Let’s face it – no-one likes paying tax! After all, to see your monthly pay decline by £1000 through taxation and national insurance has got to hurt. Yet, taxation and national insurance contributions are essential sources of government revenue to finance benefits and public and merit goods.
However, with so much attention given to the UK’s ‘culture of dependency’, many people are increasingly angry with having to pay so much in taxation to see it being spent by the government on individuals who in some cases choose not to work and at the same time seeing other rich people paying so little in taxation. The increase in the top rate of tax received a lot of coverage. Although it did make the tax system more progressive, there were many concerns that it would lead to lower growth, a lack of innovation and enterprise and increased tax evasion and avoidance, as the super-rich were being hit with phenomenal tax bills. The post on the 50p income tax available here is worth looking at again to think about the effect that taxes have on incentives.
The issue of tax avoidance is by no means new, but with a large budget deficit in the UK, tax avoidance by the super-rich has become something that everyone has an opinion on. The average household has seen its income squeezed more and more, as the government continues its efforts to cut the deficit. The fact that the super rich are avoiding sometimes millions in taxation, while the average household struggles to pay even the basic rate of tax, creates a rather contentious issue. The Chief Secretary to the Treasury, Danny Alexander, has said that the basic rate of tax could be cut by 2p in the pound if tax avoidance came to an end. He commented to the BBC’s Sunday Politics Programme that:
‘We have to make sure that everybody, especially the rich and famous, are paying their fair share of tax…These sorts of schemes that save wealthy people potentially tens of millions of pounds in tax, they are paid for by everybody else… If we could narrow the tax gap in this country by a quarter we could reduce income tax for every basic rate payer by 2p in the pound.’
This would clearly have some very positive effects on some of the poorest people living in the UK.
There is a variety of tax avoidance schemes available and the one receiving the most attention at present is the Jersey-based K2 scheme, which Jimmy Carr and others are thought to be using. The Public Accounts Committee will be reporting on the problem of using private companies to pay salaries, as a means of avoiding income tax and national insurance contributions.
If tax avoidance could be stopped, or at least reduced, then not only could basic rate tax payers benefit, but it might go some way to cutting the budget deficit, giving the government more flexibility in stimulating the economy. According to HMRC, tax avoidance and evasion cost the economy some £42 billion – enough to pay off one-third of Britain’s budget deficit.
The following articles consider the problem of tax avoidance and then try answering the questions on the issue of taxation.
Five-point plan to curb tax cheating by big firms and super-rich Guardian (27/6/12)
Stop tax dodgers or there will be ‘riots on the streets’, warns top lawyer designing new anti-avoidance rules Mail Online, Julian Gavaghan (26/6/12)
Danny Alexander describes aggressive tax avoidance as ‘morally repugnant’ Guardian, Patrick Wintour (24/6/12)
Basic tax ‘could be cut by 2p’ if avoidance ended BBC News(24/6/12)
Danny Alexander says tax avoidance ‘adds 2p in every £1 to basic tax rate’ Independent, Oliver Wright (24/6/12)
Make tax returns public, urges peer The Press Association (28/6/12)
Tax officials reveal scale of probe Financial Times, Jim Pickard (27/6/12)
Questions
- What are the key principles of a good tax system?
- Explain how taxation affects the incentive to work?
- What is the difference between tax evasion and tax avoidance?
- Using indifference analysis, illustrate the effect of a cut in the basic rate of income tax. How does it affect the decision to work more or less? You should consider the income and substitution effects in your answer and which rate of tax (if any) an individual is paying.
- Why is tax avoidance of such concern at the moment? Think about the current state of the economy.
- What are taxes and national insurance contributions used to pay for?
- To what extent do you think tax avoidance is a natural consequence of any tax system?
Calls for a simplified tax and benefit system have been ongoing and many see the Coalition’s plans for a Universal Credit as a step in the right direction. However, a second suggestion set out in a report by lobbying groups is to introduce a single rate of income tax at 30%. The argument is that it will simplify the system, help lower income earners and boost growth.
