Taxation in the UK James Browne Senior Research Economist - - PowerPoint PPT Presentation

Taxation in the UK

James Browne

Senior Research Economist Institute for Fiscal Studies

Outline

• Overview of the UK tax system in historical, international and

theoretical contexts:

1. Level and composition of revenues 2. Structure of the major taxes 3. Economic aspects of the overall tax (and benefit) system: – Effect on the income distribution – Effect on work incentives – How close to an expenditure tax?

• References

– Survey of the tax system (more on 1 & 2) www.ifs.org.uk/bns/bn09.pdf – Adam, Browne and Heady (2010), chapter 1 of ‘Dimensions of Tax Design – The M irrlees Review’, available from http://www.ifs.org.uk/mirrleesreview/dimensions/ch1.pdf

The tax burden in the UK

30% 32% 34% 36% 38% 40% 42% 44% 46% 48% 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015

% of GDP Public sector total receipts Net taxes and SSCs

Source: HMT

Tax to GDP ratios

Taxes and social security contributions

0% 10% 20% 30% 40% 50% 60%

UK EU15 OECD USA Fra Ger Jap Swe Ire Aus Can Ita

1978 2006

Source: OECD

Breakdown of net taxes and NIC s, 2010-11

Source: HMT Income t e tax ax Nat ational al Ins nsuranc nce Cor

• rpor
• ration
• n t

tax Cap apital al t tax axes es Local al t tax axes es VAT Other er i indirec ect tax axes es

C

• mposition of revenues

Net taxes and NICs

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1978-79 1997-98 2010-11

Other indirect taxes VAT Other capital taxes Rates/Poll Tax/Council Tax Corporation tax National Insurance Income tax + CGT

Source: HMT

C

• mposition of revenues, 2006

Taxes and social security contributions

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

UK EU15 OECD USA Fra Ger Jap Swe Ire Aus Can Ita

Other taxes Other capital taxes Recurrent buildings taxes Corporation tax Other indirect taxes VAT / GST SSCs + payroll tax Income tax + CGT Source: OECD

Income tax schedule

For earned income, 2012 prices

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% £0 £25,000 £50,000 £75,000 £100,000 £125,000 £150,000 £175,000

Gross income Marginal income tax rate

1978-79 2012-13

C hanges to income tax structure

• Big reduction in top rates (83/98%  40%) between 1978 and

1988

– the start of an international trend – partly reversed in 2010 with 50% rate above £150,000, to be cut to 45% from next year – withdrawal of personal allowance above £100,000 creates small band where marginal income tax rate is 60%

• Reduction in basic rate (33%  20%)

– part of an international trend

• Large-scale fiscal drag

– some increase in no. of taxpayers – massive increase in no. of higher-rate taxpayers

Is this an optimal income tax system?

• M irrlees optimal tax systems tend to have U-shaped marginal rate

schedule

– High marginal tax rates at the bottom and top, lower in the middle – When we take steep benefit withdrawal rates at the bottom into account, do have broadly this pattern of marginal tax rates in the UK

• What about 60% marginal income tax rate at £100,000?
• Possible that optimal tax system has higher rate just below the

top than at the very top:

– Very high income individuals may be more responsive to marginal tax rates than those slightly lower down – M ay be relatively few people in this band compared to number above

• But unlikely that optimal schedule has ‘spikes’ in it like current UK

system

The income tax burden, 2007

For single worker at multiples of average full-time earnings

0% 5% 10% 15% 20% 25% 30% 35%

UK EU15 OECD USA Fra Ger Jap Swe Ire Aus Can Ita

Income tax as % of gross earnings

@ 167% of average earnings @ 100% of average earnings @ 67% of average earnings

Source: OECD

C hanges to treatment of families

• Shift from joint to independent taxation in 1990

– part of an international trend away from family taxation

• Abolition of additional tax allowances for married people and

those with children

• Shift towards providing support for children and low earners

through tax credits

National Insurance schedule

Combined employer and employee NICs, 2012 prices

£0 £50 £100 £150 £200 £250 £0 £100 £200 £300 £400 £500 £600 £700 £800 £900 £1,000 Weekly earnings Weekly NICs 1984-85 2012-13

