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.

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.

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?

NOTE:

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).

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

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.

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.

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’.

Road-testing my brave new world with a guest blog from Richard Murphy is a great way to flush out the bits of this project I have not thought through thought through insufficiently. One of the less attractive aspects of the tax debate – and I have touched upon it here – is how intelligent and thoughtful commentators so readily move from enthusiastic disagreement with one another’s views to enthusiastic criticism of one another’s personal qualities. This tendency does not illuminate discussions of policy issues: indeed, it makes sensible debate harder.

But what to do?

I could simply reject comments that attack the author – but that would be a pity because those comments often also contain intelligent points alongside the ad hominem attacks.

I could assume that such is a normal and healthy function of politically charged debate. But I don’t think it is.

Or I could edit the comment to remove the personal criticisms (excepting the unusual situation where the attack is clearly relevant to an assessment of the point made by the commentator).

I’m inclined to do the latter and to indicate with the words “[edited]” that I have done so. But I’d be very grateful for your views?

A further question is what to do about anonymous posters. These I am inclined to allow because there will be many – those engaged by large professional services firms or Govt departments – who will otherwise be unable to participate. But, again, what do you think?

By Richard Murphy FCA of Tax Research UK

When Jolyon asked me to contribute to a discussion in tax and self-employment I reflected on two things. The first is my own experience as a self-employed person, which given my own temperament was probably the only real option ever available to me. The second was the advice I have given to many hundreds (if not more) clients over many years on these two related issues. The result was that I realised, first, that the decision to be self employed has, in many cases, no relationship to tax at all. And, second, that because of the real number of variables involved in the tax decision making process when it comes to self-employment questions anyone who suggests that rational, tax based, decisions are taken is, at best deluding themselves either before the event (if they’re a professional adviser with a more expensive product to sell) or after the event if, by chance, savings worked out as hoped.

What the aim of this blog is, then, is to show just how many variables there really are in this decision process and to show how irrational it is to focus upon any of them for the vast majority of people (98% +) who earn less than £100,000 or so of taxable income each year (i.e. those for whom a focus on increasing net income might be of significantly greater use). In the process I also show that almost no Laffer effect could be reliably predicted for those with the option of self employment earning below £150,000 whilst those earning above that sum in reality face a choice of varying flat rates of tax, making Laffer implications impossible to measure independently of any choice on rate substitution, which is likely to have much bigger impact.

If it gets a bit technical on the way I don’t apologise. What I do instead suggest is that it really is time that we had professional advisers in this country who helped businesses make more and create more wealth instead of concentrating on a spurious goal of tax minimisation (which is, as I show, itself meaningless because what it means varies at different income levels, some of which will only be known well after the time when decisions need to be made). In other words, a debate about self employment and tax makes sense, but only in the context of considering all the variables that might be relevant in the equation that relates the issues. And by equation, I mean equation.

There are, of course, issues relating to the tax differentials between the two bases for taxing the income of people in the UK that might have impact on an individual’s tax decision making and on national tax yield but this is not, I suggest, a binary choice of either / or employed versus self employed status.

Firstly because this is not the only choice available: there is also the option of incorporating as an alternative mechanism for running a business which in turn gives rise to at least three alternative tax rates, being those on corporate retained income, corporate distributed income via dividends and corporate distributed income via salary, and these three options are all stated before the potential to divert income to others (not considered further here, but a very real factor in much tax planning at the point where it very definitely interfaces with tax avoidance) comes into play.

Secondly, tax payments and so yields are not just impacted by tax rates. The interaction between income and state social security payments, both taxed and untaxed, also has an impact on effective tax rates, whilst the capacity of the taxpayer to save in tax enhanced ways (ISAs, pensions, VCTs, etc) has to be taken into account, as too does the capacity of the chosen mechanism for declaring income to facilitate tax evasion, the offset of expenses incurred in relation to work related activity and even the opportunity for recategorising income as gains need to be taken into account.

