Tag: direct taxes

In his Budget on 29 October, the UK Chancellor, Philip Hammond, announced a new type of tax. This is a ‘digital services tax’, which, after consultation, he is planning to introduce in April 2020. The target of the tax is the profits made by major companies providing social media platforms (e.g. Facebook and Twitter), internet marketplaces (e.g. Amazon and eBay) or search engines (such as Alphabet’s Google).

Up to now, their profits have been very hard to tax because the companies operate in many countries and use accounting techniques, such as transfer pricing (see the blogs Disappearing tax revenues: how Luxembourg saves companies billions and Starbucks pays not a bean in corporation tax, thanks to transfer pricing), to declare most of their profits in low-tax countries, such as Luxembourg. One way of doing this is for a company’s branches in different countries to pay the head office (located in a tax haven) a ‘royalty’ for using the brand.

The proposed digital services tax is a 2% tax on the revenues earned by such companies in the UK. It would only apply to large companies, defined as those whose global revenue is at least £500m a year. It is expected to raise around £400m per year.

The EU is considering a similar tax at a rate of 3%. India, Pakistan, South Korea and several other countries are considering introducing digital taxes. Indeed, many countries are arguing for a worldwide agreement on such a tax. The OECD is studying the implications of the possible use of such a tax by its 36 members. If an international agreement on such a tax can be reached, a separate UK tax may not go ahead. As the Chancellor stated in his Budget speech:

In the meantime we will continue to work at the OECD and G20 to seek a globally agreed solution. And if one emerges, we will consider adopting it in place of the UK Digital Services Tax.

The proposed UK tax is a hybrid between direct and indirect taxes. Like corporation tax, a direct tax, its aim is to tax companies’ profits. But, unlike corporation tax, it would be harder for such companies to avoid. Like VAT, an indirect tax, it would be a tax on revenue, but, unlike VAT, it would be an ‘end-stage’ tax rather than a tax on value added at each stage of production. Also, it would not be a simple sales tax on companies as it would be confined to revenue (such as advertising revenue) earned from the use in the UK of search engines, social media platforms and online marketplaces. As the Chancellor said in his speech.

It is important that I emphasise that this is not an online-sales tax on goods ordered over the internet: such a tax would fall on consumers of those goods – and that is not our intention.

There is, however, a political problem for the UK in introducing such a tax. The main companies it would affect are American. It is likely that President Trump would see such taxes as a direct assault on the USA and could well threaten retaliation. As the Accountancy Age article states, ‘Dragging the UK into an acrimonious quarrel with one of its largest trading partners is perhaps not what the Chancellor intends.’ This will be especially so as the UK seeks to build new trading relationships with the USA after Brexit. As the BBC article states, ‘The chancellor will be hoping that an international agreement rides to his rescue before the UK tax has to be imposed.’

Articles

Government documents

Questions

  1. How do multinational digital companies avoid profit taxes (corporation tax in the UK)?
  2. Explain how a digital services tax would work.
  3. Why is a digital services tax likely to be set at a much lower rate than a profit tax?
  4. Explain the difference between tax avoidance and tax evasion.
  5. Would it be possible for digital companies to avoid or evade such taxes?
  6. Is there a possibility of a prisoners’ dilemma game in terms of seeking international agreement on such taxes
  7. How does a digital services tax differ from a sales revenue tax

The ONS has just released its annual publication, The Effects of Taxes and Benefits on Household Income. The report gives data for the financial year 2012/13 and historical data from 1977 to 2012/13.

The publication looks at the distribution of income both before and after taxes and benefits. It divides the population into five and ten equal-sized groups by household income (quintiles and deciles) and shows the distribution of income between these groups. It also looks at distribution within specific categories of the population, such as non-retired and retired households and different types of household composition.

The data show that the richest fifth of households had an average pre-tax-and-benefit income of £81,284 in 2012/13, 14.7 times greater than average of £5536 for the poorest fifth. The richest tenth had an average pre-tax-and-benefit income of £104,940, 27.1 times greater than the average of £3875 for the poorest tenth.