C hanges to National Insurance

M ore like income tax:

• Abolition of ‘entry fee’
• Contributions now continue above the upper earnings limit
• Alignment of NI threshold with income tax personal allowance

between 2001 and 2008

• Upper earnings limit aligned with income tax higher rate threshold

since 2009

• Benefits in kind now subject to National Insurance
• Contributory principle undermined

S

• cial insurance and the contributory principle
• In Britain, National Insurance was traditionally closer to a

Beveridge system – flat rate payments gave entitlements to flat rate benefits when out of work etc

• Link between contributions and payments has become less

important over time, on both contributions and payments side

• Contrasts with Bismarckian system where insurance payments give

entitlements to benefits that replace previous earnings

• This tends to require higher tax rates, but despite this may have

smaller effect on work incentives

Total burden of income tax and NI

For single worker at multiples of average full-time earnings

0% 10% 20% 30% 40% 50% 60%

UK EU15 OECD USA Fra Ger Jap Swe Ire Aus Can Ita

PIT + SSC as % of gross earnings

@ 167% of average earnings @ 100% of average earnings @ 67% of average earnings

Source: OECD

Main corporation tax rate

0.1 0.2 0.3 0.4 0.5 0.6

1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015

Main rate Small companies' rate

C hanges to corporation tax

• M ain and small companies rates cut (52%  22% by 2014, 40%  20%) ,

part of a continuing international trend

• Share of revenue kept up though
• This is partly because of reduced capital allowances

– aim is to tax profits = revenue – expenses (includes capital consumption) – allowances exist to compensate companies for depreciation – difficult to know what the true economic rate of depreciation is though – allowances may not adequately compensate companies for depreciation of capital therefore (will return to this later)

The corporate tax burden

Effective average tax rates and capital allowances 2005

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

UK79 UK05 USA FRA GER JAP SWE IRE AUS CAN ITA

Capital allowances (p.d.v.), plant and machinery EATR, equity-financed plant and machinery

Source: Klemm (2005)

VAT

• M ain rate 8%15% in 1979, 17.5% in 1991 and  20% in

2011

– in first two cases to pay for reductions in other taxes, latest rise part

• f deficit reduction package

– part of international trend towards uniform VAT

• Atkinson and Stiglitz result from optimal tax theory – if there is

weak separability between leisure and all other goods, uniform sales tax optimal

• But the UK has lots of zero rated items

VAT rates and bases

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 110%

UK1980 UK EU15 OECD Fra Ger Jap Swe Ire Aus Ita NZ

Main VAT rate, 2007 VAT Revenue Ratio, 2005

Source: OECD

VAT

• Zero rating of items often defended on grounds of redistribution
• Atkinson-Stiglitz result shows that this argument is flawed -

always better to use other means of redistribution (assuming consumption and leisure separable and ignoring externalities/merit good arguments)

• So taxing all goods uniformly and increasing a universal grant will

always bring the system closer to optimality

• Submission to the M irrlees review shows that it is possible to

make VAT uniform, compensate the poor and still have £11bn left

• ver…

Distributional effect of uniform VAT and compensation package

• 10%
• 8%
• 6%
• 4%
• 2%

0% 2% 4% Poorest 2 3 4 5 6 7 8 9 Richest

Income decile Percentage change in net income

Loss from uniform VAT (raises £23bn) Uniform VAT + compensation package (costs £12bn)

Source: Crawford I., M. Keen and S. Smith (2010), ‘Value added tax and excises’, chapter 4 of ‘Dimensions of Tax Design – the Mirrlees Review’, http://www.ifs.org.uk/mirrleesreview/dimensions/ch4.pdf

Excise duties

• Fuel, alcohol and tobacco
• Rates increased, yet share of revenues declined (as in most other

countries)

• Fuel protests in 2000 led to lower rates of fuel duty

– Increases in duty rates frequently postponed and/or cancelled

• Serious concerns about smuggling, especially with spirits

– Believed that raising rates would not increase revenue – Rate frozen in cash terms 1997 – 2008 – But may have also be because taxed more highly than wine & beer per unit of alcohol

