VAT Rates in the UK. Guest Post by Professor Rita de le Feria

On why introducing increased rate of VAT on luxury products in the UK is a bad idea, and on what would be a good idea for a rate reform

With public finances consistently in the public eye, every so often we hear in the media politicians, or NGO representatives, calling for the introduction of an increased rate of VAT for luxury products. It sounds like a great idea: with revenues in short supply, it is only fair that those that can pay for luxury products, should also pay additional tax for the privilege – a proxy of sorts for those in (very) high incomes.  It sounds like feasible, sensible, tax policy, but unfortunately, it is not.  It is not feasible because such a rate would be contrary to EU law; but even if that was not the case, it would still not be sensible, as it would be likely to yield significant costs, with little or no benefits.

On why introducing increased rate of VAT on luxury products is not feasible

Within Europe differentiated rates structures date back to the introduction of VAT itself. Although evidence as regards potential negative consequences of applying multiple rates was largely unavailable at that time, difficulties have been apparent for some decades. In light of this reality, since the late 1980s, there have been several attempts to amend European rates structures under the political guidance of the European Commission. Whilst these attempts have been on many aspects unsuccessful, there has been one considerable achievement: since the early 1990s the application of increased rates of VAT to so-called luxury products has been banned.

Under the current European VAT rules (see Articles 96 et seq of the Council Directive 2009/47/EC of 5 May 2009), Member States may apply a standard rate and up to two reduced rates in theory (two more in practice), subject to a few basic rules, in particular:

  • the standard rate cannot be lower than 15%;
  • reduced rates can only apply to specific goods and services listed in the Directive; and
  • reduced rates cannot be lower than 5%, although some Member States, such as the UK, have been granted an authorisation to derogate from this rule, applying a 0%.

Whilst Member States have significant freedom to choose their own rates structures under these basic rules, it is clear that the introduction of a rate higher than the standard rate would be contrary to the VAT Directive.  Should the UK introduce such a rate for luxury products, therefore, it would be in violation of EU law, and thus susceptible of being challenged by the European Commission under an infringement procedure.

On why introducing increased rate of VAT on luxury products is not sensible

Even if application of an increase rate of VAT to luxury products was permissible under EU law, would it be sensible tax policy? The case for differential tax rates under optimum commodity taxation has been consistently made since the elaboration in the 1920s of the inverse elasticity rule.  The dynamics of this rule, however, are often misunderstood, since it suggests that economic efficiency is maximised by taxing consumption goods at rates that are inversely proportional to their price elasticity.  So under this rule, basic goods, such as food, which make up a larger proportion of the expenditures of low-income households, would be subject to higher rates of VAT.  This is not seriously supported by any policy maker – not only because highly impractical, but also because of its distributional effects.

What is often defended, therefore, is rather the opposite, namely that basic products be subject to lower rates of VAT, and that luxury items be subject to increased rates.  No economic case has been made for the optimality of such a structure, but there are two main economic reasons generally used to justify rate differentiation: vertical equity and positive externalities. The former is particularly relevant for justifying the case for luxury rates.  Essentially it is based on the idea that applying reduced rates to key products such as food, energy, healthcare, education, etc, would limit the impact of the tax on low-income households; and applying increased rates to luxury products would effectively have a redistributive effect, collecting more tax from high-income households, used to subsidise public services for lower-income households.

But what are the benefits, and what are the costs of applying such increased rate to luxury products?  For some of the benefits to be attained there is a presumption that decreases or increases in the VAT rate are reflected in consumer prices. Whilst theoretically, this should indeed be the case, empirical studies with VAT rates seem to indicate the opposite: prices are primarily based on market forces (supply and demand, price elasticities, competitiveness of markets), rather than VAT rates.  The increased revenue benefit – a main consideration in the case of luxury rates – is also dubious: whilst the amount of revenue collected will of course depend on which, and how many, products are deemed to be luxurious, and thus attract the higher rate, it is probably reasonable to assume that the amount collected would be relatively small.

On the contrary, the costs of applying such a rate are likely to be significant.  First and foremost, there is an identification / scope problem: what would be regarded as luxury products for the purposes of the tax? The narrower the scope, the less revenue collected; the broader the scope, the less likely to have a redistributive effect.  Once the scope of the new rate is eventually decided upon, however, new problems would emerge:

  • definitional and interpretative problems, likely to give rise to litigation, as so often happens now in the context of reduced rates of VAT;
  • increase scope for VAT avoidance and VAT fraud, namely misclassification of products either in contravention of the purpose of the law (avoidance) or of its letter (fraud);
  • distortions of competition, by de facto subsidising products (subject to standard rate), in detriment of often competing products (subject to increased rate);

All of the above would unavoidably result in higher compliance costs, but crucially as well, in higher administrative costs – which given the limited revenue one may expect to collect, are likely to be higher than the revenue collected.