After the receipt of cash benefits, these gaps narrow to 6.6 and 11.0 times respectively. When the effect of direct taxes are included (giving ‘disposable income’), the gaps narrow further to 5.6 and 9.3 times respectively. However, when indirect taxes are also included, the gaps widen again to 6.9 and 13.6 times.

This shows that although direct taxes are progressive between bottom and top quintiles and deciles, indirect taxes are so regressive that the overall effect of taxes is regressive. In fact, the richest fifth paid 35.1% of their income in tax, whereas the poorest fifth paid 37.4%.

Taking the period from 1977 to 2012/13, inequality of disposable income (i.e. income after direct taxes and cash benefits) increased from 1977 to 1988, especially during the second two Thatcher governments (1983 to 1990) (see chart opposite). But then in the first part of the 1990s inequality fell, only to rise again in the late 1990s and early 2000s. However, with the Labour government giving greater cash benefits for the poor, inequality reduced once more, only to widen again in the boom running up to the banking crisis of 2007/8. But then, with recession taking hold, the incomes of many top earners fell and automatic stabilisers helped protect the incomes of the poor. Inequality consequently fell. But with the capping of benefit increases and a rise in incomes of many top earners as the economy recovers, so inequality is beginning to rise once more – in 2012/13, the Gini coefficient rose to 0.332 from 0.323 the previous year.

As far as income after cash benefits and both direct and indirect taxes is concerned, the average income of the richest quintile relative to that of the poorest quintile rose from 7.2 in 2002/3 to 7.6 in 2007/8 and then fell to 6.9 in 2012/13.

Other headlines in the report include:

Since the start of the economic downturn in 2007/08, the average disposable income has decreased for the richest fifth of households but increased for the poorest fifth.

Cash benefits made up over half (56.4%) of the gross income of the poorest fifth of households, compared with 3.2% of the richest fifth, in 2012/13.

The average disposable income in 2012/13 was unchanged from 2011/12, but it remains lower than at the start of the economic downturn, with equivalised disposable income falling by £1200 since 2007/08 in real terms. The fall in income has been largest for the richest fifth of households (5.2%). In contrast, after accounting for inflation and household composition, the average income for the poorest fifth has grown over this period (3.5%).

This is clearly a mixed picture in terms of whether the UK is becoming more or less equal. Politicians will, no doubt, ‘cherry pick’ the data that suit their political position. In general, the government will present a good news story and the opposition a bad news one. As economists, it is hoped that you can take a dispassionate look at the data and attempt to relate the figures to policies and events.

Report

The Effects of Taxes and Benefits on Household Income, 2012/13 ONS (26/6/14)

Data

Reference tables in The Effects of Taxes and Benefits on Household Income, 2012/13 ONS (26/6/14)
The Effects of Taxes and Benefits on Household Income, Historical Data, 1977-2012/13 ONS (26/6/14)
Rates of Income Tax: 1990-91 to 2014-15 HMRC

Articles

Inequality is on the up again – Osborne’s boast is over New Statesman, George Eaton (26/6/14)
Disposable incomes rise for richest fifth households only Money.com, Lucinda Beeman (26/6/14)
Half of families receive more from the state than they pay in taxes but income equality widens as rich get richer Mail Online, Matt Chorley (26/6/14)
Rich getting richer as everyone else is getting poorer, Government’s own figures reveal Mirror, Mark Ellis (26/6/14)
The Richest Households Got Richer Last Year, While Everyone Else Got Poorer The Economic Voice (27/6/14)

Questions

  1. Define the following terms: original income, gross income, disposable income, post-tax income, final income.
  2. How does the receipt of benefits in kind vary across the quintile groups? Explain.
  3. What are meant by the Lorenz curve and the Gini coefficient and how is the Gini coefficient measured? Is it a good way of measuring inequality?
  4. Paint a picture of how income distribution has changed over the past 35 years.
  5. Can changes in tax be a means of helping the poorest in society?
  6. What types of income tax cuts are progressive and what are regressive?
  7. Why are taxes in the UK regressive?
  8. Why has the fall in income been largest for the richest fifth of households since 2007/8? Does this mean that, as the economy recovers, the richest fifth of households are likely to experience the fastest increase in disposable incomes?