D. Stewart: Now was that increase in the headline rate, was that going to also have a narrowing of the base or was that just a straight increase?

Dan Neidle: No, that's the thing, it's an increase, so it's not going back to where things were once upon a time when the rate was 25 percent. It represents a really significant actual increase in corporate tax.

David D. Stewart: Now that's back at 19 percent for the foreseeable future.

Dan Neidle: Well, here's the thing. When you have decisions on rates made with such frequency, they cease to be made for the foreseeable future. They start to be rates which are seen by everyone involved, particularly business, as rates that are just here for the short term.

All things being equal, would you increase investment by cutting a rate from 25 percent to 19 percent? Sure. I don't know how much, I'm not an economist, but it's very plausible it would.

If however, you increase it from 19 to 25 [percent], then before it even happens, you bring it back to 19 [percent] and it's very controversial and the government doesn't look awfully stable, then are people really going to make investment decisions on the base of 19 percent? Color me extremely skeptical.

David D. Stewart: OK, and you have a tax that I'm not particularly familiar with, the stamp duty land tax. First of all, what is it and what's happening there?

Dan Neidle: Yes, stamp duty was one of the oldest taxes. I mean, the Americans famously didn't like it, which is one of the reasons you're American.

It used to be a tax on documents because before the modern centralized state. One of the few things governments could tax effectively was official documents. Over time, it's changed in almost every possible way and now stamp duty land tax really just has those words, stamp duty, to reflect its history.

What it really is, it's a tax on purchasing real estate, that's all it is. It's a very unpopular tax because if you are looking to buy a house or an apartment, then to see a price in a realtor's window, to expect to pay that price, and then have to pay stamp duty on top is a bit of an insult. And when you get financing from a bank, that generally won't cover the stamp duty element.

Stamp duty is very unpopular and governments love fiddling with it either temporarily in what's often called a stamp duty holiday in times of economic difficulty. Or in this case they've permanently reduced it.

David D. Stewart: All right, one other change I see happened was a rollback of new rules for disguise remuneration. Could you tell us about that?

Dan Neidle: IR35, remuneration, a murky mess and I'll try and race through it without causing everyone listening to switch off their computers in frustration.

The U.K. tax system has a few really bad systemic problems and one of them is that we tax employment income more heavily than other types of income. Now, if you are a straightforward employee, an associate at law firm say, then that doesn't matter much. You're an employee, nothing can be done about it.

But for many people it's a question of facts and degree, whether you really are an employee. Take an IT consultant, they might spend six months at one bank, six months at another corporation, sometimes more, sometimes less. Are they an employee or not?

Well, if they're not an employee, they save broadly 13 percent, 14 percent tax. The employer's national insurance doesn't apply. Some of them tried to get an even better result on this, that became almost universal in the contractor world, by providing their services via a company rather than as individuals. That meant they could time when they took dividends out of a company, they got absolute savings on national insurance. There was at one point a very, very large difference indeed.

To stop this, government enacted IR35, which very broadly says that if your arrangement looks like employment, big picture, then it's going to be taxed like employment no matter what the legal form is. That was a big deal and it made life quite hard for contractors who had to operate it. And in HMRC's view, many of them didn't operate it properly and didn't pay the tax that was due.

So in 2017 the law was changed that instead of contractors having to decide whether to operate these rules, the onus became on the employer, if the employer was a government body. Then in 2020 it was increased and expanded from government employers to all employers.

When the onus is on the employer, it means two things. First, it means that individuals don't have the option to duck out of paying tax that is properly due. Second, the natural instinct of most large employers is to take a very prudent view and err on the side of caution. Whilst these two changes in 2017 and 2020 didn't actually change the substantive law around when IR35 applies, they changed who cared and that made a big difference.

That is now being scrapped supposedly in the interest of simplification. And that will cost about £2 billion a year and that's £2 billion of tax, which probably is due but ain't being paid because the wrong person, in my view, is now responsible for paying it.

David D. Stewart: We now have this mini-budget that gets announced. How was the reaction to this budget with some of these controversial changes?

Dan Neidle: There was a furious reaction focused around, in particular, the high rate. The top rate of 45 P[ence] being abolished. This was seen rightly or wrongly as giving money to the high earning. That was the political noise we were hearing.

In the background, there was market disquiet at the large unfunded nature of these tax cuts. We're talking about £40 billion or so a year, which in the context of the U.K budget is a significant sum. We started seeing the gilt market and the foreign exchange markets take a decisive turn, indicating that they did not welcome this development. That created the perception the U.K. was heading towards a crisis.

I'm not going to comment on whether that was true or not because a tax lawyer, not an economist, not a market specialist. But undeniably that was the perception.