On what would be a feasible and sensible VAT rate structure for the UK

In this context, would it be possible to have significantly improved VAT rate structure in the UK, which is both feasible in terms of EU law, and sensible tax policy?  The answer is yes. Taking into consideration both budgetary, as well as legal limitations, four criteria are proposed that would lead to a better, more efficient, more neutral, UK VAT rate structure, essentially by broadening the base of the tax, whilst protecting lower income households and key sectors of the economy. The criteria proposed are based on my experience as VAT Policy Adviser to the Portuguese Government after the troika bail-out (2011-2012).

Criterion 1: Elimination of application of reduced rates of VAT, where the rationale for its application is the creation of positive externalities and/or correction of externalities (e.g. books, environmentally friendly products, etc).

Criterion 2: Maintaining the application of reduced rates of VAT where the rationale for is application is vertical equity (e.g. food, medication).

Criterion 3: Maintaining the application of reduced rates of VAT where its elimination would have a serious impact on industries which are either labour-intensive or key for economic recovery (e.g. tourism).

Criterion 4: Rationalisation of categories of goods and services to which reduced rates of VAT apply, by eliminating distinctions within categories.

The criteria proposed for reform of the UK VAT rate structure would not result in the best VAT possible, but rather in the best VAT the UK can possible have, given budgetary and legal limitations. A broader-based VAT, which will result in increased revenue, decreased administrative and compliance costs, and less susceptibility to fraud, avoidance and planning; overall a more efficient, more neutral VAT. A rare case of significant gain, with limited pain.


  1. EU law as it stands prevents the UK from introducing an increase rate of VAT for luxury products.
  2. Even if not incompatible with EU law, the introduction of an increased rate of VAT for luxury products in the UK would give rise to significant legal and economic difficulties, with limited revenue benefits.
  3. It is possible to reform the UK VAT structure, so as to increase revenue whilst protecting lower income households, and in the process achieve a better, more efficient, VAT rate structure.


This post is based on a paper entitled “Blueprint for Reform of VAT Rates in Europe”, forthcoming on (2015) Intertax 2.  Full paper available here.

Rita de la Feria, Professor of Tax Law, Durham University; Program Director, Oxford University Centre for Business Taxation.

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Our Big Tax Gamble

This is an extract from Ladbroke’s Annual Report and Accounts 2013. Not that it matters, but it’s the bit for telephone betting and high rollers.


It makes a rather obvious point: if you’re a bookmaker, there’s a difference between the amounts your punters stake and your profit. Sometimes they win, and when they win you have to pay out.

The bit of the accounts for the UK that deals with marketed, artificial avoidance schemes shows that HM Treasury has about £14bn of exposure to the outcome of such cases. That’s the difference between the amount HM Treasury stands to collect (or avoid having to repay) if HMRC defeats all those schemes and the amount HM Treasury will lose the ability to collect (or have to repay) if HMRC loses.

This number reflects a huge backlog of unresolved cases involving about 65,000 taxpayers. Yep, that many.

That’s the background against which in the Finance Act 2014 the Government introduced its Accelerated Payment Notices provisions. HMRC has just started issuing Notices and so they’ve been much in the news. I’ve written about them here but what they do is require the taxpayer the subject of the Notice to cough up the disputed tax now pending the outcome of his fight. They accelerate the moment at which the taxpayer has to pay the amount he will have to pay if he loses. But if he goes on to win, he’ll get the money back, plus interest.

HM Treasury estimates that it will issue some £7.1bn of Accelerated Payment Notices in the next couple of years. And the 2014 Budget Policy Costings Document (page 36 for eager beavers) shows that Accelerated Payments Notices will bring in an extra £4.645bn of income over the next five years. (For the £4.645bn figure you need to read it alongside page 22 of this).

The reconciliation between the £7bn and the £4.645bn figure takes into account a number of factors: for example, not everyone who is issued with an Accelerated Payment Notice will pay or will pay immediately. Moreover, some people would have paid within that five year term anyway and so you can’t describe their payments as extra money resulting from the Accelerated Payment Notices provision.

But it’s instructive to think about what that £4.645bn figure actually represents. It’s clear that it’s not new money: Accelerated Payment Notices don’t create any new income for HM Treasury, they just advance the point in time at which a losing taxpayer would have to cough the money up. Now that’s a bit unsatisfactory because we spend it as if it’s extra income. I made that point some time ago here. But I’m a bit slow these days and I didn’t spot the real story.

When the Exchequer collects tax it accounts for that tax as revenue. Generally speaking, that’s fine. People typically don’t pay tax unless they owe it. Having received it, the Exchequer doesn’t generally have to return it. It’s not a bookmaker after all. It’s “Net Revenue” (to go back to the Ladbrokes analogy) that the Exchequer can spend.

But that general rule is not true of the £7.1bn the subject of Accelerated Payment Notices. If HMRC loses the fight, the Exchequer will have to give the money back.