Do all this and something like the following, simplified, equations, come into operation when considering effective tax rates, assuming that:

B = Tax base
P = Non-discretionary allowances
U = Untaxed social security payments
W = Taxed social security benefits in period
A = Discretionary allowances
V = Evaded
X = Expenses
S = Tax relieved savings in period
G = Capital gains
R1 = Employed tax rate
R2 = Self employed tax rate
R3 = Corporate savings rate
R4 = Distributed corporate tax rate
R5 = IR35 tax rate
Z = Capital gains tax rate
T = Tax paid
F = Effective tax rate
Y = Gross pre tax income
F = Effective tax rate
N = Net income

After which it follows that

T = (B-A-V-X-G)Rn + GZ

Where n = 1 to 5

And B = Y – P – U

And A = S – W

And F = T / Y

And N = Y – T

The question that then needs to be asked is what a person’s objectives might be in the above equations, and whether or not that objective remains consistent at all points in the income cycle or for all people at any point in that cycle.

It is also important to note that given the extensive range of variables and rates noted (even assuming national insurance and income tax rates are merged) and that the tax rate R is in in many (but not all) cases not an independent variable in this equation as it varies with the outcome of the expression (B-A-V-X-G), then the variables prioritised for ex ante decision making will almost certainly represent estimated data at the time a decision is taken since in practice in a real world situation the value of many (but not all) variables will only be known after decisions on tax status (even assuming that is unchallenged) have been made. It has to be stressed therefore that real world optimisation of any chosen outcome in this equation is nigh on impossible. Wise people should, and would, recognise this fact.

Despite this a rational economist  (a term not necessarily synonymous with a wise person) would say that the decision a person should make is to maximise N, which is net income. But economists do not understand human beings, and many real people will for wholly rational reasons not do this, because they have other intellectual and emotional objectives (see The Courageous State) or simply do not prioritise income as the most important thing in life, and so income maximisation is not just a constrained opportunity for some (which it can be for others), it can also not be a choice in the sense that a person simply satisfices in this area.

In that case can it be assumed that another objective (either tax minimisation, or tax rate minimisation or marginal tax rate minimisation, and all could be set as goals) make sense? Maybe, but probably only if you are an accountant, lawyer or large corporation so remote from normal human objectives and conflicting interests that such a proxy for rational behaviour is even considered a priority. That said, precisely because so few accountants and lawyers do have much idea how to maximise income, even if that was a client’s actual objective (and I never in my practising career heard a client say it was) I am quite sure those professional people do adopt one of these tax related proxies for rationality instead, in the process hoping to hide their inability to offer business advice or even listen to their client’s stated preferences.

However, this may be quite irrational behaviour on these professional people’s part. The evidence for the importance of any of these tax related goals is limited. Well over 80% of all people working in the UK choose to be employed even though this is likely to increase their tax rates (R1 is greater than R2 which is greater than R4, for example, almost invariably and across most income ranges) and reduce opportunities for evasion, expense deduction and conversion of income into lower taxed gains. Either all of these people are economically crazy or there is something else at play here.

Even when self-employment is chosen as an option the likelihood that a person will risk tax minimisation  (legally or illegally) is low. HMRC think that more than 40% of all self employed people under declare income on their tax returns. I believe, in addition, that the number making returns compared to those who should do so is significantly understated. But there still remain a substantial number who, nonetheless, do declare their income reasonably accurately whilst every year financial advisers suggest billions in available tax reliefs are not used by those who had opportunity to claim them. So even though tax advisers may think tax minimisation is a priority the reality is that the evidence does not support that fact.

This is not to say that tax does not impact on behaviour; it very clearly does. But, first of all, this evidence suggests that it may have relatively little impact on the decision to be self employed or not. In addition, the impact it may have might vary considerably depending on the values and priorities given to different variables in the equations noted at varying points in the income profile. So, for example, at some points the impact of the marginal tax rate (I could start expressing these variables mathematically but will resist the temptation to do so for risk of alienating most readers) will be very high. This might be especially true when there is a significant withdrawal of social security benefits (W). At other points this may arise because of the withdrawal of non-discretionary allowances (P). At other points the impact of rate substitution (R4 for R2, for example) might justify a reduction in net allowances (actually, in this case an increase in real costs with advisers, who do, I suggest, motivate much of this decision for that reason, by the way). And so on.