Now take a step back for a second. There's a big difference between tax policy in the U.K. and tax policy in the U.S., which is that in the U.K. the government gets to do essentially what it likes. It publishes a finance bill with its tax proposals, that is certainly debated in the House of Commons, but where a government has a majority, as this one must certainly does, little details here or there may change, but most of it just goes straight through guaranteed. There is no ability for anyone other than the government to create tax legislation and there's no ability for material amendments unless the government approves of them.

Normally something may be controversial, it may not be controversial, but it happens. This is different because within 10 days that cut in the 45 P[ence] top rate was reversed, which was extraordinary.

David D. Stewart: Now what explanation did the government give when reversing that policy?

Dan Neidle: They'd listened, they'd heard the disquiet and they were prepared to change course.

David D. Stewart: It deals with the public condemnation. Is that also calming the markets that were worried about crisis?

Dan Neidle: I think the perception is yes. Again, I'm going to duck the question of really where market conditions are going because it's not something I've got expertise in.

David D. Stewart: Now I'll turn to you as a tax person. If you had this power to make decisions and have very little input from others as you implement them, what changes would you like to see made to U.K. tax policy?

Dan Neidle: I'd focus on changes which I think don't cost money because I'm not foolish enough to think that I've got actual money I can spend on my magic tax proposals. Second, on changes that I think plausibly could drive economic growth. And third, changes that I think are not going to be ideologically controversial.

Here's a few. First one, which I've been blogging about today, Tax Policy Associates, we do tax policy, I wish I had associates. You'll see a posting about the U.K.'s marginal tax rates, meaning if you earn X and then you have the opportunity to earn a £1,000 more, how much of that £1,000 do you keep and how much goes in tax?

You've got a few features of our tax system that means that the marginal tax rate can get to 68 percent at certain points. If you have three children, there's one point where it can hit 90 percent, which is extraordinary.

There's even a couple of points where the marginal tax rate can hit infinity if you take advantage of a government scheme for subsidizing your childcare, then that subsidy vanishes completely when your earnings hit £100,000.

If you have three children, that is going to cost you £6,000 and to get that money back, you would have to earn not £101,000, you'd have to earn £120,000 to be in the same place you were at £99,000.

Now that is irrational and it's clearly a disincentive to people taking on more work, getting promotions, working more hours, et cetera, et cetera. We need to smooth out these discontinuities and eliminate these marginal rates. That's the first change I'd make.

Second change I'd make, similar theme, VAT. Companies have to be registered for VAT and charge 20 percent VAT on their sales when their turnover hits £85,000. Again, you're a plumber, you've got £84,000 of revenue, you're not having to charge VAT to your customers. You could do one more job, then you'd earn £85,000, you'd have 20 percent to pay to HMRC.

You could increase your prices by 20 percent, that's not going to go down well, or you could swallow the cost yourself. You're not going to like that either. There's very good evidence that businesses slow down their growth at the £85,000 point. You can chart the numbers of businesses at each point in the turnover scale.

Again, apologies for those of you who can't see this, which I think is everyone but you, Dave. But the chart, lots of small companies, slightly, slightly fewer with a large turnover, going all the way down to really very few large companies. You should have a nice neat curve, but actually the curve drops down, hits £85,000, the VAT turnover threshold, boom! Falls like a cliff and then keeps going.

It really looks like the VAT system is a break on the growth of some companies and that's a problem.

My third slightly contradictory plea is: stop making changes. Too many changes to the tax system. Particularly changes around rates, changes around incentive allowances, investment allowances and so forth. No business is going to plan on the basis of any feature of the tax system unless it believes it's going to be there long enough to actually be caught by its plan.

We saw this with some allowances in the government's windfall tax. It was only here until 2025. They had an investment allowance built into it, but 2025 is not that very far away. Building oil and gas machinery, building an offshore platform takes an awful lot more than two years from drawing board to actual construction.

What is going to be incentivized by a two year allowance? The answer I think is: little or nothing.

So can we please, please, please stop changing these allowances? Instead, commit credibly to rules, reliefs, and allowances that will be there for the long term. That may well involve cross-party agreements, some kind of royal commission or other grand body so that everybody accepts and believes that some fundamental features to the tax system are going to stop changing, please.

David D. Stewart: I can definitely see the advantage of some stability. Dan, thank you very much for being here. This has been great.

Dan Neidle: Dave, thanks a lot.

David D. Stewart: And now, coming attractions. Each week we highlight new and interesting commentary in our magazines. Joining me now is Acquisitions and Engagement Editor in Chief Paige Jones. Paige, what do you have for us?

Paige Jones: Thanks, Dave. In Tax Notes Federal, Jeffrey Kadet examines the lessons in the ongoing Whirlpool litigation. Three tax professionals examine investment expensing and they explore why businesses are not taking advantage of it. In Tax Notes State, Amy Nogid and Tiffany Li Qu discuss the potential impact of state business qualification on jurisdiction. Michael Lurie questions the constitutionality of the Multistate Tax Compact and the corresponding U.S. Steel decision that upheld it. In Tax Notes International, Costas Michail suggests a resource rent tax on European petroleum companies to stabilize high energy. Hale Sheppard examines a pending U.S. District Court case about penalties for failure to report receipt of foreign gifts and its broader implications for U.S. taxpayers with international issues. In Featured Analysis, Carrie Brandon Elliot explains that coordination of sections 959, 316 and 312 is a priority. On the Opinions page, Ryan Finley examines recent developments in transfer pricing litigation.

