Balancing the Books – with One Eye Shut

It’s a curious paradox that the delivery of the Conservatives’ desire for a smaller state, a desire born of a belief in the inefficiency of that state, throws up inefficiencies all of its own.

How we laughed at the logic that led us to consider underwriting private sector investment in the nuclear power industry at a cost exceeding that which would be incurred were we to borrow and invest ourselves.

And cried, at the Chancellor’s attempts to wrest from the tax system – one that already exempts the lower earning half of the adult population from liability to income tax – some meaningful amelioration of the swingeing cuts to tax credits that hit hardest that same half.

My own particular cranny of expertise is, of course, neither off-balance sheet financing nor how best to balance the moral imperative to tackle poverty against the desire to run a balanced budget and properly incentivise work. What I know about is the uses that our politicians make of our tax system.

But here too we find inefficiencies – borne of the same desire. And which will have profound consequences for the outcome of the Comprehensive Spending Review.


Decisions around the rates at which we pay tax – cutting corporation tax to 18% or the top rate of income tax to 45% – are closely scrutinised. So, too, are decisions around thresholds: raising personal allowances to £12.500, or the point at which you pay higher rate tax to £50,000, or the threshold before a couple must pay Inheritance Tax to £1m. For changes of this type, it is relatively straightforward to identify the cost, the beneficiaries, and the advantages.

But alongside these headline decisions sits a host of further choices made by Government to favour certain types of business activity, or individual, or activity.

This favouriting usually takes the form of a reduction in liability to tax – and sometimes payments made to the chosen subject by HMRC. But from our perspective of course – the ‘our’ here being you and me: society at large – the form makes no difference. Either we incur expenditure by handing over cash or we forego cash by choosing not to collect that which would otherwise be our due.

The technical term for these encouragements is “tax expenditures” – reflecting that through them Government is foregoing or ‘expending’ tax that might otherwise be collected. But unlike the headline decisions around rates and thresholds, the scrutiny of tax expenditures is unsatisfactory – and the evidence of their efficiency weak.

But before I get into how they’re unsatisfactory and weak let me tell you why this matters.

We’re talking staggering sums of money here. An Office for Tax Simplification report identified the existence of over 1,000 reliefs. The 50 tax expenditure reliefs which find their way onto the (somewhat misnamed) “principal” tax expenditure spreadsheet – these 50 alone – cost us collectively £111bn in 2014/15.  That’s about 20% of all the tax of all types we collected that year.

Now that I’ve piqued your interest let me explain how it’s weak and unsatisfactory.

First, what the electorate is told about the purpose of these tax expenditures is often a stranger to the reality of what they actually accomplish. Last week, for example, I wrote about the so-called Shares for Rights scheme. It was heralded by Government as a mechanic to create partnerships between workers and owners of businesses. But the reality was it was little more than a £1bn bung to wealthy private equity buyers. And it appears to have been designed as such.

Second, how the benefits are shared is poorly understood. Richard Murphy has given the example here of how entrepreneur’s relief (which cost a total of £2.77bn in 2013/14) delivered a tax saving of a staggering £600,000 (on average) to each of 3,000 people. True it is that Richard was able to effect that calculation from publicly available information – but the same is not true of most tax expenditures.

Third, their costs – in tax revenues foregone – lack transparency. HMRC publishes three spreadsheets showing the costs attached to tax expenditures. The first – here – sets out what are described (somewhat misleadingly) as the costs of the “principal” tax expenditures. The third – here – describes the costs of “minor” tax expenditure reliefs (i.e. below £50m). But (and this is why I describe the title to the first as misleading) there is also a second – here – with the  title of “cost not known”. And that second includes some punchy items – like the £1bn+ cost of Shares for Rights – which should quite clearly come within the first, “principal” tax expenditures, spreadsheet.