But with all these options, is the tax profession really able to advise rationally without either broadening its skill base or the adoption of bogus proxies for rationality (already noted). That is the first question?

The second question is whether we are in fact asking the right questions of tax design and our reaction to it when faced with all these options. That would have to be the subject of another blog. I suspect the answer is that at present we are simply failing to understand the real reasons for tax design when thinking on this issue. We are being blinkered in our focus on tax paid to the social dimensions of tax design.

And third, let me raise the question Jolyon Maugham has asked me to consider when writing this blog, which is where is Laffer in all this and, indeed, the issue of progressive taxation in all this? The only sensible answer I can give is, that to a very large degree, neither is anywhere to be seen at all. Firstly that is because much of the decision making that impacts the decisions noted has to be taken before facts, including income, are known. Therefore the impact of rates is assumed, and not known. Second it is because some residual factors, e.g. use of tax deductions for pensions can be used ex post to vary outcomes, and third, and most important, tax is just not that important to the vast majority of people, self employed or otherwise to go through all the necessary decision making processes (which might explain the appeal of evasion to some).

But perhaps, fourthly, and most importantly, over the income ranges where tax rates on earned income, however derived or recorded, vary significantly (i.e. at levels broadly speaking below £100,000 and definitely below £150,000) tax is not by a long way the most important factor in determining choice on employment versus self employment and so net income outcome. Work availability, career choice, social priorities, personal risk preference and a host of other factors will impact the decision much more significantly over this income range, not least because many within the income bracket of £150,000 or less will think they need most of their income to live on or to compulsorily save for a pension. Serious tax planning only happens at higher income brackets where more significant discretionary funds are available and in that case Laffer plays no effective part at all in the UK as rates are then flat, if albeit, substitutable (which is where planning comes into play, with most impact being the fact that R1 > R2 > R3, and this creates a regressive tax regime for many).

So what conclusion do I reach? There are several.

The first is that tax professionals over-emphasis the importance of tax to others.

The second is that tax optimisation, taking into consideration the variables I note (and there may well be others, but they only complicate matters further) requires, firstly, perfect knowledge of the future that none of us possess and secondly analytic ability to consider a a range of variables so complex most would not try to resolve the issue in any rational way.

Thirdly, in the face of these first two factors tax professionals try to sell pre-packaged solutions (e.g. incorporation as a route to national insurance minimisation) without ever being fully aware of its potential implications for the client whose interests they may not have properly noted. The chance that this is because such pre-packaged solutions enhance adviser income cannot be overlooked.

Fourth, if there is one variable designed, above all others to impact in N (net income) in the equations noted above it is Y (gross, pre taxed income) and it is time that the accountancy profession, in particular, reframed its thinking about how to help clients maximise this rather than minimise tax.

Fifth, if Laffer effects are so unlikely to be measurable in any scenario likely to be considered, why do we worry about them?

Sixth, given the substitutability of tax rates right across the income spectrum considered here (effectively from almost zero to infinity, if you wish) the chance that the Laffer effect will ever have impact at the rates available (bar short term shifting as seen with the 50p tax rate) is very low indeed, and to extrapolate from short term income shifting to long term behavioural impacts of tax is a step that no one should take.

Seventh, the impact of the integration of tax rates with tax spending (i.e. how rates are impacted by benefits and allowances and reliefs as well as indirect tax benefits of government spending) is always understated in a discussion of the sort I have attempted here. In reality tax and spend are part of an integrated whole process and not to be seen in isolation of each other.

Last, given all those factors, shouldn’t we realise that tax is not designed solely for revenue raising purposes but for any other social and economic reasons as well and that all we are looking at is the reaction to those various deliberate and often intended consequences of that design process with too limited a lens when we consider tax rates in isolation? Many people, from my experience, choose not to do so, thinking that tax is, as I said at the outset, of overstated importance in their decision making processes and that they really would prefer that their advisers take more nuanced approaches.