Most of that £7.1bn (indeed, most of that £14bn) exposure rests on two issues: what is a “trade” and what does the phrase “incurred on” mean? The two leading cases on these issues are plodding their way through the appellate system. So far HMRC has won. But so far the cases have only come before the lower tribunals. And it’s far from certain HMRC will win on appeal. The risk of a reversal in the higher courts is no mere theoretical possibility. There was, for example, a case called Conde Nast where the taxpayer lost in every tribunal except the House of Lords (where, coincidentally, I was instructed for the first time). The Exchequer’s exposure to that case ran into many billions.

If taxpayer X wins even one of those two issues then so will taxpayers Y, Z and A. I estimate HMRC’s exposure to each of those issues will be in the mid to high single digit £bns. For scale, the amount of money expected to be raised from Labour’s mansion tax is £1.2bn.

That’s bad news in relation to the £14bn: money we might have hoped to get we won’t get. But it’s extra bad news in relation to the money paid under Accelerated Payment Notices (of between £4.645bn and £7.1bn) because HM Treasury will have already accounted for that money as revenue – and spent it – whilst all but ignoring the possibility that HMRC will lose. I say “all but ignoring” because HM Treasury does make a modest adjustment for the possibility – we don’t what because they don’t tell us – but we do know it’s modest because HMRC tell us that the main uncertainties in calculating the income from Accelerated Payment Notices don’t include the possibility that HMRC will lose on one of those two issues.

Go back to Ladbrokes. If you were a shareholder, you’d want to be pretty sure the “Amounts staked” line wasn’t being represented as “Net Revenue”, wouldn’t you? You’d want to know that serious consideration had been given by expert minds to the size of any provision that should be taken. And you’d want to know the size of that provision. Before you spent the Amounts staked?


1. The Exchequer accounts for tax receipts as income and spends it on public services.

2. However, unlike normal tax receipts, receipts raised under Accelerated Payment Notices (expected to be some £7.1bn) carry a contingent liability to repay those receipts if the tax case the subject of the Notice goes against HMRC. Nevertheless those receipts are being spent just like normal tax receipts.

3. HM Treasury’s provision for that contingent liability is opaque and may well be many £billions too small.


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The High Risk Promoters Regime

The National Audit Office report “Tax avoidance: tackling marketed avoidance schemes” identified that most marketed tax avoidance schemes were devised by a relatively small number of promoters. And in its 2013 Consultation Document ‘Raising the Stakes on Tax Avoidance’, the Coalition floated proposals to target the actions of those 20 or so “high risk promoters.”

The resultant measures were enacted in Part 5 of the Finance Act 2014. They defined a class of people (“promoters”) who carry on a business of designing or promoting arrangements that enable people to obtain tax advantages where the obtaining of a tax advantage is the main purpose of those arrangements.

Where a promoter meets a threshold condition (defined in Schedule 34 of the Act) – a relatively high threshold singling out particular ‘problematic’ promoters – it will have its card marked by being issued with a conduct notice. That conduct notice will require the promoter to comply with certain conditions imposed to secure that the promoter desist from the problematic conduct.

If the promoter goes on to breach a condition they will then be issued with a monitoring notice. A kind of fiscal asbo, if you like.

Being subject to a monitoring notice will be profoundly detrimental to the conduct of a monitored person’s business. HMRC will publicise the fact that they are a monitored promoter along with the conditions they have failed to comply with. A monitored person will be required to notify actual and potential clients of their “promoter reference number.” And those clients will be obliged to report that number to HMRC if they expect to obtain a tax advantage from arrangements proposed by the promoter. They will also be subject to additional information gathering powers and longer periods within which HMRC can raise discovery assessments.

A breach of any of those conditions will render the promoter liable to a fine of up to £1 million.

How do these measures fit into the broader arsenal at HMRC’s disposal for tackling tax avoidance?

First, they recognise that tax avoidance can be tackled not merely by addressing demand – through such measures as accelerated payments – but also by tackling supply by increasing the commercial impediments to problematic promoters staying in business.

Second, they have been adopted against a background of an inadequate regulatory regime. Many promoters are not subject to regulatory control and, whilst it is not HMRC’s role to act as a regulator, a sensibly designed fiscal regime proceeds from an understanding of the broader world in which it operates.

Third, they recognise that the world of tax is a complex one – often, even to an insider – and that taxpayers can lack a practical mechanism for testing whether that which is being sold to them as pro-purposive plain vanilla planning has in actuality a rather more exotic fiscal flavour. The high-risk promoters regime aims to give prospective clients fair warning that the arrangements they are contemplating are likely to be high risk.

Finally, they seek to tackle a rather particular problem. The use of DOTAS disclosures as a gateway to Accelerated Payment Notices – and the effect of APNs on the economics of selling marketed tax avoidance schemes – has created a new distortion in the tax market. If promoters, often with the benefit of advice from Counsel, are able to form the view that a particular scheme is not disclosable, users of the scheme can benefit from a favourable cash flow treatment. This, in turn, increases the attractiveness of the scheme from the perspective of potential consumers, and enhances the profitability of the promoter.

