Financing | Web-desiging | CVS surveyors

Taxation in the UK

CVS SURVEYORS

OutlineOverview of the UK tax system in historical, international and theoretical

contexts:

1. Level and composition of revenues2. Structure of the major taxes3. Economic aspects of the overall tax (and benefit) system:

– Effect on the income distribution– Effect on incentives to work– Effect on incentives to save and invest

For more on 1 and 2: S. Adam & J. Browne, A survey of the UK tax system– www.ifs.org.uk/bns/bn09.pdf

http://www.ifs.org.uk/bns/bn09.pdf

The tax burden in the UK

30%

32%

34%

36%

38%

40%

42%

44%

46%

79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11

% o

f GD

P

Public sector total receipts Net taxes and SSCsLine 3 Line 4

Source: HM Treasury

Tax to GDP ratiosTaxes and social security contributions

0%

10%

20%

30%

40%

50%

60%

UK EU15 OECD USA FRA GER JAP SWE IRE AUS CAN ITA

19792003

Source: OECD

Composition of revenuesCurrent receipts, 2006-07

Income tax + CGT

National Insurance

VAT

Other indirect taxes

Corporation tax

Recurrent buildings taxes

Other capital taxes

Other receipts

Source: HM Treasury

Composition of revenuesCurrent receipts

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

100%

1978-79 2006-07

Other receipts

Other capital taxes


Corporation tax


VAT

National Insurance

Income tax + CGT

Source: HM Treasury

Composition of revenues 2003Taxes and social security contributions

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Other taxes

Other capital taxes


Corporation tax


VAT / retail sales taxes

SSCs + payroll taxes

Income tax + CGT

Source: OECD

Income tax scheduleFor earned income, 2006 prices

£0

£10,000

£20,000

£30,000

£40,000

£50,000

£60,000

£0 £20,000 £40,000 £60,000 £80,000 £100,000

Gross income

Inco

me

tax

liabi

lity

1978-792006-07

Changes to income tax rate structure

• Big reduction in top rates (83/98% 40%)– the start of an international trend

• Reduction in basic rate (33% 22%)– part of an international trend

• Abolition and re-introduction of starting rate (now 10%)– international trend is to reduce number of rates

• Large-scale fiscal drag– some increase in no. of taxpayers– massive increase in no. of higher-rate taxpayers

The income tax burdenFor single worker at multiples of average full-time earnings

0%

5%

10%

15%

20%

25%

30%

35%


Inco

me

tax

as %

of g

ross

ear

ning

s

@ 167% of AW@ 100% of AW@ 67% of AW

Source: OECD

Changes to treatment of families

• Independent taxation introduced 1990– part of an international trend away from family

taxation• Abolition of additional tax allowances for married

people and those with children• Tax credits bring support for children and low

earners into the tax system– spread of means-testing revives joint assessment– major delivery problems with latest (2003) reforms

National Insurance scheduleCombined employer and employee NICs, 2006 prices

£0£20£40

£60£80

£100£120£140

£160£180£200

£0 £200 £400 £600 £800 £1,000Weekly earnings

Wee

kly

NIC

s

1984-852006-07

Changes to National Insurance

More like income tax:• Abolition of ‘entry fee’• Entry point aligned with tax allowance• End of cap on contributions• Extension to benefits in kind• Erosion of the contributory principle

The burden of income tax + NICsFor single worker at multiples of average full-time earnings

0%

10%

20%

30%

40%

50%

60%


PIT

+ S

SC

as

% o

f gro

ss e

arni

ngs

@ 167% of AW@ 100% of AW@ 67% of AW

Main corporation tax rate

0%

10%

20%

30%

40%

50%

60%

1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

Changes to corporation tax

• Main rate cut (52%30%)• Small companies’ rate cut (40%19%)

– ill-fated experiment with 0% starting rate• Reduced capital allowances

– aim is to tax profit = revenue – expenses– expenses should include true economic depreciation– hard to measure so give fixed capital allowances instead– these deduct capital spending bit by bit over several years

• R&D tax credit introduced 2000• Rate cuts and base broadening is in line with international

trends

Taxation of corporations and shareholders 2005

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

UK79 UK05 EU15 OECD USA FRA GER JAP SWE IRE AUS CAN ITA

Top net income tax rate on dividendsMain corporation tax rate

Source: OECD

The corporation tax burdenEffective 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 machineryEATR, equity-financed plant and machinery

Source: Klemm (2005)

VAT

• Main rate 8%15% in 1979 and 17.5% in 1991– part of international move towards uniform

VAT

• UK has lots of zero-rated items– but uses reduced rates less than other

countries

VAT rates and bases

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

UK1980UK2003 EU15 OECD FRA GER JAP SWE IRE AUS ITA NZ

main VAT rate

c-efficiency ratio: revenue / (main rate x national accounts consumption)

Source: OECD

VAT

• Is this narrow base a good idea?• Atkinson-Stiglitz: if leisure is weakly separable from all

other goods, uniform VAT is optimal• May still be arguments for differential rates…

