Shrinking the State? It looks like this.

Last year HMRC collected £515bn through the tax system (page 8).

It would have been more but for a number of ‘tax expenditures’ – a particular type of tax relief which you might think of as a substitute for a subsidy (paragraph 7.3.2). Through them we give away by foregoing income “some £100 billion a year” – according to the (Conservative majority) Public Accounts Committee (page 9).

On 25th of November, George Osborne will publish the results of his Spending Review, designed to cut a further £20 billion from public spending by 2019-2020 (table 1.A). His aim – or more accurately his avowed aim – is to “deliver value for money for the taxpayer” (paragraph 1.2).

Value for money is, of course, what good governance in the public sector looks like. It’s why HM Treasury has a so-called Green Book entitled “Appraisal and Evaluation in Central Government.” The 118 pages of that Green Book are one long argument for the need to understand what we get when we spend public money. There is a need to ensure that “Public funds are spent on activities that provide the greatest benefits to society… in the most efficient way.”

No one is pretending that the Spending Review will be easy. The Introductory section to the Spending Review provides that it will “involve difficult decisions” (paragraph 1.3). Not least because it follows on from “£14.3 billion from efficiency compared to 2010” achieved in the last Parliament (paragraph 2.6).

But here’s the thing.

Why are we taking difficult decisions with spending – but deliberately ignoring easy ones around tax reliefs? Why does “value for money” dictate spending cuts when it is absent from Government thinking about reliefs?

And where is the Green Book assessment of the value delivered by that £100bn of tax expenditures?

There isn’t one.

Here’s what the National Audit Office said in November 2014:

“We found little evidence that HMRC evaluates reliefs to see if their objectives are being met.”

(paragraph 17).

And here’s the Public Accounts Committee:

“HM Treasury and HM Revenue and Customs (HMRC) do not keep track of those tax reliefs intended to influence behaviour. They do not adequately report to Parliament or the public on whether reliefs are working as intended and what they cost and whether they represent good value for money.”



“HMRC rarely, if ever, assesses whether a tax relief is an economic, efficient and effective way of meeting its policy objectives.”

(Paragraph 4).


Let me try and bring this to life with one example – of the 1,156 reliefs the Office of Tax Simplification says exist.

Entrepreneur’s Relief reduces capital gains tax to 10% for entrepreneurs selling their business. It was forecast to cost £0.475bn in 2007-08 but in 2013-14 cost £2.77bn – an increase of more than 500%. But, says the National Audit Office, there was “No detailed analysis carried out to explain the increase” (Figure 6).

What has this £2.77bn of expenditure delivered? HMRC says that “the relief may have formed a genuine incentive for entrepreneurs based on the finding that the average age of beneficiaries had dropped from 59 to 53. The analysis did not explain or justify the link between age and entrepreneurship” (paragraph 2.15).

It’s not even clear what the purpose of the relief was in the first place.

Giving evidence to the House of Lords Select Committee on Economic Affairs the Oxford University Centre for Business Taxation pointed out that: “The economic rationale for Entrepreneur’s Relief is unclear… an entrepreneur that has already gained the benefit of the relief has a (comparatively) reduced incentive to undertake a new enterprise” (page 124).


Let’s return to the Spending Review.

George Osborne, in his Foreword to the HM Treasury paper (“A country that lives within its means: Spending Review 2015”) stresses the need to “eliminate the deficit by 2019-20” to deliver an economy that “offers security for the working people of Britain.”

Of course, you could eliminate the deficit by reducing your spending. But you could also eliminate it by raising your income through cutting back on tax giveaways. Indeed it’s not an either/or. Anyone whose interest genuinely lay in a balanced budget would take a long hard look at both.

You’d look at how much fat there was on the spending side, for sure. You’d recognise that £14bn had already been trimmed – and you’d ask yourself whether more could be done.

But you’d also look at the £100bn cost of those tax giveaways and what public benefit they delivered.

Osborne’s doing the former. But he’s closing his eyes to the latter. There’s compelling evidence of waste on the tax side of the Government’s P&L but Osborne, quite literally, does not want to know.

This is not where you get to if you’re trying to “eliminate the deficit”. It’s not the way to delivery “security for working people”. It’s not what you do if you have a genuine focus on “the best value for money for taxpayers”.

But an ideological exercise in shrinking the State? It looks like this.

33 thoughts on “Shrinking the State? It looks like this.

