Six thoughts about the tax credit cuts
- Working tax credits are a good idea in principle. Low pay is a big problem, and shifting the welfare system away from being a safety net towards topping up the incomes of low-skilled people who are in work is probably the right approach.
- It doesn’t make sense to both tax people and pay them benefits. Cutting income tax and, especially, raising the National Insurance threshold on low-income workers is less complicated than making them apply for tax credits, and probably would incentivise work by getting rid of the tax credit withdrawal 'tax', without removing their incentive to join the work force (as ditching tax credits alone might do).
- That isn’t what’s happening here, though. These cuts are meant to reduce the deficit, so they won’t be offset entirely by tax cuts. That might disincentivise work (reducing people’s incentive to enter the work force) and will clearly make some poor people worse off.
- Lowering the child tax credits threshold and increasing the withdrawal rate would be one of the least harmful ways to cut tax credits, because these are not tied to work and because they are paid to couples earning up to £41,000/year, which is quite high.
- Housing benefit and pensions would probably be better things to cut. The £26bn housing benefit bill could be reduced significantly by reforming planning to allow more houses to be built. Abolishing the pensions triple-lock and increasing pensions in line with inflation only would produce major year-on-year savings – this year, the £92 billion pensions budget would be essentially frozen.
- Deregulations that cut the cost of living would offset some of these cuts. Housing and, for people with children, childcare are the biggest costs for people on low incomes, and payments for childcare in particular are built in to the tax credits system. The UK has some of the harshest regulations in Europe on both of these things, driving up costs. If the government made it easier for the private sector to build more houses and relaxed regulations about staff:child ratios in crèches for children, the cost of living for poor people would fall significantly.
Yes, this is our fault
While this is indeed our fault we're not going to apologise for it. The this being the insistence that we do not want to harmonise tax codes, tax rates or the corporate tax system across jurisdictions. The OECD, the G7, the EU and every other assemblage of our governors is trying to get to a system that taxes corporations "fairly". And we would very much prefer to have competition in such matters. As one whining about our stance says, we have indeed said:
In this context there should be no mistaking the fact that those who propose tax competition are the ones who are seeking to exercise control. Time and again right wing think tanks have said things like this by Dan Mitchell of the US based Center for Freedom and Prosperity[i], writing on this occasion for the UK based Adam Smith Institute:
Tax competition exists when people can reduce tax burdens by shifting capital and/or labour from high-tax jurisdictions to low-tax jurisdictions. This migration disciplines profligate governments and rewards nations that lower tax rates and engage in pro-growth tax reform.
The emphasis is mine, and appropriate. Think tanks like those Mitchell works for go out of their way to defend tax havens. And what they are really saying is that tax havens should be able to use their laws to undermine the tax laws of other states by inducing the relocation of economic activity to low tax jurisdictions. This is what tax competition means, and this is what the UK is subscribing to.
We stand by this and we stand by it, the insistence on the benefits of competition, for two reasons.
The first is the entirely uncontroversial idea that tax rates can be too high. Where the good of raising the revenue to perform the (sure, we think these necessary functions are rather fewer than many others do but we're fine with the idea that there's some necessary functions of government) necessary functions of government fails to outweigh the harms done by the raising of that revenue. It's only competition between jurisdictions that is going to beat down rates to where less harm is done. Just as competition between suppliers of other goods and services beats down the price charged for them.
The second reason is a little more subtle: there are some taxes that are "bad" taxes, in the sense that they have higher costs in economic activity foregone for the revenue raised. That is, they have higher deadweight costs. Again, competition among jurisdictions is required to shift revenue raising from such bad taxes to ones that are less bad. The standard hierarchy here being that corporate and capital taxes are bad, income such less so and consumption and land taxes even less. It's worth noting that those higher deadweight costs apply to taxes on those factors which are more mobile: that's what actually causes those higher deadweight costs. Thus we want lower or no taxation of highly mobile factors of production (for the mobility leads to a greater elasticity of supply) and higher taxation of immobile and inelastic ones.