This dynamic has given rise to a familiar, and rather unattractive, dance in which responsibility for the question whether to make a DOTAS disclosure is diffused between Counsel and promoter. The high-risk promoters regime enables HMRC gently to cut in by treating a failure to make a DOTAS disclosure as grounds for the issuance of a conduct notice.

It’s a surprisingly tentative step, the high risk promoters regime. Perhaps, as with the GAAR, it is a first, tentative step into new waters. I find it difficult to see how marketed tax avoidance will survive the slew of measures adopted in the Finance Act 2014 but should this prediction prove wrong, you can expect to see a significantly strengthening of this regime.


The above piece was published last week in Accountancy Magazine and is reprinted here with kind permission.

Future of Tax. Guest post by Kevin Nicholson, Head of Tax, PWC

Improving the quality of debate around tax is something I feel strongly about. So I was pleased to be asked to write here about PwC’s campaign to extend the debate to a wider group of taxpayers than is often the case.

This blog highlights the range of perspectives and opinions on tax reform, yet it’s still possible to find common threads between them. This is one of the reasons I think it’s important for discussion about tax to move beyond the profession, politicians and academia. It’s easy to make assumptions about what people think about tax: it’s too complicated, too dull, and all that matters is how it affects me. The discussions we’ve held for our Paying for Tomorrow campaign give the lie to all these things.

I’ve long felt that there needs to be a more strategic look at the tax system. The UK currently raises about £600bn in tax revenues each year – how are we going to raise that in a future world where the emerging economies are the bigger producers and employers, and have greater GDP? How will the UK raise the taxes it needs to run the country; will it be from business, income, wealth or sales? We need to think about what our future economy is going to look like, and then get our tax system in tune.

Dating back over two centuries, our tax regime needs a thorough overhaul – and I recognise that PwC, as the largest tax business in the UK, has a responsibility to be part of that change.

Our campaign is about pulling together views on building a tax system fit for the future, and the principles that should underpin policy. Crucially, it involves talking to all groups of tax payers.

So in June we commissioned Britain Thinks to bring together 22 representative members of the British public to have their say. Our Citizens’ Jury spent two days listening to a range of experts before debating and reaching their verdicts. We recently held a similar forum for businesses, again a real cross section of sizes and industries. And we’re currently running a major student competition, offering £20,000 for the best essay on how the tax system should change to improve job prospects. We want to engage with the people who will be most affected by the tax policies put in place now.

We’ll be drawing together the outcomes in the spring, but one of the most striking observations so far is the consistency of views. The main themes include:

  • People want far clearer and more transparent communications on tax – both the purpose of policies and how taxes are being spent. Individuals and businesses are more likely to support policies they understand.
  • While everyone recognises that tax is governed by politics, more must be done to counter political short-termism and encourage a more sustainable approach to policy making. Some of the ideas we’re hearing echo recent suggestions made on this blog  by Stephen Herring and Jolyon Maugham for independent scrutiny of costings.
  • Tax simplification is crucial and people are more likely to accept the trade-offs that come with say streamlining VAT or reducing the number of reliefs, if they understand the big picture goal and are confident progress will be made.

Perhaps for me the most illuminating part of the research is the willingness of taxpayers to put aside self interest. For instance our Citizens’ Jury rejected the idea of a mansion tax, even though none of their homes would touch the threshold. They just didn’t like the principle. It is important that we don’t make assumptions about different groups of taxpayers, and too often this has been the case.

Ultimately comprehensive tax reform can only be achieved if people buy-in to the common goal. And the only way to find out what people really want on tax is by speaking to them.

A Question on the Mansion Tax

I’ve made no secret of my personal preference for altering the mix between taxes on wealth – on those who have – and taxes on income – on those who accrue. I recognise the technical impediments to wealth taxes – but don’t see them as insuperable. I tend to think a better balance might offer Governments a bulwark against the defining fiscal (indeed economic) problem of our time – that of competition between nations. And I would counter the political challenges by introducing wealth taxes as part of a package which cut income taxes.

I have grey hair enough to recognise this, today at least, as a pipe dream. Labour’s first faltering step in this direction – the mansion tax – has met widespread opposition.

But one aspect of the debate has puzzled me. We have heard much of the elderly widow – that unfortunate beneficiary of a rising property market – who now lives in a £2m London property but without the means to meet a tax bill. What of her?

The outrage that changes in tax regimes might precipitate changes in behaviour I find puzzling. The world I inhabit is one where the ability of tax to influence behaviour is regarded as a helpful orthodoxy. Why, otherwise, increase the personal allowance rather than increasing benefits? Is there not something to be said for increasing the costs of holding a scare resource?