  1. Pingback: Shrinking the State? It looks like this. | Waiting for Godot | sdbast

  2. I follow your posts with interest Jolyon and am fascinated to know what items the rest of the £100 Billion you mention comes from. But on this one you are really showing your socialist colours and evidencing a failure of understanding as to the true sources of wealth generation, jobs –and, yes, taxes. New jobs and economic growth come from entrepreneurs. Large companies don’t (on average) create jobs –they buy other companies and cut costs by shrinking their workforces, thus less jobs. The government doesn’t create jobs (despite repeatedly trumpeting that it has done so) –unless of course you count Gordon Brown’s New Labour project that created almost a million new civil servants, who did SFA and helped get us into the crash of 2008, and then had to be fired all over again. No, economic growth and jobs are created by people starting up new private sector companies with their and other people’s savings (that’s why it’s called capitalism, because excess capital is needed to start a new company). The success rate of these entrepreneurs is dismal. Maybe 6 out of 7 fail, bankrupting the entrepreneur or at least thrusting them into poverty so that they have to start all over again. The returns in Europe to early stage Venture Capital have been dismal. Given that, entrepreneurs need to be given every possible incentive to take the huge risk that starting up a company entails. Since 2010 one of the things Cameron and Osborne seem to have been doing right is encouraging all sorts of tax incentives to foster entrepreneurialism –Patent Box; EIS and SEIS schemes (in particular pushing HMRC to be less niggardly with their approvals of such); and yes, entrepreneur’s relief (originally introduced by Gordon Brown I think, and a very good thing it was too!). And the various initiatives succeeded! If indeed the amount forgone due to entrepreneur’s relief has shot up, that means that realisations (amounts received by entrepreneurs sellng their businesses) have shot up! Which means that many more entrepreneurs have started up companies than heretofor! And in turn results in that there are many more new small companies around, providing more jobs, wealth, new goods and products, and –yes– taxes (those lovely PAYE and NIC taxes which return higher levels overall than cgt does).

    Jolyon, you are way too smart to have such a linear view of the world as you apparently profess to have in this post. You need to see the world in dynamic terms –what impact and outcome occurs for a given tax relief? What feedback loops are created by each action?

    And rather than carping at those dastardly capitalists who actually got a tax break, celebrate their success.



    PS if you made these entrepreneurs pay 28% cgt, the most successful ones with the largest gains would likely decamp to Monaco before unloading their company, resulting in ZERO tax paid on realisation. Perhaps this is another reason why realisations in the UK have gone up –because less people are decamping –10% being too small to incent them to leave the UK.

    PPS these entrepreneurs, having stayed in the UK, and especially because as you say the average age has gone down, then reinvest some of their gains in new businesses leading to even greater job and wealth and tax growth (in particular because experienced entrepreneurs have a greater success rate than newbie entrepreneurs)–a good example of one of many beneficial feedback loops that you need to take into account.

  3. I agree with some of that and – no surprise – disagree with some of it too. But the key question you don’t address is how much more entrepreneurialism we get because of a relief which increases post-tax gains. You simply assert an answer. My point – which I think is unanswerable – is that we need to know the answer to that question before we describe that £2.8bn every year as money well spent.

  4. “an entrepreneur that has already gained the benefit of the relief has a (comparatively) reduced incentive to undertake a new enterprise”

    What an extraordinarily daft thing to say. Let’s incentivise the sort of behaviour we want by taxing it more.

    I have seen Entrepreneur’s Relief in action many times and it undoubtedly has the effect of enhancing management’s focus on equity value. But it’s never been entirely clear to me why the taxman should be funding this, rather than the other shareholders who stand to benefit.

    And in the cases I’ve seen the people involved have always been senior managers in established companies, which I’m not sure was the target population. Or at least, the stated target population.

  5. That’s not me but the Oxford University Center for Business Taxation – more frequently criticised for being pro-business than anti.

  6. Yes I realise it wasn’t you! I don’t always agree with everything you write (although I do agree with most of it, including the main points you are making in this post) but I have yet to see you write anything daft.

  7. That’s only because you haven’t been reading me for very long…

  8. 🙂

  9. I think the stated figure of £101 billion is based on 46 costed measures that are classified as “tax expenditures”. Is there a lists somewhere? How much freedom of manoeuvre is there, in reality?

    Remembering that the OBR counted over a thousand tax reliefs in all, most pretty minor, the tables here – – include about 90 reliefs, summing to about £380 billion (for 2014-15).

    Most of those reliefs are about £260 billion of “structural reliefs” (bottom half) which include about £86 billion for the income tax personal allowance, about £50 billion for NICs thresholds, £24 billion for capital allowances, and £15 billion for double tax relief.

