Netting off tax and benefits

On Sunday I wrote about how the tax system, examined as a whole, isn’t nearly as progressive as George Osborne suggests. It’s regressive, in fact.

I gave the Office for National Statistics numbers for ‘quintiles’ – the lowest to highest earning fifths – of households. But here’s a chart for deciles which makes the point even more strikingly.

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These are ONS numbers – taken from here – and they give tax as a percentage of the total of earned income and cash benefits.

The main culprit is Council Tax which – even after ‘Council tax support’ – consumes 9% of the total for the First 10% but only 1.5% of the income for the Top 10%. Every time – as with, for example, the Social Care Precept – Government chooses to fund spending through Council Tax you should be outraged. It is willfully choosing to dump those costs on the poorest because to do so is politically expedient. Collectively we understand but poorly the distributional effects of raising Council Tax. This enables Government to do what it should not without political cost.

But alongside the regressive nature of our tax system there is a related debate to be had about benefits.

Does it matter that the poor are disproportionately taxed if they disproportionately benefit from the benefits taxes fund? Is it the net effect of taxes paid and benefits received that one should analyse?

Of course, this is not what Osborne sought to do. The currency of political debate is ‘who bears the burden of taxation’. That political debate readily assumes, and often in ugly language (see this reference to “scroungers“), that the poor are beneficiaries of a burden borne by others.

But there is also a discrete, economic, debate.

This debate is also informed by ONS figures. Here are their absolute numbers for cash and other benefits in kind received directly from Government (see Table 14).

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The explanation for these numbers lies, in particular, in the universality of the state pension; the fact that all deciles are substantial consumers of education and (in particular) the NHS; and the fact that the rail subsidy is disproportionately enjoyed by the rich.

Of course, looked at as a percentage of income rather than in absolute terms, the poorer deciles benefit more than this chart reveals. But in absolute terms the differences in the extent to which the deciles benefit directly from Government are far less profound than you may expect.

I use this phrase “directly from Government” quite deliberately. The ONS figures capture those benefits we receive directly. But they do not capture those benefits we receive indirectly. They do not capture the extent to which the wealthy benefit from the infrastructure that enables income to be generated and wealth to be protected.

If we analyse who are the big beneficiaries of that infrastructure – of the legal system that enables income to be generated and protects property rights, of the police and army that secure our wealth from confiscation by acquisitive forces, of all the complex systems that Government provides and sustains and which enable us to earn our incomes – it is self-evidently the wealthy and high earners who benefit most.

Is there some argument that requires that we have regard to the direct benefits our tax system funds – but that we ignore the indirect benefits? If there is, I do not see it.

Of course, we should all benefit – as economic agents and as moral beings – from the social compact to which we, willingly or unwillingly, subscribe. We are, as George Osborne observed in the quote with which I began this discussion, “in it together.” True, we benefit differently. But we must each contribute according to our means.

Postscript:

Here’s Andrew Jackson’s chart (see ‘Comments’below) of net direct contributions (I have re-titled his chart but the data is his).

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Andrew adds:

“At first glance it looks very odd that the negative bars are so much bigger than the positive even though the total is 1%, but of course the negatives are percentages of much smaller numbers so this is to be expected.

“The other odd thing is that it comes down to only 1% difference, implying personal tax and benefits are largely breaking even; presumably other taxes cover all other spending.  Although with council tax in there but local services excluded, that is also odd. In fact, the more you look at this the more you realise what is not included, at least in the way of benefits… but it’s a start.”

The wealthy and the tax burden

Here’s what George Osborne said in his Budget speech:

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Income tax represents almost 32% of all the tax we receive so this is a not insignificant statistic. But is it right?

It is, in fact, very wrong indeed. It would be more accurate to say that the highest earning half a percent pay 28% of all the income tax we receive. But it’s important we understand why this is. And what it tells us about whether we really are “all in it together”.

A high proportion of income tax revenue being paid by a small proportion of earners might be because we have a progressive tax system. Or it might be because we have income inequality. Either would deliver this result. But only one of them would be thought a positive political achievement.