Anyway. I said there was a question. Let’s assume – merely for the sake of argument – that it would be a bad thing that those who could not afford higher property taxes should be compelled to downsize. I have seen no modelling of the number of those who would be driven from their homes. If one was to assume (for example, for the details of the mansion tax are not yet known) a rate of 1% per annum of values over £2m, how many are there in £2.5m homes who could not find £5,000 per annum? How many in £5m homes who could not find £30,000 per annum? (For scale, if the target of £1.2b per annum is to be hit, the average annual bill for those owning a house worth more than £2m is estimated to be £11,000 – but obviously this burden will be skewed towards those owning more valuable homes.)

For if our tax policy is to be designed around the interests of the few, I’d like to see (numerically at least) the whites of their eyes. Just how many people are we talking about?


Three quick points from Ed Balls’ announcement – just hours after I posted the above – on the Mansion Tax.

First, he says that liability for the tax will be banded. And for those owning properties between £2m-£3m per annum the tax will amount to £3,000 per annum. This will create a precipice effect – either your property is worth over £2m (in which case you will have a liability to £3k per annum) or it isn’t (in which case you won’t). But it will be a modest effect – because the precipice isn’t terribly high.

Second, he says there will be a right to defer the liability if your taxable income is less than £42,000 per annum. This is a measure designed to tackle the ‘Granny’ issue (see the foregoing and the helpful discussion in the comments section) and will carry a price in terms of delaying tax receipts. The quantum and period of delay will need to be modelled – and will be a function (in large part) of the age and income profile of the ‘Grannies’ in question. My gut says the delays will be very modest indeed in terms of quantity but (and this is the question I posed this morning) until we model it (and I’m not aware that anyone has) we can’t know.

Third, Ed Balls says the £2m threshold will rise with property price inflation. But what happens in the event of falls in the property market? If the threshold is subject to a £2m floor, then a falling property market will lead to disappearing tax revenues all of which have been politically hypothecated to fund fixed costs (i.e. the NHS).

A better way of doing politics

What fun to be a new Government. In you bound, full of non-partisan cheer and an unshakeable conviction that you can make the world a better place.

As did the Coalition. Within ten days of taking power, George Osborne had delivered a landmark speech – “not about party interests [but] about the national interest” – in which he announced the creation of a new, independent Office for Budget Responsibility. Such stood to deliver many benefits:

  • It would “[w]ith help from a secretariat of civil servants…  be in charge of making independent forecasts for the economy and the public finances.”
  • It would “remove the temptation to fiddle the figures by giving up control over the economic and fiscal forecast”
  • We would become “one of the few advanced economies with an independent fiscal agency that produces official fiscal and economic forecasts.”

And there would be “nowhere to hide the debts, no way to fiddle the figures, and no way of avoiding the difficult choices.”

A marvellous thing.

In opposition, Labour came to wonder whether the OBR might be a route to counteract public scepticism that it could be trusted with the economy. If the political parties were to submit their manifestos to the OBR to be costed, the public might take a less jaundiced view of deliverability. As Robert Chote, Chairman of the OBR, wrote to Andrew Tyrie, Chairman of the Treasury Select Committee:

I believe that independent scrutiny of pre-election policy proposals could contribute to better policy making [and] to a more informed policy debate.

That letter (which is well worth reading) goes on to set out a number of (achievable) pre-conditions to that objective being achieved.

Labour eventually procured a debate on the issue. The motion was:

That this House believes the role of the Office for Budget Responsibility should be enhanced to allow it to independently audit the spending and tax commitments in the general election manifestos of the main political parties, and calls for legislative proposals to enable this to be brought forward at the earliest opportunity.

And it was defeated.

The Conservatives’ position – not unsupported by Robert Chote’s letter – was that any change in the OBR’s remit was temporally too proximate to the general election to be implemented.  As the then Financial Secretary to the Treasury, Nicky Morgan (who opened the debate for the Coalition) (Column 392) put it:

we are not suggesting that the issues that the shadow Chancellor’s proposals present are insurmountable, but we do believe very firmly that the independence and operation of the OBR is critical. We need to make sure that independence and impartiality is preserved, and as such, Parliament would need time to scrutinise the proposals properly and the OBR still needs time to establish itself fully as an independent fiscal watchdog before being drawn into the political heart of a general election.

So not now, but next time.

Nevertheless, we had the cautious beginnings of a political consensus. And by goodness, the electorate needs it. When the FT, not often Pravda for this sort of agitprop, writes

The deficit policies of both main parties blur into one. Forgetfulness or deceit, it does not matter. When the new government opens the books after the election and the truth comes out, voters will think their new rulers are a bunch of liars who were willing to say anything to get elected. They would be right,

then the hour is surely nigh.

If we are to do more than talk about addressing public cynicism about politics, if politicians are to be incentivised to be straight with the electorate, if we are to fight back against the destructive tribalism that passes for public engagement with Government finances, then it is with measures like this that we must start. Technocratic, apolitical but incredibly important.