Again, competition between jurisdictions is what will provide this outcome for us. For the taxers will note that as they try to tax those mobile factors more highly, they'll get less revenue as it hightails it over the jurisdiction's boundaries.
The complaint about all of this is that by having competition then the taxing authorities cannot tax as they would wish. Yes, correct, that's the point: we want the taxing authorities to be taxing efficiently, not as they wish, and it's competition that will cause this. Thus we are in favour of competition and not of harmonisation.
Quite right, we should abolish stamp duty on shares
As ever when there's a budget in the offing we've people making suggestions about what should be in said budget. Some of these suggestions are even sensible, as is this one arguing that we should abolish stamp duty on shares:
“Abolishing the tax would lead to an immediate 7.7pc, or £133bn, increase in the value of listed companies on the LSE’s main market on the day of abolition,” he wrote. “It would incentivise saving for the future, removing a £402m a year burden from UK pension schemes and reduce the tax liability by up to £18,000 from the average UK family’s savings.”
A previous academic look into the subject is here.
The important thing to understand is the incidence of this tax. Certainly, it's the people buying and selling shares that appear to pay the tax itself. But after everything has flowed through the economy who is it that actually bears the economic cost of its existence? One answer is as above, pension funds. The end result is that pensions are lower than they would be in the absence of this tax. And, given that we tax privilege pensions in the first place it seems most odd to have another tax which then reduces them.
The other group who lose out is the workers in the country in general. As is noted above share prices would rise in the absence of the tax. This is equal and equivalent to making capital cheaper for companies. Cheaper capital will mean more capital being employed. And it's the addition of capital to labour that increases productivity, the average productivity of labour being what determines the average wages in the economy. Thus more expensive capital lowers average wages.
A tax which both lowers pensions and also wages in general doesn't seem to have a lot going for it. So, yes, we agree, abolish stamp duty on shares.
Not the way to reform business rates
This is a cheeky little attempt here by the CBI:
The antiquated business rates system is a major barrier to investment and must be reformed, the Confederation of Business Industry (CBI) has urged. The CBI has recommended that smaller properties should be exempt from business rates, revaluations should be more frequent, and future increases should be limited as a result of a switch of the inflation benchmark which they track. The recommendations were made in a response by the industry body to a review of business rates announced by George Osborne, the Chancellor, in last year’s Autumn Statement. The industry body has recommended properties valued below £12,000 should be exempt from rates. The CBI has also called on the Government to reform its “decades-old” business rates model and shift towards raising the tax in line with the consumer price index (CPI), as opposed to the retail price index (RPI). Unlike CPI, RPI includes housing costs, which considerably inflates the rate and has largely fallen out of favour as an economic measure. Such a move could save UK companies £1.5bn, the CBI has said, and would ensure business rates do not outpace the official measure of inflation.
That's really not the point at all. Business rates are the closest thing to land value taxation that we have. As such they're pretty close to being the perfect tax (for we're always going to have government and thus do have to raise tax money somehow). And the point is that land (or at least land with the permission to build a commercial outlet upon) is the scarce thing. We thus want to tax that thing at its current market value. It is this which leads to the use of that scarce thing more efficiently.
It shouldn't actually be linked to an inflation measure at all: it should be linked solely to that underlying land value. But if it is going to be linked to an inflation measurement then it has to be to the one that includes that underlying land value, not the one that excludes it.
There is the other point of course. Which is that they're only arguing for this at a time when CPI is lower than RPI. As and when that reverses they'll be calling for a reversal. As has happened with things like cost of living increases in pensions. When wage growth is higher than inflation the government tends to link the increases to inflation. When wage growth is below inflation then the switch occurs to linking to wage growth.
So, of course, we could say that the CBI is just trying on what the politicians do routinely. To which the response is, come on CBI, you're not politicians and they are. Meaning that you're better than that.
