Gus O’Donnell: Why merging the Inland Revenue and HM Customs and Excise worked

The government made radical changes when Gordon Brown took over at the Treasury in 1997: establishing the Monetary Policy Committee to set interest rates and setting new fiscal rules. At the same time the Treasury implemented its own internal reform programme – the results of the late Jeremy Heywood’s Fundamental Expenditure review, itself triggered by the shock of the UK’s exit from the ERM. But the New Labour government did not come in with a plan to merge Revenue and Customs, and the tax side of the Treasury was untouched. 

That meant HMT lacked the ability to analyse tax issues. The Treasury had a small team coordinating the Budget, but most of the tax competence was housed in the Revenue and Customs departments. The chancellor and the financial secretary, Dawn Primarolo, wanted HMT to be more capable of giving them tax advice while Customs and Revenue would implement their decisions. My review was tasked with working out how to deliver those objectives.

The chancellor and his principal adviser, Ed Balls, were also very surprised about the lack of cooperation between the two revenue collection agencies and the stark differences in their cultures. Past reviews had recommended closer working but failed to deliver significant change. 

There was strong external support for merging the Inland Revenue and HM Customs and Excise

The review team was comprised of up-and-coming officials who were prepared to look for radical solutions, and they started by taking evidence quite widely. 

Business complained about having to submit the same data twice to Customs and Revenue and of inconsistencies in the approaches. Certainly many in the private sector and some in HMT believed that Customs was determined to put as many offenders in jail as possible while the Revenue was determined to squeeze as much money as they could out of miscreants – reflecting their very different heritages. But what stood out was the UK’s exceptionalism in separating out two big business taxes – corporation tax collected by the Inland Revenue and VAT by Customs and Excise. 

The idea of this merger was not a new one

In 1889 Gladstone, who had originally been opposed, told the Royal Commission on Civil Establishment:
“the nature of the duties seems to me to point to amalgamation rather than the continuation of a separate existence.”
Fast forward to April 2000, and the Treasury select committee in the House of Commons recommended a merger and noted that earlier attempts at “closer working” had never really made much difference. The Law society and the Chartered Institute of Taxation concurred while the Institute of Chartered accountants of Scotland had mixed views, scarred by problems caused by the merger of the contributions agency into the revenue.  

The review recommended merger for three reasons: to improve tax collection, to reduce burdens on business and individuals, and to raise the efficiency of the process of tax collection. The main expected costs were the transitional costs associated with bringing together the IT systems, the potential loss of focus on reducing the tax gap, and pay equalisation where people were paid different amounts for similar jobs. The change required legislation – and here the fact the TSC had already recommended the merger was helpful as it avoided the issue becoming partisan. The private sector – as it is so often on these occasions – was not opposed, but nor was it helpful. 

The review deliberately did not specify how the changes should be implemented. That was left to the first head of HMRC, David Varney, who came from the private sector and did a commendable job in very difficult circumstances.  

The Treasury had to increase its tax policy capability

But the complement to the HMRC merger was to meet ministers’ desire to beef up HMT’s tax analysis. We recommended that ‘strategic’ tax policy responsibility should pass to the Treasury, with HMRC remaining responsible for ‘policy maintenance’, which included drafting the Finance Bill. Some 150 posts were transferred to the Budget and Public Finance Directorate. Nick Macpherson, later to become HMT’s permanent secretary, was in charge, ably supported by four first-rate directors, two from the Revenue, one from HMT and one from the private sector. The new challenge was to create a ‘policy partnership’ with HMRC, made easier by HMRC top management moving into the back half of the Treasury building. 

There has been no detailed assessment of the extent to which the original ambitions were realised. Ten years on, Nick Macpherson, by then Treasury permanent secretary, could point to successes – both in terms of innovative projects implemented and staff savings realised, with numbers in the combined department down 40 per cent.  

I remain, in general, a sceptic of machinery of government changes, believing that the benefits rarely outweigh the costs and disruption. But in this case, I think the long overdue merger has brought many of the benefits we hoped to achieve – even though I can’t prove this conclusively.