Environmental taxes

• Various new environmental taxes introduced:

– Air passenger duty (1994, reformed with more bands in 2009) – Landfill tax (1996) – Climate change levy (2001) – Aggregates levy (2002) – London congestion charge (2003)

• None of these will raise more than £3bn in 2012–13

– compared with £27bn (+ VAT) from fuel duty

Property / local taxes

• Council tax:

– Based on property values (banded, no revaluation) with discounts for 1-person households and low-income families – UK’s only local tax (councils set average rate only) – M ore flexibility on rebates for low-income families and exemptions for second homes and empty properties from 2013–14

• Business rates:

– Proportion of estimated market rent (unbanded, revalued) with discounts for businesses with low rents – Central government now sets the proportion

Part of an international trend?

YES:

• Cuts in top and basic rates of income tax
• Shift from duties on specific goods towards VAT
• Corporate tax rates cut, base broadened
• Shift from family to individual taxation
• In-work support through the tax system
• SSC rates up even as PIT rates down
• Introduction of environmental taxes

NO:

• Unusual in removing mortgage interest relief
• Increasing centralisation not matched elsewhere

Distributional effect of the tax and benefit system, 2010–11

Excluding most ‘business taxes’

• 60%
• 40%
• 20%

0% 20% 40% 60%

Poorest 2nd 3rd 4th 5th 6th 7th 8th 9th Richest All

Decile group of equivalised household disposable income

Benefits - taxes as a percentage of original income Benefits - taxes as a percentage of disposable income

Source: ‘The effect of taxes and benefits on household income’, ONS statistical bulletin, http://www.ons.gov.uk/ons/dcp171778_267839.pdf

Effect of tax and benefit system on income inequality

Excluding most ‘business taxes’ 0.0 0.1 0.2 0.3 0.4 0.5 0.6 1978 1982 1986 1990 1994 1998 2002 2006 2010 Gini coefficient Private income Private + benefits Private + benefits - direct taxes Private + benefits - all taxes

Source: ‘The effect of taxes and benefits on household income’, ONS statistical bulletin, http://www.ons.gov.uk/ons/dcp171778_267839.pdf

Effect of tax and benefit system on income inequality

2003, personal taxes and benefits only

0.0 0.1 0.2 0.3 0.4 0.5 0.6

UK EU15 Aut Bel Den* Fin Fra* Ger Gre Ire* Ita* Lux Neth Por Spa Swe*

Gini coefficient Private income Disposable income

Source: EUROMOD statistics: http://www.iser.essex.ac.uk/msu/emod/statistics/

Effect of tax and benefit changes on income inequality

Personal direct taxes and benefits only, 2005-06 population

• 0.04
• 0.03
• 0.02
• 0.01

0.00 0.01 0.02 0.03 0.04 0.05 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2009 Change in Gini Uprated in line with RPI Uprated in line with GDP Taxes RPI-uprated, benefits GDP-uprated

Source: Adam and Browne (2010), ‘Redistribution, work incentives and thirty years of tax and benefit reform’, IFS Working Paper W10/24, http://www.ifs.org.uk/wps/wp1024.pdf

Mean participation tax rates

Personal taxes and benefits only

50% 55% 60% 65% 70% 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2009

RPI indexed GDP indexed Benefits in line with GDP, tax thresholds in line with RPI

Note: In work incomes for non workers calculated as described in Adam and Browne (2010) op. cit.