    The top half appears to be about 50 “tax expenditures” but they sum to £110 billion (for 2014-15), including about £22 billion for income tax relief and £11 billion for employer NICs relief for contributions to or income in pension schemes, £2.6 billion for ISAs, £13 billion for capital gains tax relief on sales of principal private residences, and £41 billion for VAT zero-rating (£17.5 billion for food and £8.3 billion for new houses) plus £4.8 billion for the 5% VAT rate on domestic power.

    Assuming we don’t want to disincentivise those four things (pensions, ISAs, PPR, and VAT), that is £94 billion of the £110 billion of “tax expenditures” accounted for already. That leaves about £16 billion up for grabs.

  10. I agree that your point is ‘unanswerable’ as you put it, because how can we tell what the answer is? If there is no study (and I can’t begin to think how one would be designed, anyway there hasn’t been one), then necessarily we don’t know (apart from the anecdotal evdience provided by another of your commenters, with which I as a venture capitalist can fervently support from my own observation). But there are so many other economic phenomena where (not totally sure of your views here so only guessing) you will most likely enthusiastically agree that if the price changes, behaviour will respond to the incentive. For example carbon taxes. Otherwise why have them? (and note the closing down of huge number of energy intensive businesses in the UK with them moving them to other countries where enregy is less expensive for further admittedly anecdotal not scientific evidence for same). If you agree that price changes lead to changed behaviour in other cases, why do you not believe it will change behaviour in this case? I appeal to your fine rational mind to overcome your ideological prejudice in this matter.

  11. It’s you who is asserting the £2.77bn is well spent. My point is that we don’t know whether that money is well spent and we should do. Even if I assume that spending encourages entrepreneurialism it doesn’t follow that any amount spent on encouraging entrepreneurialism is well spent. What about £5bn, £10bn, £100bn, £500bn? If you accept that proposition you have to accept that the same is true for £500m, £1bn, £2.77bn as well. And you have to consider those questions against a background that £2.77bn is not the only tax expenditure on encouraging entrepreneurialism.

    I’m afraid it’s you who is caught up by “ideological prejudice” – you are closing your eyes to the unanswerable demands of good governance.

  12. Gosh, no, the point being that if the relief was (as you say) £2.3 Billion higher than expected, then the additional unforeseen realisations that year were 2.3/(.28-.1) = approx £13 Billion of extra unexpected realisations from sales of startups in just that one year. (and if, to respond to your challenge, it were £500 billion, then the new realisations would have been £2.7 trillion!) The difficulty being in estimating how many new jobs, PAYE taxes etc were created from this — ‘unaswerable’, as you put it– but just looking at those numbers, seems like a more or less unanswerable good bargain to me. But as I say, I and you can’t prove it either way –you are just setting up a straw man in arguing that the tax relief shouldn’t happen because the ‘unanswerable demands of good governance’, whatever those are, remain unanswered. We can see that it logically makes sense that the tax relief would work; the outcome relative to expected says it did work; there are, as you say, other incentives too (but not really to the entrepreneur –EIS etc are more to encourage investors), so again it is a sticky situation to untangle and analyse, but why would that mean that something that makes sense, and seems to work, should be (it does seem from this side) sacrificed on the altar of socialist ideology?

    I did try to explain this in my original post but I didn’t realise I needed to spell the math out. But having seen this clearer explanation, I do hope you will see mine is not written from an ideological viewpoint, but rather merely from the view of some poor joe who has to bring entrepreneurs and investors together to start the businesses up that make the economy grow. If it doesn’t work, I’m out of a job. I think I have the right, particularly given I try to argue the logic, to be given the benefit of the doubt there! ;o)

  13. Entrepreneur’s Relief does help to focus managers on equity value, but they are still incentivised to do this if the tax rate is 28%. So the relief acts at least in part as a financial reward for behaviour that would have occurred anyway.

    Any assessment of the value we get from the relief would need to try to take this into account. Of course that’s not simple to do but that doesn’t mean we shouldn’t try.

  14. As usual, a thought-provoking blog, Jolyon, even if I don’t agree with all that is set out.

    I am only going to comment on one point: “Entrepreneur’s Relief … was forecast to cost £0.475bn in 2007-08 but in 2013-14 cost £2.77bn – an increase of more than 500% but …“No detailed analysis carried out to explain the increase””.

    Firstly, ER only applied from 2008-09 so the £0.475bn forecast figure (let alone the actual figure) must have related to CGT taper relief. Secondly, a detailed analysis is probably not required, at least to begin with, when we know that the lifetime limit was increased three times (£1m to £2m prior to 23 June 2010, £2m to £5m prior to April 2011, and £10m thereafter). I make this an increase of 900%, and all brought in when the economy surely was in a weaker position than now.

