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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 Mirrlees Review’, available from
http://www.ifs.org.uk/mirrleesreview/dimensions/ch1.pdf
The tax burden in the UK
48%
46%
44%
% of GDP
42%
40%
38%
36%
34%
32%
30%
1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015
Public sector total receipts
Line 3
Source: HMT
Net taxes and SSCs
Line 4
Tax to GDP ratios
Taxes and social security contributions
60%
1978
2006
50%
40%
30%
20%
10%
0%
UK
EU15 OECD
Source: OECD
USA
Fra
Ger
Jap
Swe
Ire
Aus
Can
Ita
Breakdown of net taxes and NICs, 2010-11
Other indirect
taxes
Income tax
VAT
Local taxes
Capital taxes
Corporation tax
Source: HMT
National
Insurance
Composition of revenues
Net taxes and NICs
100%
Other indirect taxes
90%
80%
VAT
70%
Other capital taxes
60%
50%
Rates/Poll Tax/Council Tax
40%
Corporation tax
30%
National Insurance
20%
10%
Income tax + CGT
0%
1978-79
Source: HMT
1997-98
2010-11
Composition of revenues, 2006
Taxes and social security contributions
100%
Other taxes
90%
Other capital taxes
80%
60%
Recurrent buildings
taxes
Corporation tax
50%
Other indirect taxes
40%
VAT / GST
70%
30%
SSCs + payroll tax
20%
Income tax + CGT
10%
0%
UK
EU15 OECD USA
Source: OECD
Fra
Ger
Jap
Swe
Ire
Aus
Can
Ita
Income tax schedule
For earned income, 2012 prices
Marginal income tax rate
100%
90%
1978-79
80%
2012-13
70%
60%
50%
40%
30%
20%
10%
0%
£0
£25,000
£50,000
£75,000
£100,000
Gross income
£125,000
£150,000
£175,000
Changes 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?
• Mirrlees 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
– May 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
Income tax as % of gross earnings
35%
30%
@ 167% of average earnings
@ 100% of average earnings
@ 67% of average earnings
25%
20%
15%
10%
5%
0%
UK
EU15 OECD
Source: OECD
USA
Fra
Ger
Jap
Swe
Ire
Aus
Can
Ita
Changes 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
£250
1984-85
2012-13
Weekly NICs
£200
£150
£100
£50
£0
£0
£100
£200
£300
£600
£500
£400
Weekly earnings
£700
£800
£900
£1,000
Changes to National Insurance
More 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
Social 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
@ 167% of
average
earnings
@ 100% of
average
earnings
@ 67% of
average
earnings
PIT + SSC as % of gross earnings
60%
50%
40%
30%
20%
10%
0%
UK
EU15 OECD
Source: OECD
USA
Fra
Ger
Jap
Swe
Ire
Aus
Can
Ita
Main corporation tax rate
0.6
Main rate
Small companies' rate
0.5
0.4
0.3
0.2
0.1
0
1979 1982
1985 1988 1991 1994
1997 2000 2003 2006
2009 2012 2015
Changes to corporation tax
•
Main 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
100%
Capital allowances (p.d.v.), plant and machinery
EATR, equity-financed plant and machinery
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
UK79
UK05
Source: Klemm (2005)
USA
FRA
GER
JAP
SWE
IRE
AUS
CAN
ITA
VAT
• Main 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
of 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
110%
100%
Main VAT rate, 2007
VAT Revenue Ratio, 2005
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
UK1980
UK
Source: OECD
EU15
OECD
Fra
Ger
Jap
Swe
Ire
Aus
Ita
NZ
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 Mirrlees review shows that it is possible to
make VAT uniform, compensate the poor and still have £11bn left
over…
Distributional effect of uniform VAT and compensation
package
Percentage change in net income
4%
2%
0%
-2%
-4%
-6%
Loss from uniform VAT (raises £23bn)
-8%
Uniform VAT + compensation package (costs £12bn)
-10%
Poorest
2
3
4
5
6
Income decile
7
8
9
Richest