Five reasons to support Osborne's budget surplus law
1. This law makes it harder for governments to run deficits when the economy is healthy. This is a sound approach to the public finances whatever you think the government should do during recessions. Both the Clinton and Blair governments ran surpluses for part of their time in power and they are usually praised for doing so. It's hard to think of a good argument against that. Keynes said in 1937 that, "The boom, not the slump, is the right time for austerity". 2. The law will not prevent deficit spending during recessions. The point is to make deficit spending the exception, not the rule. That also means that deficit spending is much easier if we think we need it – it's easier to go from 0% to -5% than from -5% to -10%. According to Keynesian theory it is the change in spending that matters, not the level. Advocates of fiscal stimulus should love this rule – it makes their policies much easier to implement in busts.
3. Yes, the law can be repealed by an Act of Parliament. So can any other law, that doesn't mean that they're irrelevant. There is inertia in politics and a government that is seen to repeal this kind of law will need a good reason for doing so. Making the public more aware of what's going on with government spending makes politicians more accountable.
4. Even if our models of economics told us that it was better for the government to have as much flexibility over spending as possible, our models of politics tell us that constitution-like rules are a good way of stopping abuses. This is about political economy as well as economics.
5. An honest Keynesian argument would be that the public is too ignorant and will oppose necessary deficit spending, so it's better to keep them in the dark. In this case the argument is simply that monetary policy is clearly and demonstrably just as or more effective than fiscal policy during recessions and depressions (indeed fiscal policy probably only 'works' through the monetary policy channel). The US cut fiscal spending by $85bn/year in 2013 (the "Sequester") which people like Paul Krugman warned would cost 700,000 jobs. Because monetary policy was accommodative under QE3, offsetting those cuts, this did not happen.
Today is Tax Freedom Day
As of June 2024, this is out of date. Please refer to Tax Freedom Day 2024 for the updated statistics.
For the full press release, click here. This year’s Tax Freedom Day, the day when Britons stop working to pay their taxes and start earning for themselves, falls on 31st May, according to Adam Smith Institute calculations.
The Adam Smith Institute estimates that Britons will work 150 days this year solely to pay their taxes. This is one day later than 2014′s Tax Freedom Day, which is not statistically significant. However, the UK’s Tax Freedom Day falls more than a month later than it does in the United States, where citizens started earning for themselves on 24th April.
Tax Freedom Day is designed to reveal to the public how much they really pay out in taxes, which Britain’s lengthy tax code can often obscure. The Institute’s calculations include all taxes raised by HM Revenue and Customs: direct taxes like income tax, national insurance and corporation tax, and indirect taxes like VAT and excise duties.
Cost of Government Day, which represents Total Managed Expenditure as a day of the year, falls on 29th June, three days earlier than it fell in 2014. While this suggests a slight improvement over last year, the money borrowed to cover the month-long gap between Tax Freedom Day must eventually be paid off with future taxes. This means without tax cuts or major growth Tax Freedom Day would eventually have to drift even later.
Director of the Adam Smith Institute, Dr Eamonn Butler, said:
The Treasury hates Tax Freedom Day, because they don’t want us to know how much tax we really pay. They prefer to conceal the tax burden through stealth taxes and indirect taxes that we don’t even realise we’re paying.
Most people are shocked to learn that the government takes over two-fifths of the country’s earnings – and then borrows more. Mediaeval serfs had to work about a third of their time for their feudal lord, but we are in serfdom to the government for even longer!
High taxes are very bad for economic growth, as talent and initiative drain abroad. Ask President Hollande of France.
Alan Mak, Conservative MP for Havant, added:
The ASI’s work on Tax Freedom Day reminds us that we must carry on reducing the tax burden on hardworking individuals and businesses so we have greater economic growth and individual prosperity. That’s a goal I champion as a member of the new Conservative intake; income tax cuts and frozen council tax and fuel duty have so far made millions of Britons better off, but politicians must continue to look for new ways to get money back into taxpayer pockets, not out.
The ASI calculates Tax Freedom Day by measuring local taxes, direct and indirect national taxes, and national insurance contributions as a proportion of the UK’s net national income (41.2% per cent in 2015), mapping that proportion onto the days of the year.
Tax Freedom Day figures are not available up-to-date for calendar years so they are proxied from government and OBR forecasts and financial year numbers. They are then revised when exact numbers become available.
