Taxation in the UK

1. Taxation in the UK Stuart Adam

2. Outline Overview of the UK tax system in historical, international and theoretical contexts: • Level and composition of revenues • Structure of the major taxes • 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

3. The tax burden in the UK Source: HM Treasury

4. Tax to GDP ratiosTaxes and social security contributions Source: OECD

5. Composition of revenuesCurrent receipts, 2006-07 Source: HM Treasury

6. Composition of revenuesCurrent receipts Source: HM Treasury

7. Composition of revenues 2003Taxes and social security contributions Source: OECD

8. Income tax scheduleFor earned income, 2006 prices

9. 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

10. The income tax burdenFor single worker at multiples of average full-time earnings Source: OECD

11. 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

12. National Insurance scheduleCombined employer and employee NICs, 2006 prices

13. 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

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

15. Main corporation tax rate

16. 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

17. Taxation of corporations and shareholders 2005 Source: OECD

18. The corporation tax burdenEffective average tax rates and capital allowances 2005 Source: Klemm (2005)

19. 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

20. VAT rates and bases Source: OECD

21. 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

22. 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

23. 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

24. Environmental tax revenue, 2006-07

25. 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

26. Distributional effect of the tax and benefit systemExcluding most ‘business taxes’ Source: Authors’ calculations from ONS (2006)

27. Effect of tax and benefit system on income inequality1998, personal taxes and benefits only Source: Immervol, Levy, Lietz, Mantovani, O’Donoghue, Sutherland and Verbist (2005)

28. Effect of tax and benefit system on income inequalityExcluding most ‘business taxes’ Source: ONS (2002, 2006)

29. Effect of tax and benefit changes on income inequalityPersonal direct taxes and benefits only, 1997-98 population Source: Clark and Leicester (2004)

30. Work incentives among workersPersonal taxes and benefits only Source: Adam (2005)

31. Work incentives among workers1998, personal taxes and benefits only Source: Immervol, Kleven, Kreiner and Saez (2005)

32. 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

33. 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: • Tax earnings, ignore savings completely: NICs • Tax expenditure, ignore income completely: VAT • Tax expenditure, calculated as: earnings – net contributions into saving accounts

34. Income tax treatment of saving Default is to tax returns to saving (interest, dividends, capital gains) as well as earnings But… • 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

35. 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)

36. Company-level EMTRs, 2005 Source: Klemm (2005)

37. 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

38. Taxation in the UK Stuart Adam