    I haven’t read as widely as you on tax / economic data but shouldn’t one question be, rather than ER ‘costing’ an increase of 483%, why the increase in the lifetime limit has not produced an equivalent increase in CGT collected (assuming forecasts are compared with actual figures) and what, if anything, should be done to ensure this takes place. My experience of advising clients, and I presume it accords with the rationale of increasing the lifetime limit although I only have anecdotal rather than empirical evidence, is that it did encourage entrepreneurs to grow their businesses rather than selling out too quickly. Many have gone on to (re-)invest in EIS / SEIS / VCT companies thereby encouraging further economic growth (having sufficient post-tax cash for their own requirements) whereas a higher tax rate would make many people (I do not define them as serial entrepreneurs as most of them only start / grow / sell one or two businesses in their lifetime) simply use the post-tax cash for their own needs rather than re-investing elsewhere.

  15. “If indeed the amount forgone due to entrepreneur’s relief has shot up, that means that realisations (amounts received by entrepreneurs selling their businesses) have shot up! ”

    Correct, with one important clarification: how do YOU define entrepreneur, and is that the same as how the legislation defines it?

    The context of your post is that the being an entrepreneur is hard and capital intensive, but important because entrepreneurship creates more jobs than existing companies. Which I think is an argument with merit.

    However, consider the following case study example: Company A is a medium sized company. It gets bought out by a private equity fund. The new owners want to make the company more profitable, so they cut a third of the jobs and reorganise. To incentivise management to push the reforms through, they offer management an equity stake in the business.

    Do you think these managers should qualify for entrepreneurs’ relief, even though their pay is a reward for successfully cutting jobs? Because they often do.

    How about the private equity fund manager? They don’t actually put any money in at all – that all comes from investors and banks. Should their fee qualify for a 10% tax rate? Because it often does.

    I can’t prove how much of the extra 2 billion in cost comes from these types of arrangements, but I’m sure it’s most of it. The Government probably expected the relief to apply to “true” entrepreneurs, under the meaning you set out. But in practice, loads of non-entrepreneurs jumped in.

    BTW, generally entrepreneurs can’t move to Monaco before selling, mainly because they are running their UK business at that point! It doesn’t lend itself to leaving the country just at the most critical point.

  16. Thank you for your nice words Andy. And I should say straight out that I too am uneasy if a Private Equity company plays “pass the parcel” with an acquisition, cutting costs to improve short term performance and then selling it on. But from my own observation, those days are mostly over –acquirers are no longer fooled by that sort of thing,

    1. I can’t point to the details offhand, but there is a well known study showing that Private Equity-owned companies grow their business more than do Publicly owned companies, and cut jobs less (/grow jobs more). While it is true that the largest companies tend to cut costs by amalgamating and firing people (not necessarily a bad thing if you put it in a Schumpeterian context, but growing jobs is always preferable!), it is a caricature of capitalism to imply that “most of it” is about asset stripping, cutting costs and firing people. if that were the case, how could the economy of the world have grown so much over the past two centuries? (Read Deidre McCloskey for a convincing critique of that claim).

    2. I don’t think that Private Equity fund managers qualify for entrepreneurs’ relief, but I’m not an expert. In any case it’s not what I’m talking about and when you assert, about whether that is true or not, “it often does” (hmmm) and then jump straight to saying “I’m sure it [“these type of arrangements”]’s most of it” –ie that most is a tax fiddle not proper entrepreneurs’ relief– I wonder whether in that, too, there is not a tiny flash of ideological petticoats because it’s not at all my experience.

    3. In any case even if that were true (I don’t think it is) what matter? SOMEHOW there has been a major increase in successful Venture capital realisations. So: more jobs! A bigger economy! More employment taxes! What’s not to like??



    PS. I’m afraid you underestimate Man’s ingenuity in seeking to keep the rewards of their labours from the taxman if you think that “entrepreneurs can’t move to Monaco” when they are selling their business. And with the boot on a different tax foot, why do you think that so many Swedish billionaires live in the UK? Ask Philip Green how easy it is to run things from Monaco. . . . .

  17. OK, so I was looking at the same list.

    You are questioning whether the government needs to “spend” all of that money on those reliefs (or, equivalently, not demand that money from taxpayers). The point I was trying to make is that most of the £100 billion or so is accounted for in just four areas.

    No doubt a case could be made for yet further restrictions on pension tax reliefs, or abolishing tax-favoured savings, or taxing capital gains on dwellings above a generous threshold (say £2m, although beware fiscal drag), or applying 20% VAT to food. But are you really advocating any of them? So, which of them do you want to cut, and by how much? Or are we only talking about the remaining £16 billion of “tax expenditures”?