Mean effective marginal tax rates

Personal taxes and benefits only

44% 46% 48% 50% 52% 54% 56% 58% 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2009

RPI indexed GDP indexed Benefits indexed with GDP, tax thresholds with RPI

Note: Workers only. See Adam and Browne (2010) op. cit. for more details

Work incentives among workers

1998, personal taxes and benefits only

30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% UK EU15 Aus Bel Den Fin Fra Ger Gre Ire Ita Lux Neth Por Spa Swe

Mean effective marginal tax rate Mean participation tax rate

Source: Immervol, Kleven, Kreiner and Saez (2005)

Taxation of savings

• Atkinson-Stiglitz result again – uniform commodity taxation

implies tax on consumption should be the same in both periods (again, if leisure and consumption weakly separable)

• This implies a zero net tax rate for savings
• This is called an expenditure tax
• Caveats

– ignores the fact that there is labour income in different periods – no reason that leisure in different periods should have same tax schedule – may be optimal to have age-specific schedules or make future tax schedule conditional on current decisions – But even so, difficulty of taxing all forms of capital income equally may mean uniform rate of zero is desirable

Expenditure tax - implementation

• Not just a sales tax – can be progressive
• Remember that C = Y – S
• Two ways of implementing it

– EET t treat eatmen ent: e.g. pensions in the UK (almost)

• C
• ntributions:

Exempt from tax (or tax relief on contributions)

• R

eturns:

Exempt from tax

• Withdrawals:

Taxed (on whole amount)

– TEE t treat eatmen ent: e.g. ISAs

• C
• ntributions made out of: Taxed income
• R

eturns:

Exempt from tax

• Withdrawals:

Exempt from tax

• Identical if investments zero net present value

Expenditure tax at the corporate level

• Various ways of operating it:

– 100% first year capital allowances (i.e. count all investment as an expense when first made, but no depreciation allowances) – used to have this in the UK for plant and machinery – capital allowances that reflect true economic depreciation – Allowance for Corporate Equity – allow dividends that represent the normal return to capital as an expense (but no capital allowances)

How close is the UK to an expenditure tax?

• ISAs, owner occupied housing, durables have TEE treatment
• Pensions have what is sometimes called EEt treatment (tax free

lump sum of 25%)

• This covers almost everything for most people
• But other savings accounts and shares have TTE treatment
• This is just in income tax though: need to consider

– Council tax (taxing returns from housing) – Stamp duty (transactions based tax) – Inheritance Tax (if bequests not accidental) – M eans tested benefits effectively impose a high rate of tax on saving

Effective tax rates on different forms of saving over a 25 year period

Asset Effective tax rate (%) for: Basic rate taxpayer Higher rate taxpayer ISA, owner occupied house Other savings account 33 67 Pension (own contribution)

• 8
• 21

Pension (employer contribution)

• 49
• 40

Buy to let housing 28 48 Direct equity holdings 7 33

Note: various assumptions – see Adam, Browne and Heady (2010) for details

But EET structure of pensions can make them very (un)attractive…

Rate in work Rate when retired Effective tax rate (%) for: Own contribution Employer contribution Basic rate Basic rate

• 8
• 45

Higher rate Higher rate

• 21
• 40

Higher rate Basic rate

• 48
• 67

Basic rate Pension credit taper 18

• 19

Basic rate and tax credit taper

• 74
• 136

Basic rate

• 102
• 163

Tax rates on investments

• 80%
• 60%
• 40%
• 20%

0% 20% 40% 60% 80% 100%

UK1979 UK2005 USA FRANCE GERMANY JAPAN

Company-level EMTR, equity-financed plant and machinery Company-level EMTR, debt-financed plant and machinery Company-level EMTR, equity-financed industrial buildings Top net income tax rate on dividends Top income tax rate on interest

Source: Klemm (2005)

C hanges to treatment of savings

Closer to uniform tax-free treatment at personal level:

• Uniform rate of zero for pensions, ISAs, durables
• Removal of tax relief on life assurance and mortgage interest (EEE

treatment)

– The removal of mortgage interest relief is an achievement that few countries have been able to emulate

Further away from expenditure tax at corporate level:

• 100% capital allowances for plant & machinery ended

S ummary

• Some successful attempts to reform the tax system in recent years, but

still many areas in need of reform

• Debatable to what extent tax and benefit reforms are responsible for

increased inequality

• Tax and benefit changes have improved the incentive to work at all, but

left effective marginal tax rates unchanged overall

• Closer to expenditure tax treatment at the personal level, further away at

corporate level