For further comments or to arrange an interview, contact Head of Communications Kate Andrews: kate@old.adamsmith.org | 07476 915072
Against the idea of a 100% inheritance tax
There are arguments in favour of a 100% inheritance tax. For example, we could look to John Rawls and the argument from behind the veil of ignorance. If we didn't know where we would arrive in that lucky sperm club lottery wouldn't we prefer a society in which starting points were equal? So, tax inheritances at 100% and then distribute that wealth as a starting grant perhaps. However, the idea does seem to fail on two points. The first is that while it's true that we can't take it with us, therefore this could be seen as a "fair" tax, that people will fight, struggle and even lie to be able to provide an inheritance to their children does rather militate against the idea that people do see it as a fair tax. Peoples' actions do seem at odds with that particular result of that particular blend of moral reasoning.
But much more importantly we've evidence that such a system is not efficient. For we've had societies that did effectively have 100% inheritance taxes: and those societies failed precisely because they did.
Both Mamluk Egypt and the Ottoman Empire worked on the basis that whatever was accumulated during the lifetime of the elite (with the Mamluks, generals, with the Ottomans, Pashas) in the way of property, businesses, land and so on, was theirs for life and only for life. When they popped off those estates, however grand or vast they were, were distributed to the next generation of generals and pashas. With the Mamluks the children of the generals were, as they had not been recruited as military slaves from the steppes, specifically barred from even attempting to join that next generation of the elite.
This led to a certain short termism in how such properties were managed: having reached the top there would be, at most, a couple of decades to enjoy the wealth. Nothing could be passed down to the next generation. Thus, don't invest in anything, simply extract. Societies in which we do have 100% inheritance taxes therefore seem to become extractive ones, not investing ones. With all of the obvious connotations for the living standards of the subsequent generations. To say nothing of the current living standards of the peasantry being extracted from.
Whatever the philosophy here we have tried it as a species and it really just doesn't seem to work.
An interesting supposition
And one that may well have a measure of truth to it. That supposition being that there's only so much tax that you can pull out of an economy:
While raising taxes was “easier” for a future chancellor to do than shrink expenditure, Dame DeAnne added: “My personal view is that this country is hitting rates of marginal taxation that are pretty close to the ceiling of what you can expect to actually get to work for you by getting increasing revenues by increasing rates.” Dame DeAnne suggested that spending cuts were the only solution,
She used the example of Labour’s pledge to restore the 50p top rate of tax to illustrate her point. The Institute for Fiscal Studies believes the policy is unlikely to raise more than £100m, after the Coalition’s decision to cut it to 45p cost the government around the same amount, according to official studies.
“It’s difficult to see where you can get substansial additional revenue from the tax side unless it’s through broadening the VAT base, which both parties have said they are not going to do,” said Dame DeAnne. “Anyway, that’s a politically difficult thing to do.”
Mr Plenderleith agreed. “There are a range of views as to what the optimal tipping point is and it seems to me that we’re quite close to that,” he said.
We do not say that this is absolutely true. But that it is generally true seems to us to be an intriguing thought. That there's a rough amount of the economy that you can tax out of it. That rough amount changing over very long periods of time perhaps, and over different countries, but each place having its own natural rate. Outside true emergencies like all out war no one's really managed to get much more than 35% of the British economy in tax. The American Federal system never seems to manage more than 19 to 20% for anything other than a couple of years. Yet the tax burdens in other countries can and have been for decades rather higher.
This is also true whatever the tax system actually is. Whether it's all largely consumption based, or income, or they try to nickel and dime us to death with imposts on this or that, some cultures will accept higher tax burdens than others. For we've tried different variations of the tax system over time and those amounts that we can collect don't seem to budge all that much.
all of which will be something of a disappointment to Polly Toynbee of course. For as she's fond of pointing out we Brits seem to want Scandinavian style services with American style tax rates. The analysis here leading us to the conclusion that it's the taxes that are the immovable object: meaning that it's the services that have to be cut to fit that, not just the tax rates raised to provide that chicken in every pot and a pony.