And it’s not easy to avoid the conclusion that that lack of transparency is sometimes deliberate. Let me give some examples:

  • The Shares for Rights scheme appears on the “cost not known” spreadsheet – despite the fact that Treasury promised at the time to monitor it. Moreover, as I pointed out in my post last week, the OBR was perfectly well able to estimate the £1bn+ cost. So you might be forgiven for some scepticism about the assertion that Treasury and HMRC are unable to.
  • The second item on the “cost not known” spreadsheet is ‘10% wear and tear allowance.’ But how can that cost not have been known when, in July’s Summer Budget, the Government abolished the allowance, a measure that Treasury was able to estimate carried a forecast yield of £205m in 2017/18 (with more to follow in succeeding years)?
  • The National Audit Office has made similar (and related) points in relation to Lettings Relief:


But a number of the items on the first spreadsheet – misleadingly marked “principal” tax expenditures – are marked as “particularly tentative and subject to a wide margin of error.” What’s the rationale for including them but excluding lettings relief?

It is temping indeed to conclude that the “costs not known” spreadsheet might better be entitled “costs we’re not going to tell you.”

And even where the costs of tax expenditures are published there are profound doubts about the reliability of those numbers. As the NAO pointed out:


(and that’s four of only ten reliefs the NAO examined).

And, critically too, fourth, there is no ongoing assessment of whether those reliefs deliver value for money. Even if you make the generous assumption in favour of the Government of the Day that the reliefs do deliver its assessment of value for money at the time they’re introduced, the structure of that relief, its cost and what it delivers, is not routinely reviewed to take account of changes in the economic climate.

Take Agricultural Property Relief from Inheritance Tax, for example. It is expected to cost us £420m in 2014/15 but what value does it now deliver? When I looked at that question here I concluded that whatever had been its original intention, it now acted as a barrier rather than a spur to the productive use of agricultural property.

Or Entrepreneurs’ Relief (which I have already referred to). The National Audit Office has calculated that the actual cost is fully three times what was forecast.


but there is no suggestion that this heightened level of expenditure is necessary to deliver the purpose of “encouraging enterprise”. Or even that Government has seen fit, in light of this much higher level of expenditure than anticipated, even to ask itself the question whether we get value for money from that 300% increase in the originally anticipated cost.

To take another example, a detailed literature review of the effectiveness of tax expenditures on research and development (at a cost in 2014/15 of £1.7bn) presented a very mixed picture. Certainly those reliefs became less effective over time. And we also did not know how effective they were to start with:


I could go on. But you have the point. For further reading I recommend this Report from the National Audit Office and this one from the Public Accounts Committee.

Given the scale of tax expenditure – over £110bn on 50 tax expenditures alone (HMRC estimate there are may be 150 in total) – these problems of disinformation, poor knowledge of costs and distributional effects, limited understanding of value for money and a lack of monitoring are profoundly troubling.

So Corbyn has been right to highlight it, albeit that his particular focus on corporate reliefs is difficult to understand.


But these issues rise above the party political: they ought to be absolutely centre-stage for all of us who care about efficient and well-run Government.

We have been told to expect £20bn of savings in the Government Spending Review, the results of which will be announced with the Autumn Statement on 25 November.


And, as has been well flagged, delivery of this £20bn number whilst meeting the pledge to ‘protect’ substantial parts of public spending, will involve swingeing cuts to some unprotected departments. Departments have been asked to identify prospective cuts of 25% and 40% – here’s one possible scenario the IFS has modeled:


And these cuts follow, of course, from substantial cuts achieved during the last Parliament.

No one would argue that the Conservatives – initially with the Liberal Democrats and now alone – have failed to look long and hard at how to cut expenditure. But where is the similar detailed focus on revenues foregone?

Because, of course, there is another way to achieve your goal of balancing the budget: you can increase your income. Or do a little of both.

It seems bizarre that you might look to balance the books solely through the mechanic of cutting £20bn of expenditure whilst turning a blind eye to the value for money delivered by your choices to forego income. Especially when there is a tidal wave of evidence that our understanding of that value for money is poor and the sums – in excess of £110bn for fifty tax expenditures alone – are so enormous.

Why would you choose to balance the books with one eye shut?

In another context Government rejected this analogy between revenues foregone and expenditure incurred.