Our system for taxing income is not nearly as progressive as you might think.

On income over £10,600, you will pay tax – including National Insurance Contributions – of 32%. On income over £42,385 you pay tax of 42% and on income over £150,000 you pay tax on income of 47%. But tax on income – excluding National Insurance Contributions – is more progressive.

George Osborne gave us the figure for income tax. Because it is our most progressive tax it overstates both the proportion of tax paid by high earners and the proportion of tax on income paid by high earners.

What about the alternative, income inequality?

From 2010-11 to 2015-16, the number of people earning more than £500,000 grew 44% from 32,000 to 46,000. And the number earning more than £2m per annum grew by around 500%. But this (it should be noted) only returned us to roughly pre-financial crisis levels.

And it wasn’t merely the number of high earners who increased – but also the amounts they earned. The amount earned by the average earner in that £500,000 plus bracket increased 16% from £1.122m in 2010-11 to £1.3m in 2015-16. By way of rough comparison, average weekly earnings grew from January 2011 to January 2016 by about 7%.

What about the tax paid by the average earner in that £500,000 plus bracket? It increased too (from £472,000 in 2010/11 to 514,000 in 2015/16) but only by 8.9%, much less than the increase in earnings. This is, of course, because of the cut in the top rate of tax from 50% to 45%.

So both are contributors.

One final point.

If you want to understand how progressive our tax system is, you really should look at it as a whole rather than focusing (as Osborne did) only on its most progressive element (income tax).

Looked at as a whole, the lowest earning 20% of households is the most highly taxed. That 20% pays 38% of its cash income – including benefits – in taxes. The second ‘quintile’ pays 30% then 33% for the third, 33% for the fourth and 35% for the top 20% (see Table 1 here).

This is because pretty much all of our other taxes are regressive. Big shout out to Council Tax which – even after Council Tax Support – consumes 5.8% of the cash income of the lowest earning 20% of households but only 1.8% of that of the highest earning.

If the Conservatives really did want a more progressive tax system they could start with that.

Coming Unstuck

The Chancellor’s plans to eliminate the deficit were always going to come unstuck.

Do not fear. I do not blog to advertise my lack of knowledge of macro-economics. Why would I, when that market is already so crowded?

I do not blog today on the effects of cutting public spending on growth. Nor, although previously I have elsewhere, do I mean to point to the consequences of Osborne’s decision to narrow our tax base. Nor, although I will, his relentless focus on cutting tax for corporations – beyond our G20 peers, beyond that which influences their investment decisions, beyond even that which they ask for. Nor, although it is something the OBR has persistently pointed to, will I point to the fact that Osborne’s deficit reduction plans rely in good part on asset sales rather than balancing income and expenditure.

No, the reason why Osborne’s plans were always going to come unstuck is a function of simple arithmetic.

Assume my spending remains constant at 100. To fund that spending I must have receipts, every year, of 100. Over five years to fund spending of 500 I must have income of 500. That five years is important because it’s the time horizon over which we plan our nation’s spending.

If my income is not 100 a year but 85, I have a problem. You might think, and rightly so, that I am 15 short. This Government has been 15 short.

What it has done, to hide that truth, is accelerate a whole bunch of 15s from later years into earlier years to hide the shortfall. Which is fine in earlier years – your budget looks balanced – but it leaves you in those later years with a shortfall of 30: the 15 you had anyway and the further shortfall consequential on you taking 15 from those later years for use in earlier years. Instead of having 85 you’ll only have 70. It’s not that complicated: if you spend tomorrow’s money today, you won’t have it tomorrow.

For a number of years, this is what we’ve been doing. On an extraordinary scale. Did you see those italics? Good, because I’m going to come back to them. And we’re now looking at a whole bunch of 70s.

You don’t believe me? Let me give you some examples. I don’t need to go back too far to justify those italics.

I’ll start with the Autumn Statement 2013. The Chancellor announced “follower notice” provisions which brought into earlier years £670m of receipts from tax avoidance cases that were expected to be won in later years. In Budget 2014, the Government dramatically extended the scope of the follower notice provisions with some “accelerated payment notice” provisions that moved a further £3.9bn from later into earlier years. A few points about these sums: of course, they moved money from later years into earlier years. But they also treated “possible” wins as certain. And they treated one off sums – resulting from a huge stockpile of tax avoidance litigation – as ongoing income.