And now, for a closer look at what's new and noteworthy in our magazines, here is Tax Notes State Editor in Chief Jéanne Rauch-Zender.

Jéanne Rauch-Zender: Thank you, Paige. I'm here with Karl Frieden, vice president and general counsel for the Council On State Taxation. Welcome to the podcast, Karl.

Karl Frieden: Well, thank you. Pleasure to be here.

Jéanne Rauch-Zender: Let's chat about your Tax Notes State article titled, "Down The Rabbit Hole: Sales Taxation of Digital Business Inputs," which you co-authored with two COST colleagues, Senior Tax Council Fred Nicely and Legislative Tax Council Priya Nair. How did you get interested in doing a study on the sales taxation of digital business inputs?

Karl Frieden: Well, this is a topic I've been interested in for about 25 plus years. I actually had written the initial book that was ever written on the taxation of the internet, it was about 25 years ago called Cyber Taxation.

Always been interested in the topic, but recently there at the state level, there's been a much greater focus on should states and if so, how should states tax digital goods and services? And many more states are expanding their tax base.

Then that process I think, is starting to accelerate as groups like the Multistate Tax Commission are launching into a project and in their case, to do a broad white paper on how states are taxing digital commerce now and what are some of the options in terms of how they should or shouldn't do it.

Volumes been written about the topic. The particular article that we wrote, and I had co-authored this article with two COST colleagues, Fred Nicely and Priya Nair, and the information that we looked at was what we thought was a gap in the analysis and the research and literature on this. That is not just how are states taxing digital goods and services, which ones are they taxing or not taxing, but looking more specifically at the issue of are they taxing B2C, business to consumer, are they taxing B2B, business to business transactions? That was the information gap that we were trying to look at.

Jéanne Rauch-Zender: It is an excellent, robust article, as we discussed. In the article, you write that, "The U.S. approach to imposing a sales tax on digital products without a broad exemption for business inputs is unique among the major consumption taxes in the world. Virtually all other advanced nations use a value added tax that avoids tax pyramiding through a credit provision."

Would you explain a little more on how other countries tackle the sales or consumption tax on digital business inputs and how you'd like for the U.S. to respond?

Karl Frieden: Yeah, maybe if I could just start with just summarizing the conclusions we reached in our study and then that'll lead me directly into your question.

I mean, what we found was of the 47 states that tax either software, digital business services, at either the state and local level, there's only a handful of them that exempt B2B transactions. Iowa does it with a robust exemption and Washington, New Jersey, Connecticut do it with partial exemptions.

It's very clear cut what's happening in the U.S. and we think from a policy perspective it's the wrong thing to do. It helps to look then at what the rest of the world is doing because there is no real disagreement among sales tax or consumption tax experts as to what a well designed consumption tax looks like. That includes how consumption tax like a sales tax or a VAT should address digital goods and services.

If you look at what the rest of the world's doing, they're following the norms of a good consumption tax, which is to tax consumption once, to not have pyramiding of taxes and where possible, the tax consumption which is purchased by end users and households.

The way that the rest of the world does it, and this is standard really across the world, is that the tax bases generally include both purchases by businesses and end users of digital goods and services. But to the extent that the end users are taxed under a VAT on the digital goods and services, then the purchases by businesses which have been taxed are then credited back. Effectively, they have an exemption for most business purchases of digital goods and services.

The reason again, is so you avoid pyramiding, you only impose the consumption tax once.

Unfortunately, in the U.S. we do it almost the opposite, which is those states, and it's not all states, but those states that tax some or all of digital goods and services tax both B2C and B2B, leading unfortunately to a pyramiding of the tax in a way that cuts against any norms of a good consumption tax.

Jéanne Rauch-Zender: Absolutely, all excellent points.

Well, thank you so much for joining me today, Karl. It's always a pleasure to catch up.

Before I let you go, where can listeners find you online?

Karl Frieden: Just through cost.org is the website. Also, if you go to cost.org, all of the different studies that we've done, all the articles that I've worked on or others at COST have worked on, are all there online. That's the best place to go to find things.

Jéanne Rauch-Zender: Excellent. You can find Karl, Fred, and Priya's article online at taxnotes.com. And be sure to subscribe to our YouTube channel, Tax Notes, for more in-depth discussions on what's new and noteworthy. Again, that's Tax Notes with an S. Back to you, Dave.

David D. Stewart: That's it for this week. You can follow me online @TaxStew, that's S-T-E-W, and be sure to follow @Tax Notes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.