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)
– More 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%
Benefits - taxes as a percentage of original income
40%
Benefits - taxes as a percentage of disposable income
20%
0%
-20%
-40%
-60%
Poorest
2nd
3rd
4th
5th
6th
7th
8th
9th
Richest
Decile group of equivalised household disposable income
Source: ‘The effect of taxes and benefits on household income’, ONS statistical bulletin,
http://www.ons.gov.uk/ons/dcp171778_267839.pdf
All
Effect of tax and benefit system on income inequality
Excluding most ‘business taxes’
0.6
0.5
Gini coefficient
0.4
0.3
Private income
Private + benefits
Private + benefits - direct taxes
Private + benefits - all taxes
0.2
0.1
0.0
1978
1982
1986
1990
1994
1998
2002
2006
Source: ‘The effect of taxes and benefits on household income’, ONS statistical bulletin,
http://www.ons.gov.uk/ons/dcp171778_267839.pdf
2010
Effect of tax and benefit system on income inequality
2003, personal taxes and benefits only
0.6
Private income
Disposable income
Gini coefficient
0.5
0.4
0.3
0.2
0.1
0.0
UK EU15 Aut
Bel Den* Fin
Fra*
Ger
Gre
Ire*
Ita*
Lux Neth Por
Source: EUROMOD statistics: http://www.iser.essex.ac.uk/msu/emod/statistics/
Spa Swe*
Effect of tax and benefit changes on income inequality
Personal direct taxes and benefits only, 2005-06 population
Uprated in line with RPI
Uprated in line with GDP
0.05
Taxes RPI-uprated, benefits GDP-uprated
0.04
Change in Gini
0.03
0.02
0.01
0.00
-0.01
-0.02
-0.03
-0.04
1978 1981 1984 1987 1990 1993 1996 1999 2002 2005
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
2009
Mean participation tax rates
Personal taxes and benefits only
70%
RPI indexed
GDP indexed
65%
Benefits in line with GDP, tax thresholds in
line with RPI
60%
55%
50%
1978
1981
1984
1987
1990
1993
1996
1999
2002
Note: In work incomes for non workers calculated as described in Adam and
Browne (2010) op. cit.
2005
2009
Mean effective marginal tax rates
Personal taxes and benefits only
58%
RPI indexed
56%
GDP indexed
54%
Benefits indexed with GDP, tax thresholds
with RPI
52%
50%
48%
46%
44%
1978
1981
1984
1987
1990
1993
1996
1999
Note: Workers only. See Adam and Browne (2010) op. cit. for more details
2002
2005
2009
Work incentives among workers
1998, personal taxes and benefits only
80%
Mean effective marginal tax rate
Mean participation tax rate
75%
70%
65%
60%
55%
50%
45%
40%
35%
30%
UK EU15 Aus Bel Den Fin Fra Ger Gre Ire
Source: Immervol, Kleven, Kreiner and Saez (2005)
Ita
Lux Neth Por Spa Swe
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 treatment: e.g. pensions in the UK (almost)
• Contributions:
• Returns:
• Withdrawals:
Exempt from tax (or tax relief on contributions)
Exempt from tax
Taxed (on whole amount)
– TEE treatment: e.g. ISAs
• Contributions made out of:
• Returns:
• Withdrawals:
•
Taxed income
Exempt from tax
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)
Means 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
ISA, owner occupied house
Higher rate
taxpayer
0
0
Other savings account
33
67
Pension (own contribution)
-8
-21
-49
-40
28
48
7
33
Pension (employer contribution)
Buy to let housing
Direct equity holdings
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
-74
-136
-102
-163
Basic rate and
tax credit taper
Basic rate
Tax rates on investments
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
100%
80%
60%
40%
20%
0%
-20%
-40%
-60%
-80%
UK1979
Source: Klemm (2005)
UK2005
USA
FRANCE
GERMANY
JAPAN
Changes 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
Summary
•
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