But Budget 2014 didn’t pull this trick once. It pulled it twice.

Government knew that if you released pensioners from the obligation to buy an annuity from their pension funds and allowed them instead to withdraw cash lump sums they would. And when they did, income tax that would otherwise have been paid later on that annuity would instead be paid earlier, on the cash lump sum. Government would get the tax in the cash withdrawal year – but it wouldn’t get it in the later annuity years.

What was styled ‘pension freedom’ brought £3.05bn from later years into earlier years.

On to that year’s Autumn Statement. If we make a profit in tax year one but have made earlier losses, we can set those earlier losses against the tax year one profit and avoid paying corporation tax in tax year one. Government decided it wouldn’t let banks deduct their earlier losses against all of their tax year one profits: instead it would only let them deduct earlier losses against half of those tax year one profits. This would increase the Government’s take in tax year one but would also, of course, mean that in future tax years banks would have more losses available – because they wouldn’t have been set against tax year one profits. The result would be to increase the tax paid in earlier years and reduce it in later years.

By this mechanic, the Government brought from later years into earlier years the sum of £3.48bn.

In the March Budget of 2015 Government addressed its mind to those who’d already bought annuities. If we allowed them to sell those annuities, the same thing would happen as those who had yet to buy annuities. Those selling them would be in a position to make cash withdrawals giving rise to a tax liability now – rather than a later tax liability on payments under the annuities. This extension of pension freedom dragged a further £820m from later to earlier years. There was also an extension of the accelerated payments regime dragging in a further £550m from later into earlier years.

This all continued after the election. In the Summer Budget 2015 Government advanced the date at which big corporations had to pay their corporation tax. This brought an extra £7.83bn into earlier years. It wasn’t lost from later years – but it was a one off boost which made it look as though we had an extra £7.83bn of ongoing receipts.

In the Autumn Statement 2015 we repeated the ‘advancing the tax receipts’ mechanic, but this time for capital gains tax on residential properties, bringing into earlier years a one-off boost of £1.16bn.

And in last week’s Budget 2016 Government extended the Autumn Statement 2014 restriction on loss reliefs for banks and other companies, bring from later years into earlier years a further £3.36bn.

This isn’t over – the Making Tax Digital project will create an enormous one off boost – quite possibly in the tens of billions of pounds – to public finances in earlier years. This boost will flatter the real condition of public finances but won’t alter the underlying reality.

Even ignoring the Making Tax Digital boost, and only looking back to the Autumn Statement 2013, this combination of measures has brought £24.82bn into receipt for the five year timescale of earlier years. Much of this sum represents a one off boost; much of it will worsen the state of public finances in later years; none of it is repeatable; and all of it is matched against on-going expenditure.

And those later years? We’re looking at them now.

Be afraid.

Discriminating against the State

One of the odder measures in today’s Budget is this (from George Osborne’s speech)

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In principle, it is welcome.

I explained here that self-employed workers are favourably treated for tax purposes, that a worker’s status as self-employment delivers very valuable benefits to her engager, and that personal service companies are abused to denude the Government of much needed tax revenues and workers of valuable employment law rights.

This measure carries a predicted yield of £555m over the life of the Parliament and appears to be exactly the measure I argued for here.

The curiosity is why it is confined to public sector employers?

George Osborne gives us no clue. Nor does the Office for Budget Responsibility’s Economic and fiscal outlook. The closest we get is in the Red Book:

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But this reasoning is not particular to the public sector. Everyone, surely, has a responsibility to ensure that the people working for them are paying the right tax?

The abuse is far from public-sector specific. Indeed I argued here that the private sector is the environment in which the behaviour has its most destructive impacts – of distorting competition and destroying ‘good’ businesses. And the types of environment in which it is most likely to be seen are in the private sector:

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This Select Committee report, too, suggests that personal service companies are most often used in the private sector. And Government has already tackled public sector abuse through this Procurement Policy Note.