I shall be inviting the Liberal Democrat incumbent, Simon Hughes, and the Labour challenger, Neil Coyle, in my constituency, Bermondsey and Old Southwark, to indicate their support for these measures. I hope you might ask the same of your candidates.

Follow me on twitter @jolyonmaugham

Reflections on Party Conferences. Guest post by Stephen Herring, Head of Taxation at IOD

I am attempting what could well be an impossible task here which is to write about tax policy and the party conferences in a non-party political manner. I own up to being on the right of the political spectrum but hope that those in the centre or on the left will accept that that I have done my best to remove any overt political bias in my remarks below.

 I attended both the Labour and Conservative conferences but made very few visits to the main conference hall. Instead, I attended (or spoke at) perhaps a dozen fringe meetings at each conference organised by think tanks, business groups, professional bodies and other lobbying organisations. No one will be surprised that the tax discussions focussed upon the electoral popularity of the measures proposed rather than their tax technical soundness or their impact upon the complexity of UK tax legislation. Very little was said at either conference about corporation tax other than, at both conferences, some vague promises to tackle avoidance by multinational, especially US-owned, corporations (presumably tax avoidance is less unacceptable if implemented by UK-owned SMEs?). Even less was said about VAT, national insurance, capital gains tax, business rates or the ‘sin taxes’ but a little more about inheritance tax and council tax or their perceived wealth tax alternatives.

It is fair to state that Labour might have more wriggle room on tax policy (albeit with a consequential and matching increase in government debt) as they are targeting to  eliminate the current annual fiscal deficit (i.e. excluding investment spending) by the end of the next Parliament rather than the Conservative target of eliminating the overall annual fiscal deficit (i.e. including investment spending), The challenge faced by the Conservative focus on income tax cuts (principally the proposal for a £12,500 personal and a £37,500 basic rate tax band) will be convincing the electorate that these can be delivered whilst reducing the fiscal deficit. The Labour challenge on taxation policy will be more focussed upon finessing their tax policies with public spending commitments.

I have spent some time since the conferences thinking about the poor level of traction which tax reforms secure on the political agenda unless there is the perception that they translate into electoral appeal. Whilst it would be extremely naïve to believe that this will not continue be the case, I have suggested below a couple of ideas that might merit further consideration, focussing upon tax simplification.

Firstly, independent forecasters should be asked to maintain an ongoing (‘live’) bible of costings for policy options in the public arena on a fuller basis than HMRC’s existing annual tax ready reckoner (now called ‘The Direct Effects of Illustrative Tax Changes). Areas which come to mind, include the projected collections from the proposed mansion tax as opposed to additional council tax brackets and the tax which would be collected if capital gains tax were to applied to gains at death as opposed to inheritance tax becoming payable.

Secondly, a list of alternative tax cuts and tax increases should be maintained for each level of tax adjustment e.g. if HMG needed to raise (or were able to cut) total taxes by £1m/£2m/£5m/£10m/£25m, it could look at the alternative tax packages to deliver this (including additional reliefs, reliefs repealed and adjustments to tax rates and tax bands).

I consider something along the above lines could facilitate debate about proposed tax reforms, rates and reliefs, noting that the public, the news media (and even tax practitioners!) sometimes fail to appreciate the overall fiscal impact of proposed tax changes as opposed to the impact upon them personally.

Ed’s Note: You can – indeed you should – follow Stephen Herring on twitter at @Stephen_Herring

The Challenges of Taxing Employment (II) False Self-Employment

A consistent focus of UK Governments stretching back to, materially, Roman times has been an avowed desire to ‘clamp down on  false self employment’. Last week the Social Security Advisory Committee released a report identifying this as a phenomenon which:

occurs where employers (re)define their employees as being self-employed, which would not be appropriate if they effectively work for the ‘employer’.

This followed hot on the heels of the Consultation Document on the Onshore Employment Intermediaries provisions (“OEI”) in the Finance Act 2014. In his foreword, David Gauke, then Exchequer Secretary to the Treasury, said:

1.5 There are many legitimate reasons why a worker is engaged on a self-employed basis. The Government strongly supports enterprise and welcomes the contribution these entrepreneurs make to the economy. They recognise the additional financial risks someone who is genuinely self-employed takes and believe this should be recognised in the tax system.

1.6. However, there are times when someone who should be an employee is engaged on a self-employed basis. There are a number of benefits of engaging someone on a self-employed basis to the engager. The engager does not have to pay 13.8 per cent employer NICs and has none of the other costs associated with being an employer, including those associated with employment rights such as pensions contributions, redundancy pay and sick pay. The worker may benefit from a small increase in pay in the short term but this is at the expense of longer term benefits and protections such as employment rights.