Don't campaign against tax havens: they are good for us
Thanks to faulty headline-grabbing propaganda, most people think tax havens are outrageous places in which tens of billions of pounds are being stored offshore, denying UK citizens valuable tax revenue that could be used on public services like schools, health care and roads. Nice idea. But like many nice ideas, it veers far from the truth. First off, what of the complaint that if the money stays in the private sector in tax havens then UK citizens are being robbed of vital tax revenue? To answer this, consider if the money stays in the private sector in a tax haven, who else benefits from that apart from the person with the money? On the one hand that money is invested, which generates plenty of jobs and lots of economic growth. On the other, if a British billionaire keeps £500 million in a tax haven then all the time he's not spending it he makes everyone else in the UK better off in terms of more resources and lower prices. This is because money earned but not spent is like conferring a gift to the UK taxpayers. Moreover, it's important to remember that the primary contribution high earners make to society is not in the taxes they pay, it is in the goods and services they produce.
When it comes to tax havens, what is also being missed by a lot of people is that tax havens actually make us better off in another way, in that they provide vital competition to tax rates in the UK. A popular view from the left is that because of tax havens governments have to increase our taxes to make up for all the tax they are not getting from money stored in places like the Cayman Islands. In actual fact, the opposite is true – tax havens keep our UK taxes lower not higher.
To see why, suppose there is just one quite expensive Bakery in town (call it Bakery A). Along comes another Bakery in competition (Bakery B), offering townsfolk lower prices for bread. The very worst thing that Bakery A could do in response would be to raise its prices even more. Their best response would be to try to out-compete Bakery B for custom. This is the nature of competition, and how it lowers prices and improves efficiency.
Similarly, tax havens are like Bakery B: their more competitive tax rates place competitive pressures on governments that might be tempted to tax us highly. Competition for prices occurs with tax just as it does with bread, laptops and cars. Governments must be competitive with their tax rates, otherwise more and more money will be stored in places with lower tax rates. Tax competition is a key driver of economic growth in the world, as this incentivises politicians to keep taxes on savings and investments low. When tax rates are excessive, there is less economic growth. Tax havens provide the necessary competition to militate against this happening.
Finally, tax havens can claim to have some of best standards of living and economic growth in the world. That's precisely because low taxes stimulate economic growth and better standards of living, as the qualities of the free market predominate over party political interests. Instead of calling for politicians to tackle the grave injustices of tax havens, campaigners should be calling for a more fruitful tax system here, based on lower rates, reduced complexity and bureaucracy, and increased market freedom.
There is no such thing as tax avoidance
You don't have to go far through the public prints to find all sorts of blood curdling tales about how the Treasury is being ripped off by varied forms of tax avoidance and even aggressive tax avoidance. And yet the truth is that as a thing tax avoidance doesn't actually exist. So it isn't as we're told in the Telegraph, that tax avoidance is actually a good thing, it's that it just doesn't happen:
Successive governments have left us with a tax regime so complex it verges on chaotic.
Which is exactly why we should be suspicious of politicians who talk imprecisely about “tax avoidance” and “tax evasion” – or who muddle the two terms, or use them interchangeably.
There is nothing wrong with tax avoidance.
Tax avoidance is what everyone does, not just the wealthy. It’s what we do when we save in Isas and pensions, or in Junior Isas for our children.
There's no doubt at all that there are attempts to avoid tax. Sticking your money in an ISA or simply not declaring millions in income are both attempts to avoid tax. But we have a system which decides which of those plans is successful in doing so. That system being HMRC in the first line, the various tax tribunals in the second and then on and up to the European Court of Justice as both Vodafone and Cadbury found out. The end result of this system of adjudicating upon attempts is that there's no room left for tax avoidance to actually happen in. For, obviously, once the courts have had their say either whatever is going on is obeying the law of the land or it isn't. And when it is decided that it isn't that's tax evasion. And when it's decided that it is according to said law that's not actually avoiding anything, is it? It's paying, in full, one's dues as Parliament has decided you ought to.
There really isn't anything called tax avoidance. There's only obeying the law and not obeying it.