But of course, everything has a reason.

What we do know is that it will put the public sector at a competitive disadvantage compared with the private sector. It will be difficult for public sector organisations to engage workers on a self-employed basis: they will bear the risk of getting wrong the assessment that a worker is self-employed. They will be driven to engage workers on an employed basis to avoid that risk – and this will increase their wage bill by up to 13.8%. The private sector will continue to be able to transfer that risk to the worker – or his personal service company. The private sector will, in effect, be able to buy the same worker for 13.8% less.

Why might this result be desired?

I can think of only one explanation.

Were you wanting to shrink the State; to force more outsourcing; to pass public money to big outsourcing companies… you might tilt the playing field. You might do this.

 

 

 

The future of tax avoidance

We don’t know much about tax avoidance. Not how much it costs us. Nor how to stop it. We barely know what it is. But we’re pretty sure we don’t like it. And we now know – thanks to Deutsche Bank and UBS – that the Supreme Court doesn’t either.

Last week’s decision concerned a scheme dating back to the early 2000s. Glory days for tax advisers who found, come bonus round, a willing buyer in every board room in City. The Deutsche Bank and UBS arrangements were variants on a scheme that lasted a number of years. You’d line up willing – and few weren’t – participants. To them you would deliver, instead of a cash bonus, shares in a cashbox company. It would declare a dividend in the amount of the cash bonus. Employees would pay a lower rate of tax – or even none at all.  And there’d be a nice little NICs saving for you too.

We barely noticed, prior to 2008, this stuff. And when we did we didn’t care. But true to history – which tells us tax avoidance is the most reliably pro-cyclical industry of all – this all changed with the financial crisis. Who could we find to blame? Whose shoulders might bear the burden? From whose had it, well, slipped a little?

We soon found out.

That our judges sit aloof from the winds of public opinion is an article of public faith. But the faith of tax lawyers quickly lapsed. Points that, before the financial crisis, HMRC lawyers had regarded as so hopeless as not even to bother to argue acquired, a mere few years later, the fixed status of orthodoxy.

The speed of this process caused concern in the legal community. Government appointed a ‘study group’ to help it decide whether to adopt a General Anti Abuse Rule to tackle tax avoidance. That group included, amongst others, a retired Law Lord and a serving High Court judge. It agreed, unanimously, that when confronted with avoidance judges adopted a “stretched interpretation” to the law. And quite how stretched depended on how much her or she disapproved of the transaction before her.

The GAAR was to solve all of this by giving judges an objective legal framework within which they might articulate their instinct to fairness. But it’s now been on the statute books for almost three years and a judge has yet to have the chance to use it. So the judicial activism continues.

Both Deutsche Bank and UBS had enjoyed success in the lower courts. Judges had not been able to find in the language of the legislation an intention that the bonuses should be taxed as HMRC contended.

But you didn’t need to read further than the first paragraph of the Supreme Court decision to know that this time would be different. When judges start the conversation with talk of the “sophisticated attempts of the Houdini taxpayer to escape from the manacles of tax” it’s rarely as a precursor to offering the tax freedom our would-be Houdini desires. It found that the result contended for by the banks would be “positively contrary to rationality, bearing in mind the general aims of income tax statutes” and dismissed their arguments.

A thrilling denouement to the story of tax planning. Few politicians intend that the highly paid should be able to apply the expensive emollient of good tax advice to slip the shackles of taxation. Not least because the British public, unlike those who flocked to Houdini, tend not to applaud when they do.

But is an extra set of judicial leg-irons really a good thing?

Yes – if your mind’s eye sees a judge who wears a blindfold and balances the scales with an invariable thoughtfulness and care. But there are reasons to be cautious too. There are times when we genuinely don’t know whether a transaction is “avoidance”. And if the reality does look like that subscribed to by the GAAR study group – judges applying a personalised sniff test – our tax system could come to deliver a little less than law and, sometimes, only a little more than popular opinion.

The UK’s tax competitiveness

Here’s what the FT reported this morning:

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Ouch. That doesn’t sound so good. More tax cuts for multinationals must be the answer, right?