And in 2009 the last Labour Government consulted on proposals which described the problem thus:

1.2 False self-employment occurs where workers are treated as self-employed for income tax and National Insurance (NICs) despite the fact that the way in which the work is carried out on a day to day basis demonstrates that there is an employment relationship.

And this Labour opposition has pledged, should it regain government in 2015, to introduce proposals similar to those it consulted on in 2009. And it’s not exactly as if the current legislative code ignores the issue. The Income Tax (Earnings and Pensions) Act 2003 contains (in addition to the Agency rules  revised in the Finance Act 2014) so-called ‘IR35’ provisions and ‘Managed service company’ provisions.

Because the line separating employment and self-employment is “blurred and shorn of logic and economic principle“; because the difference in tax rates (for those who recognise a rose by other names) is huge; and because there is fiscal advantage for both workers and engagers (to adopt two neutral expressions) in classing workers as self-employed, there is every incentive to arrange matters so that that which might be the one is taxed as the other.

Even so. That one might need (presently) three – and with a contemplated fourth – sets of statutory provisions to tackle a single issue might cause even us benighted professionals plying our trades in the field of tax to raise a wearied eye. How has this come about? And does the contemplated fourth provide reason to cast off the pessimism of experience?

An informed walk through the story above reveals three discrete but related issues.

First, there is a remarkable lack of clarity about the problem. None of the papers referred to above define (or define better than the quoted paragraphs) what false self employment is. Now, it is undoubtedly true that there are some workers who are wrongly treated for tax purposes by their engagers as self-employed when they are employed. But that is not a problem that requires legislative solution: the Tax Tribunal is perfectly able to address it without recourse to any of the provisions set out above. All the Tribunal need do is ask whether the worker is employed or self-employed.

The real problem (in this context) with the Tax Tribunal – as we know but do not say – is that the assessment of a worker as employed or self-employed is a fact rich one. In consequence, it is usually disproportionately (compared with the value of the arbitrage) resource intensive for HMRC to tackle the question worker by worker. The legislative solution that is offered is to substitute a less fact rich assessment. But this is, of course, a solution to a different problem (resourcing rather than wrongly characterisation). And these solutions create a different issue: that of false employment.

Take the on-shore intermediaries provisions, for example. They eschew the multi-factorial assessment of the Tax Tribunal for a focus on a single question, that of supervision, direction or control. Fail this and you’re deemed to be – and taxed as – an employee. Even if, having regard to all the relevant features, you would be deemed to be self-employed.

Second, there is, as I have stated above, a lack of clarity about the reasons for the difference in tax treatment between these categories of employed and self-employed. None of the papers cited advance beyond David Gauke’s rather imprecise observation about ‘risk-taking’. The tax code pays no mind to the differences between dynamic and steady state businesses; between those where capital is and capital is not being risked; and between those who do and do not employ. It has no regard at all to the huge value for the economy as a whole of having a flexible labour market. It’s a difference likely without any – and certainly without any articulated – rationale.

What the papers referred to above also reveal is a (largely unspoken) frustration with the fact that it is often possible to toggle the tax status of a worker through adjustments to the drafting of his or her contract. That workers in economically similar situations might be taxed so differently (with distortive effects on the ability of engagers to compete on price) might seem surprising. But it is a natural – indeed, it is an inevitable – consequence of the fact that the relationship of employment – and hence the incidence of taxation – is a function of contractual terms.

Third, there is an apparent lack of understanding about how the problem should in practice be tackled.

The OEI provisions contain an excellent example of such a short-coming. It’s all very well creating a liability to tax on a person. But this is meaningless unless you can in practice collect it. These provisions (immaterial exceptions aside) put the liability on a third party – neither the engager nor the worker. And they create a situation where both engager and worker are largely indifferent to whether that third party meets its liability. We – taxpayers at large – have long and bitter experience of such circumstances. The practical reality is that the third party too – invariably a barely capitalised corporate – will itself be indifferent as to its liability. Its owners will remove its income, let the corporate fail, and then (in a practice known as ‘phoenixing’) simply create another corporate.

Let me look at these issues in turn.

If one was honest about the real problem one was seeking to tackle – the problem shared by both HMRC and engagers of how to form a secure view of status – one might then more readily move to a sensible discussion of what fit-for-purpose legislative solutions looked like. But so long we pretend that the problem is otherwise, we remain handicapped in our ability to tackle it.

If we were clearer about the behaviour we wished to encourage through the differential in the rates between employment and self-employment we could more readily tax to encourage or reward that behaviour. At the moment it is difficult to discern a rationale beyond discouraging the contractual status of employment. And this – to me at least – feels like no rationale at all.

What is it that we really wish to encourage – surely it is not everything that is not employment? Might it be businesses that risk capital? Is it those that employ others? Is it businesses that seek to grow – as opposed to those that seek merely to remain in a steady state? Is it those who are prepared to commit to short term contracts to provide supply chain flexibility for their clients?