– if not separable, tax complements with leisure more to offset usual distortion towards leisure

– externality or merit good arguments

• But widespread distributional defence is just wrong– progressive income tax is more efficient tool for redistribution

Excise duties

• Fuel, alcohol and tobacco• Rates increased, yet share of revenues

declined (as in most other countries)– Rates fallen since 2000

• Fuel protests in 2000• Serious concerns about smuggling

Environmental taxes

• Various new environmental taxes introduced:– Air passenger duty (1994)– Landfill tax (1996) – Climate change levy (2001)– Aggregates levy (2002)– London congestion charge (2003)

• None of these raised more than £1bn in 2005– compared with £24bn (+ VAT) from fuel duty

• But revenues don’t tell the whole story

Environmental tax revenue, 2006-07

Fuel duty (+ VAT on duty)

Vehicle Excise Duty

Other

Property / local taxes• Council tax:

– Replaced poll tax in 1993 (previously domestic rates)– 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)

• Business rates:– Proportion of estimated market rent (unbanded, revalued) with

discounts for businesses with low rents– Centralised in 1990

• Lyons Inquiry report due on Wednesday

Distributional effect of the tax and benefit systemExcluding most ‘business taxes’

-40%

-20%

0%

20%

40%

60%

80%

Poorest 2nd 3rd 4th 5th 6th 7th 8th 9th RichestDecile group of equivalised household disposable income

Benefits - Taxes as % of original (private) income

Source: Authors’ calculations from ONS (2006)

Effect of tax and benefit system on income inequality1998, personal taxes and benefits only

0.0

0.1

0.2

0.3

0.4

0.5

0.6

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

Gin

i coe

ffici

ent

Private income Disposable income

Source: Immervol, Levy, Lietz, Mantovani, O’Donoghue, Sutherland and Verbist (2005)

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

79 81 83 85 87 89 91 93 95 97 99 01 03 05

Gin

i coe

ffici

ent

Private incomePrivate + benefitsPrivate + benefits - direct taxesPrivate + benefits - all taxes

Source: ONS (2002, 2006)

Effect of tax and benefit changes on income inequality

Personal direct taxes and benefits only, 1997-98 population

-0.01

0.00

0.01

0.02

0.03

0.04

0.05

0.06

79 81 83 85 87 89 91 93 95 97 99 01

Cum

ulat

ive

chan

ge in

Gin

i

relative to RPI upratingrelative to RPI uprating of taxes, GDP uprating of benefits

Source: Clark and Leicester (2004)

Work incentives among workers

Personal taxes and benefits only

40%

45%

50%

55%

60%

65%

70%

79 81 83 85 87 89 91 93 95 97 99 01 03

Mean effective marginal tax rateMean participation tax rate

Source: Adam (2005)

Work incentives among workers1998, 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• Starting point not obvious

– Tax all income (earnings and savings) equally?– Savers are rich so tax them more?– No…

• Saving is just deferral of consumption• Atkinson-Stiglitz again: under various assumptions, should tax

consumption today and consumption tomorrow the same• This implies no net tax on the normal return to saving• The assumptions are unrealistic, but it’s a useful benchmark

How not to tax saving

• Present value of lifetime earnings and expenditure are the same if all saving earns the normal return r

– Ignoring bequests: a tricky issue!

So three mechanisms:

1. Tax earnings, ignore savings completely: NICs2. Tax expenditure, ignore income completely: VAT3. Tax expenditure, calculated as:

earnings – net contributions into saving accounts

Income tax treatment of savingDefault is to tax returns to saving (interest, dividends, capital

gains) as well as earningsBut…• ISAs: returns tax-exempt (wage tax treatment)• Housing & other durables: ditto• Pensions: expenditure tax treatment

– contributions deducted from taxable income– returns within the fund untaxed– withdrawals (pension income) mostly taxed

These account for most saving for most people

Other taxes on saving• Savings cut entitlement to means-tested benefits• Other capital taxes

– council tax, inheritance tax, stamp duties

• Corporation tax– lots of savings are invested by companies– effective marginal tax rate (EMTR) depends on how far investment

and returns can be deducted from taxable profits– this varies:

• different types of investment (plant & machinery, buildings, R&D,…)• different methods of finance (debt, equity)

Company-level EMTRs, 2005

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

UK1979 UK2005 USA FRANCE GERMANY JAPAN

Equity-financed plant and machineryDebt-financed plant and machineryEquity-financed industrial buildings

Source: CVS (2005)

Conclusions• UK mostly in line with international trends

– Rise in overall tax burden since 1979– Income tax rates cut– Shift from excise duties to VAT– Corporation tax rates cut, base broadened – Shift from family to individual taxation

• Whether reforms have increased inequality depends what you mean by a “reform”!– Labour’s reforms (relative to price-indexation) have been progressive

but weakened work incentives• Distortions between different savings vehicles and forms of

investment have been reduced

Taxation in the UK

Stuart Adam