That’s what you’d think from the responses from Government:

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But is that really what the KPMG ‘league tables’ show? Do we really need “further improvements” (for them, that is. You and I would probably describe it as collecting even less tax from multinationals)?

Here’s the KPMG Survey. It has lots and lots of questions comparing our ‘tax competitiveness’ with that of other nations. And business is asked over and again what would help our ‘tax competitiveness’. And they have lots of suggestions which result, unsurprisingly, in them paying less tax.

But when I take my three daughters into an ice-cream parlour and ask them whether they’d like ice-cream they tend to say yes. There’s not a single question in the KPMG report which seeks to assesses whether those tax breaks are in any way decisive of a decision to invest here or not.

This is close as the reports gets:

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You’ll note the tiny sample size. You’ll also note that “high influence” is counted together with “some influence (and is not disaggregated). It could perfectly well be – indeed I would guess – that the number saying it has “high influence” is lower than the number saying it has “no influence.”

You don’t believe me? Well, here’s what the selfsame KPMG survey showed in 2014 (where they did disaggregate ‘high’ and ‘some’):

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In 2013, the number saying the tax regime has “no influence” on where they located their activities was a staggering 350% of the number saying “high influence”.

And the report contains no analysis at all of the costs and the benefits for us as a nation of cutting the tax burden on business.

You see, at 20% we already have a corporation tax rate which is by far the lowest in the G7 and the joint lowest in the G20. Those other G20 nations with a 20 per cent rate? Russia, Saudi Arabia and Turkey. And are there really businesses contemplating setting up in Saudi Arabia who might be induced to set up here instead with a 2 per cent cut in corporation tax?

Nine years ago the rate of Corporation Tax was 30 per cent; today it is 20 per cent. In his 2015 Budget Osborne announced plans to cut it further to 18 per cent. That cut alone will cost £2.5bn in its first year. And that’s not my number, by the way. It’s HM Treasury’s own number – you can read it at Table 2.1 here. So “tax attractiveness” carries a very meaningful cost.

And the effect on Foreign Direct Investment in the UK – not the only measure of success, granted, but perhaps the one most applicable to the KPMG survey? Here’s the ONS’s chart.

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In 2005, our rate of corporation tax was 30%. As it was in 2007.

You might think the KPMG report is a naked pitch for business to pay less tax. Dressed nicely for dinner, for sure, the better to be able to engage policy-makers and the electorate. And journalists. But still, just a pitch.

What do we actually get for foregoing the tax revenue – the “further improvements” described by Treasury? The effects of the greater “tax attractiveness” described by KPMG? And is it worth it?

We have no idea.

 

David Cameron and Corporation Tax Receipts

Here’s what David Cameron said at PMQs this afternoon:

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But is this true? Or, like George Osborne’s claim on income tax receipts last week, is its relationship with the truth a fleeting one?

The General Election in 2010 was on 6 May 2010 – a month into the 2010/11 tax year.

Our corporation tax receipts in the 2010/11 tax year – according to HMRC’s own figures (page 8) – were £43.040bn. In the year 2014/15 – the last year for which figures are available – they are £43.005bn.

That’s not a 20% rise. It’s a small fall.

Of course, it’s worse than that because since 2010/11 the economy has grown modestly, tax receipts generally have grown, and there has been modest inflation. Yet corporation tax receipts have still fallen. This is exactly as HM Treasury predicted as it attributed significant costs to these cuts – £2.475bn in the year 2020-21 alone for the cut to 18% made in the Summer Budget.

Perhaps there’s an explanation. But I can’t see it.

Postscript: Iain Campbell points out that in 2009/10 receipts were (at £36.628bn) a sum a 20% increase to which gives you that recorded in 2014/15. If that is the ‘explanation’, Cameron is taking ‘credit’ for policies that Labour introduced: the first cut to Corporation Tax under the Coalition took place with effect from the 2011/12 tax year. It also invites the observation that in 2008/09 corporation tax receipts were £43.927bn: materially higher than now they are even in cash terms.