Legislators, compelled to avert their eyes from such considerations, are left to tinker about with aspects of the contractual definition of employment. This impedes their ability fiscally to grease the right economic cogs. Indeed, I would go further. It is – in my opinion – very likely but quite inadvertently to have the effect of removing fiscal incentives from behaviour that, clear-sighted, we would undoubtedly wish to encourage in our economy.

And as to the third? Beats me. If you have the answer, do let me know. Certainly shooting from the hip at politically expedient targets can dis-incentivise business from engaging in developing workable solutions.

I should note, finally, that I will return to consider the role of intermediaries in the labour market in more detail in a later post. For now it is enough for me to note that they are a feature of this landscape but not one that alters the analysis set out above.

Mixing tax and politics

A small bird – one who wants this project to succeed – informed me this morning of a concern that my Primer on the Conservative’s proposed rise in the personal allowance was perceived as too political.  I also know very well that my pieces on Labour and Tax Avoidance during its party conference were unwelcome (or perhaps more accurately, unwelcome to some). I tackled UKIP’s WAG (weekend fling?) tax. And I shall strive to find something of interest to say on Liberal Democrat announcements in the fiscal sphere.

But how consistent is this with my avowed intention to be apolitical?

There’s no escaping the fact that tax has a political dimension. Many of the big questions that divide right and left – the size of the State or the prioritising of relative and absolute wealth – are readily examined through a fiscal lens. Are taxes the price we pay for a civilised society or an undesirable confiscation of private wealth? Is progressivity in the tax system an absolute end – one to be pursued even at the cost of economic growth?

So close is the relationship between tax and politics that I shall propose a challenge. There is, in any plausible world, no tax decision that one fellow Waiter can propose that another Waiter will not be able to badge as inherently political. Give it a try (it’s my neck on the line, after all).

Of course, the concerns are of a different nature. There I am, wading into party politics, at this most tribal of moments. Surely that is political in a meaningfully different way?

It is, of course.

But that doesn’t mean that to tackle such stuff is to cease to be apolitical. I think it’s entirely proper to point out the distributional effects of particular tax measures. If the Conservatives find that embarrassing, that’s their problem: adopt a different policy. Qualitatively the same, in my view, is pointing out some arithmetical questions arising from Labour’s pledge to fish another £650m out of a rather dry looking pool. The problem isn’t that I’ve pointed it out.

Improving the quality of public and political debate around tax“: I can’t pretend to be aiming for that without doing my best, with my available time and limited skills, to point out where it seems to me that what we’re being told by politicians doesn’t stack up. Should I be backing off because of the time of the political day? Absolutely not: now is the moment it matters most.


A small postscript. I’m slightly embarrassed about the amount of inward looking stuff here. I wanted to say this: it’s important to me. But next week we’ll be back to the real stuff. Promise.





A £12,500 personal allowance: a primer

Raising the personal allowance has been a key fiscal policy objective of the coalition. David Cameron has just announced a future Conservative Government would raise it from £10,500 (to be introduced in 2015-16) to £12,500. What might this cost, who will benefit, and who is it targeted at?

The cost:

Here are some very rough back of the envelope calculations. When, in Budget 2014, the Coalition announced the raise to £10,500 (from, assume, £10,000), this was forecast to cost an average of £1.75bn pa over each of the next four years. Multiply that by, roughly, four (if 500 costs £1.75b than 2000 all things being equal will cost four times as much) gives you £7bn pa – but of course you then have to factor in the fact that as the personal allowance increases the number of people able to take advantage of that increase declines (because they earn less than the increased allowance). About (these percentage figures only cover people with some liability to income tax) 11% of people earn below £10,500 and about 21% below £12,500. And that fact is a rather telling one – I’ll come back to it.

Who benefits:

The first thing to note is that it only benefit those earning more than £10,500.

If you work part-time, or you’re self-employed, or you work on a zero-hours contract you may well benefit not at all. Self-evidently, if you don’t have taxable earnings – because for example you’re reliant on benefits – the increase will do nothing for you.

What about those on the minimum wage? £6.50 per hour x a 35 hour week gives you a weekly taxable income of £227.50 or an annual income of £11,830. So if you earn minimum wage, you’ll benefit. Somewhat. To the tune of £266 per annum post tax. Those earning the median wage (something around £520 pw), on the other hand, will benefit by £400 pa. (These figures assume that there are not corresponding rises in national insurance contributions thresholds – although past practice suggests there will be).

Who is it targeted at?

The short answer is, not the lowest paid. If you wanted to help only those earning minimum wage, you could certainly do so an awful lot more cheaply and an awful lot more generously than by this measure (which is likely, depending on the detail, to benefit everyone earning below £100,000).

Remember that when you hear a politician say, in response to the question: ‘What have you done to lift people out of poverty?’ the answer ‘I raised the personal allowance to £12,500 and took a whole bunch of people out of personal income tax’.