And this rejection stands, apparently, despite the fact that these tax expenditures can and do take the form of cash payments made by HMRC to beneficiaries.

But whatever the merits of this reasoning – and I personally struggle to identify any – it is surely a truism to say that one can balance the books as easily by increasing your income as cutting your expenditure.

And you would only close your eyes to this truth if you were bent on shrinking the size of the state.

11 thoughts on “Balancing the Books – with One Eye Shut

  1. A fascinating and incisive analysis, as ever.

    I have long struggled with the concept that HMRC is unable to measure the cost of specific reliefs and incentives. To the extent that there is not a deliberate attempt to simply obfuscate, I suspect that part of the problem may come down to a lack of resource.

    The behavioural issue is the really interesting part, however. There has been a fair bit of discussion of late about the effectiveness of behavioural taxes – e.g. the proposed sugar tax. Does increasing the tax on something really lead to a reduction on consumption? The issue with most reliefs/incentives is pretty much the same – will the desired activity increase as a result of the relief/incentive?

    The issue of R&D reliefs – which you highlight above – is particularly interesting for me and (I believe) quite nicely summarises the problem. Human behaviour is complex, add in the inherent complexities of business and predicting the consequences of any measure with any degree of accuracy becomes nigh on impossible. The surprise to many people (which, again, your post draws out) is that it seems so difficult to measure what is actually happening in reality. Again, however, I suspect that this is a function of the complexity of real life. There are so many factors at play that it is difficult to see which one is having the biggest impact.

    The really worrying conclusion is that this has become such a standard part of the armoury for all governments that there is an unquestioned (and rather arrogant) assumption that they must work – even if that cannot be proved!

  2. Pingback: Tax Research UK » If tax expenditure is £111 billion a year why is the government targeting tax credits?

  3. An interesting and informative analysis, but I am not sure the conclusion flows smoothly, or that the initial assertion is correct.

    Do the Conservatives really want small government? They may say they do, but Mr Cameron said ‘the greenest government ever’, Mr Brown said ‘an end to boom and bust’ and ‘British jobs for British people’ so all that shows is that politicians say and do whatever they feel may satisfy potential voters.

    Looking at what the Tories have actually done, if they are aiming for smaller government they are doing an exceptionally poor job of it, as your analysis shows.

    In places your own evidence is incomplete too. Mr Murphy is no doubt correct that Entrepreneur’s Relief ‘delivered a tax saving of a staggering £600,000 (on average) to each of 3,000 people’. But that wasn’t its purpose, which was instead to promote the formation of new, small companies. Has it done that? Mr Murphy is silent on this issue, so it is impossible to say if this was efficient or not just by counting the relief granted. (Disclosure – I work with such a business. So far, the amount invested in 3 years far outweighs any relief to the investor, who is not me)

    One can say the same about previous governments. Is a Tax Credit regime that pays out to 9 out of 10 of all families, including those of MPs on £60k+ per year, really an efficient way to combat poverty? Was £10bn spent on not computerising NHS IT efficient? Were ID Cards an efficient way to stop NHS & Benefit fraud, both of which are held to be at least 10x less than the cost of the scheme? Is giving a Winter Fuel Allowance to millionaire pensioners efficient? As you say, this is not party political – to give a further example, Mr Osborne spent £6bn extra on his recent ‘Granny Bonds’, giving additional interest over the market rate, funded by taxpayers, to mostly already well-off pensioners.

    So government spending is frequently, especially on the margin, inefficient. And yet your conclusion seems to be that more should be raised by taxation, presumably so even more money can be used in even more inefficient ways.

    I would rather suggest that we ask Government to do what only it can do, which is not subsidising wind farms or nuclear power stations, invading foreign countries, running railways or manipulating markets through inefficient schemes of any sort. Rather it should provide Health Care & Education free at the point of delivery, law & order, defence, benefits for those in difficulties and a few other services which are agreed by a large majority (a smaller number can pay for services they want themselves, such as the BBC). With a smaller workload, perhaps they could be more efficient, but in any case the population will have less removed in taxation, so they can choose for themselves what they want to fund.