  18. I am talking – as will be abundantly clear to a reader of the post – about the need to assess whether tax expenditures deliver value for money. I am not advancing a positive case for the abolition of any of them.

  19. It is clearly a good idea to look at VfM. But in the case of say the 4 big areas identified above. I think there are two significant problems.
    The first is the criteria used to calculate VfM, especially in using metrics and measures that are comparable across say £1 of relief on energy with £1 of relief on pensions.
    The second, and linked problem, is that if these reliefs represent political choices it is harder to use VfM as a measure. Party A may have an ideological commitment to certain views that lead them to score VfM in ways that differ from say the IFS, or Party B. I’m not sure if our political process gives VfM a lot of weight in assessing decisions on policies.
    Maybe it should.

  20. I probably shouldn’t have been as flippant as I was on private equity. I didn’t really mean it that way.

    PE does add value to companies, absolutely. I was highlighting that sometimes that value comes from commercial growth and sometimes it comes from reducing inefficiencies, and my point was that both qualify for entrepreneurs’ relief. Applying your perfectly reasonable justification for the relief, only the first kind qualifies; yet we are giving it to the second kind equally.

    Regarding the other stuff – It’s bad form to assert something without being able to provide evidence, but here I must: UK private equity could easily get ER if they wanted it (you just stick the guy in question on the board and give him at least 5% of the shareholder votes). Similarly management can be easily incentivised by awarding them shares that qualify for the relief. And the PE houses do the management thing on every single deal they can, because it’s just good financial sense.

    I’m sure Jolyon will be able to back me up on that.

    And the important point is there’s no evidence that that any deal happened because of the relief (i’ve never heard of one that did), and it’s not consistent with how private equity works i..e they raise the money first, and then go out and spend it. The money is almost always going to be spent on something. Decisions on how to incentivise management are almost always made after the decision to buy has already been made.

    Re: Monaco – If you have a 10 billion pound business, you can run it from anywhere; if you have a 10 million pound business, you need to be local. Entrepreneurs relief is about the 10 million pound business, not the billionaires.

  21. Just on this point “entrepreneurs pay 28% cgt”, I’m reminded of Nigel Lawson, who had the excellent idea of equalising top rates of CGT and income tax – at 40%, but the level is not the point. Immediately a whole industry built round rebadging income as capital gains disappeared.

    Some years later the misguided Gordon Brown, having listened too much to special pleaders badged as heroic entrepreneurs, introduced a special 10% CGT for assets held over some period of years – it’s what led in due course to Sir Ronald Cohen’s embarrassment at paying less tax than his cleaner. At the time I was working for a large fund management company, who immediately came out with the marketing material for a fund to exploit the opportunity. I keep the coffee mug as a souvenir, and it is in front of me right now.

    The problem about special pleading for entrepreneurs is that it requires the state to decide who is an entrepreneur, which reveals such special pleading as yet another example trying to use state power as a means of enrichment, rather than delivering products and services to the benefit of consumers, which is what real entrepreneurs do.

  22. Perhaps an explanation for the vast rise in ER lies with the promoters of tax avoidance schemes availing of the opportunities afforded by the ER regieme?

  23. Private equity executives don’t qualify for ER. To assert otherwise is either total ignorance of the rules or a deliberate lie.

  24. I love the way wealthy people can donate to their children’s private school and the taxpayer foots a large chunk of the bill through Gift Aid and higher tax relief.

  25. I’ll throw a little point into the mix here.

    I was recently approached by an adviser of a well known accounting firm who wanted to discuss a plan (his?) whereby his client could effectively use the relief in order to remove accumulated profits from his business at an effective 10% tax rate. The client was not interested in paying 10% on actually selling the business at the end of it and his natural cycle and saw ER as a way of extracting cash cheaply. Would HMRC see this as aggressive and challenge it?

    I was tempted to say “yes”, but having read this and just how little HMRC may understand about how the relief is used, perhaps the plan has better chances than I thought.

    Therefore Mr Keane above may well have nailed a fair chunk of the £2.77bn?

  26. Pingback: Who benefits from tax expenditures? | Waiting for Godot

  27. I love that too.

  28. ive no idea why you are all banging on about ER. Have none of you heard of ESS – thats where the real outrage should be directed. The first big gains triggered under ER will cause public outrage, that I am sure.

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  31. I can’t think of a more lame and feeble criticism of someone else’s political view than describing it as “ideological”. It’s an old chestnut, not to say an old turkey.

    You are motivated by ideology. I on the other hand am principled.

    Come off it Jolyon!

  32. Hang on! I think you protest a little much! You’re reading it pejoratively. I’m simply saying that it’s about an ideology that the state should be smaller.

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