As well as the introduction of a single rate of income tax, The 2020 Tax Commission’s Report also suggests an increase in the personal allowance to £10,000; scrapping National Insurance Contributions, stamp duty, inheritance tax and air passenger duty, as well as cutting fuel duty by 5p. For the typical tax payer, it may sound great – the difference between your gross and your net pay would narrow, but the wider consequences must be considered. Although a single rate of income tax would undoubtedly simplify the system, the impact on government finances must be considered. The commission predicts that overall borrowing would fall by £35bn after 15 years, but that the national deficit would increase by £49.1bn in the first year. Perhaps not an ideal solution given the current state of the national deficit!
The report does contain some radical change, but the idea of simplification is well-recognised as a necessary principle of any tax system. As the Chairman of the Commission, Allister Heath said:
It is time for Britain to make a vital choice between tweaking the status quo and letting our economy continue to be crippled by complex and punitive taxes, and drastically changing course with a radical but realistic plan for a tax system fit for the 21st century.
The 2020 Tax Commission has set out that plan and would ensure that income is taxed once at a single, much more reasonable rate. It could create the conditions to establish the UK as a global trading hub, generating renewed prosperity for all those who live and work here.
The current system is complex and many people end up paying an extremely high rate of tax, once everything has been paid. The Guardian article below gives a nice illustration. “If you earn income from shares, first corporation tax is taken out of the profits. Then you pay taxes on the dividends. Then because those profits drive up the share price you pay capital gains tax as well.” With a simpler and fairer tax system, the Commission argues that it will boost the competitiveness of the UK economy and help boost its struggling growth rate. How many, if any, of these proposals will be incorporated into the government’s plans is anybody’s guess, but it definitely presents an interesting solution and problem.
Report
The Single Income Tax The 2020 Tax Commission (May 2012)
Articles
Why it’s time for a single income tax Guardian, Matthew Elliott (21/5/12)
Business backs income tax rate of 30% Financial Times, Martin Sandbu (21/5/12)
Calls for single 30% income tax rate BBC News (21/5/12)
Single 30% tax rate ‘essential’ for growth Sky News (21/5/12)
Osborne urged to introduce 30pc income tax for all The Telegraph, Tim Ross (20/5/12)
Tax shake-up urged to empower consumers and kickstart growth Independent, Russell Lynch (21/5/12)
The Tax Reform Britain needs Wall Street Journal, Matthew Sinclair (20/5/12)
Questions
- What are the key principles of a tax system?
- Explain why simplicity is so important when reforming a tax system. How can it affect the incentive to work?
- Would a 30% single rate of income tax be equitable?
- If the reforms set out in the report were to go ahead, what do you think would be the impact on goods and services provided by the government, such as the NHS, education, roads?
- Using indifference analysis, illustrate the effect of a cut in the basic rate of income tax. How does it affect the decision to work more or less? You should consider the income and substitution effects in your answer.
- Why does the report argue that the reforms they suggest would help boost growth?
- How might the proposals affect government finances in both the short and long term?
Through new legislation, the Ministry of Justice is aiming to make ‘offenders … take personal responsibility for their crimes’. The idea is to cut the wages of prisoners who work in communities, with the objective of raising £1m a year for victim support services. Any prisoner earning above £20 a week after tax, national insurance, child support payments etc, will face a 40% deduction in their pay. The money raised will be used to ‘repair the damage done by crime’ and begin to remove the burden from the general taxpayer. Critics, however, argue that this legislation will create a disincentive effect and discourage prisoners to work in the community before their release. It may also create additional bureaucracy for the external firms that employ them and at the end of the day may not even affect most prisoners, as many receive earnings, after all deductions, below £20 and so would not be liable. The following articles consider this policy.
Prisoners’ wages docked to fund victim support Associated Press (26/9/11)
Prisoners’ wages to help crime victims BBC News (26/9/11)
Prisoners to pay victims of crime The Press Association (26/9/11)
Victims handed £1m as prisoners suffer wage cut Independent, Nigel Morris (26/9/11)
Questions
- To what extent do you think the above policy is (a) equitable and (b) efficient?
- What might be the adverse effects of such legislation, from the point of view of both prisoners and the firms that employ them?
- What are the income and substitution effects in the context of a worker’s decision to work more or less hours?
- Using indifference analysis, explain how a fall in the prisoners’ net pay (due to this latest deduction) might have an impact on their desire to work more or less.
- Using your analysis from the previous question, explain the importance of the income and substitution effects.