  4. I am not sure a balanced budget is much more than an it may happen. It all seems a schtick to sell to voters politically about need for a balanced budget etc even when clearly it’s not a genuine priority. Con voters often being rural folk and pensioners get substantial income from the state! And growing and guaranteed one at that. By tax exempting and other devices the Govt essentially has more power as it can turn off and on certain spigots. What has loosely been called neo Liberalism [Brown/Osborneism] is essentially an expansion of Govt control – backed up by ludicrous state spying.

    Maybe they genuinely want a smaller [but more powerrtful] state but use of off balance sheet fudges and turning capital expenditure into excessive rent via PFI/Chinese Investment/Hinckley Point style points to short termism or fraud or incompetence like Homer Simpson turning $50 of bacon into a $1 of grease.

  5. soarrergtl says:

    “In places your own evidence is incomplete too. Mr Murphy is no doubt correct that Entrepreneur’s Relief ‘delivered a tax saving of a staggering £600,000 (on average) to each of 3,000 people’. But that wasn’t its purpose, which was instead to promote the formation of new, small companies. Has it done that? ”

    That is a reasonable enough question, but there is a fairly remote causality between the introduction of a relief for disposal of assets and the decision *now* to form a new small company in an entrepreneurial way. If such causality existed, one would expect to see growth in the formation of such companies by entrepreneurs over time and then also over time, *after* the entrepreneur has built a successful business, the take-up and cost of the relief to rise as entrepreneurs cash in to realise the value of the business they have developed by selling some or all of it.

    However, when the relief was first introduced (in 2008 under the then Labour government), while the possibility of less tax on eventual disposal of a business might have prompted some people who might not otherwise have thought of starting a business to do so, its actual concrete and immediate effect was to provide tax relief to those who *already* had established a business if they were to dispose of some or all of it. So arguably its real incentive was not to start businesses but to sell them (or to provide the possibility of reducing tax payable by taking a return from the business through selling bits of it and paying CGT at the ‘relief’ rate rather than through income and paying income tax on it). This might not have been a particularly distortive incentive or significant in terms of tax foregone when introduced as the maximum relief available over a ‘lifetime’ was only £80,000 (derived from a £1m lifetime allowance and an 8% difference between the entrepreneur relief rate and the standard rate of CGT).

    But changes under the last government upped the lifetime allowance to £10m and the difference in rate to 18%, giving the possibility of £1.8m of relief. The enormous increase in the cost of the relief illustrated in Fig.8 above – and its increasing divergence from its forecast cost – is not as such evidence of the success of a policy to encourage entrepreneurs to start businesses, but more likely evidence of increasing usage by individuals with existing businesses who are already by any ordinary standards ‘rich’ to reduce their personal tax bills.

  6. I liked the paragraph which said “Agricultural Property Relief from Inheritance Tax . . . . is expected to cost us £420m”
    Get stuck in!
    No doubt there are numbers somewhere for the cost of diesel subsidies and business rate exemptions for this sector, as well as the direct subsidies they get in farm payments. Removing these subsidies would reverse the rise in land values and make it cheaper for new entrants in this industry with new ideas. As you state the productive use of agricultural assets is currently being inhibited.

  7. Thanks Michael. The detail you supply does make it look like an unsupportable ruse to give tax relief with no apparent benefit to anyone but those so relieved.

    Is that a reasonable characterisation, would you say?

  8. Great article, but please lets not through the baby out with the bathwater. Some tax reliefs do enable genuinely good things to raise funds – including community shares for cooperatives etc. and can encourage money into early stage research such as new energy storage.

  9. Absolutely not. I wouldn’t want to be read as suggesting no reliefs serve a purpose. It’s just that I’d like to know which do. And whether the tax foregone is worth the extent to which it’s achieved.

  10. I would be surprised if there were many people thinking about starting a business who would be put off from doing so by the prospect of the tax charge they might incur in selling it, and instead stick with the pay packet from the day job (or stay slumped in front of daytime TV).

  11. Pingback: How many people has HMRC prosecuted for offshore evasion? | Waiting for Godot

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