HOW THE DEBATE OVER TAX IS BASED ON IGNORANCE AND MYTH
The debate over flat taxes is flawed by the belief that they favour the rich. Countering this belief and the associated belief that the ‘rich’ pay the highest taxes at present, is the most important step to putting the debate over flat taxes on a proper basis.
Unfortunately, many of the most eminent confuse the ‘rich’ with those with high incomes or even high earnings, let alone high taxable earnings or high taxable incomes.
EMBARRASSING QUOTATIONS
Let us examine a selection of quotations.
Kenneth Clarke in the Daily Telegraph, 22/9/05, is reported as addressing the Centre for Social Justice that the Tories: ‘had no licence from the voters to shake up public services because many people still suspect we just want to privatise them in order to save money and then cut taxes for our rich friends’. The former Chancellor, who should know better, confuses high taxable incomes with being rich and also seems to believe the rich pay high taxes.
One would expect the New Statesman (Nick Pearce, 12/9/05) to take the same view. ‘If a no-lose guarantee is introduced for low earners, then a flat tax simply becomes a tax cut for the rich’.
The same confusion occurred in Philip Stephens’ article in the Financial Times (13/9/05) ‘Conversely, the big gains from abolishing the top rate of income tax go to the richest’. Once again, high taxable incomes are confused with ‘riches’ and the assumption is that the richest pay the highest taxes.
Even the leaked Treasury Paper (Daily Telegraph 19/8/05) stated ‘opponents, therefore, argue that a flat tax structure is beneficial to the rich and damaging for the poor’.
The reality is that the rich are not heavily taxed. It is the middle classes who pay for the poor, especially the educated upper income middle classes. For example, we read that the average GP gets £100,000p.a. and consultants average £90,000p.a. and there are around 56,000 of these. Yet only 1% of UK incomes (about 300,000) are over £107,000 per annum. The medics probably just fall outside the top 1% of UK incomes but certainly fall into the top 2%. However, it would be hard to call most GPs and consultants ‘rich’ even if, for a time in their working lives, they may have high earnings.
HISTORY OF TAXES
The history of taxes is instructive. They were indeed originally levied on the rich via land taxes. The idea of taxes as a good was made popular and sold progressively to the increasing electorate of the nineteenth and twentieth centuries by promoting the idea that taxes were to be paid by the better off, comprising the rich and high income earners which was, of course, popular with the mass electorate. In reality taxes ended up punishing those who voted for them, the poor and the middle classes.
The problem was that governments measured their success by expanding into new spending areas and as their appetite grew, taxes soon needed to be levied on the middle classes and the poor.
Every time governments tried to take money from the rich or the tiny echelon of high income earners, these people did not simply comply, they acted. They had the money, the power and the motivation to do something. They did not simply pay up, they acted perfectly legally to minimize their tax burdens with professional help by using tax concessions, promoting new tax loopholes and so arranging their affairs as to minimize the tax take.
REGRESSIVE TAXATION
So, high taxation became regressive taxation. The fact that the ‘rich’ pay less proportionate tax is hardly novel. Nick Pearce of the New Statesman refers to it without putting forward any alternatives and taking it as a mater of fact. Even Mathew Taylor, MP, at the LibDem Conference stated, also quite as a matter of fact, that ‘the rich are paying right now less tax as a proportion of their income’ even though apparently he was referring to the sum of direct and indirect taxation. To be fair to the LibDems, there are stirrings among their better thinkers that the idea of a flat tax is worth examining. At the other end of the scale in passivity, we have a combination of Ken Clarke, the New Statesman and the Financial Times, confusing a flow (of income) with a stock (of riches).
It is unclear what taxes Mathew Taylor was referring to at the LibDem Conference but it is a matter of fact that the percentage of total income paid in total taxes is higher for lower incomes than higher incomes, mainly because indirect taxes fall most heavily on poorer groups.
Britain in Numbers analyses the figures for total taxes paid of total income per quintile groups of households as:
Bottom quintile 37.9%
Second 32.2%
Third 34.7%
Fourth 35.5%
Fifth 35.1%
But we are not concerned here with the impact of total taxation, but of income tax and also National Insurance Contributions, which are the main direct taxes on income.
DIRECT TAXES
While it is generally known, although a reality hardly promoted in political discussions, that, taking all taxes together, the tax burden proportion to income is ‘flat’ in total including all taxes, both direct and indirect, there seem to be a number of myths regarding the direct tax burden widely believed by politicians and the commentariat. These are:
FLAT TAXES
Taking direct income tax and employee national insurance contributions, together, the difference between the rate of tax on marginal income between standard rate and higher rate taxpayer, is not as great as thought.
Standard Rate Taxes on Incomes:
Income Tax 22.0%
Employee’s National Insurance 11.0%
Total marginal tax rate 33.0%
A. Higher Rate Taxes on Earnings (PAYE)
Income Tax 40.0%
Employee’s National Insurance 1.0%
41.0%
B. Higher Rate Taxes on (Non PAYE) Earnings
Income Tax 40.0%
NIC 1.0%
41.0%
Interest saved by paying in arrears:
7 months (gross interest at 4.5% less 40% tax for 7 months) (0.63%)
Effective Rate 40.37%
C. Higher Rate Taxes on Incomes from Property, Interest, etc.
Income Tax 40.0%
Interest Saving, as above (0.63%)
Effective Rate 39.37%
D. Dividend Income. This is the only class of income where there is a substantial difference in tax rates between the standard rate and higher rate taxpayer. The standard rate taxpayer pays an effective rate of 30% on corporate income distributed in dividends while the higher rate taxpayer pays 47.5% (large companies rate) (including Corporation Tax on profits).
So, even looking at direct tax, the effective tax and National Insurance Contribution rates for higher rate taxpayers are 7.37% on average higher than for a standard rate taxpayer, except for dividend income.
Additionally, most tax concessions are far more useful to, and much more used by, higher rate taxpayers.
These include:
So, the higher rate taxpayer can shelter some of his income in pension contributions, gradually build up a dividend stream which does not bear higher rate tax in ISA’s and get relief on his savings via VCT investment and CGT reliefs.
When one takes all the above into account, the effective tax rate difference is likely to be already very small between a standard rate taxpayer and a higher rate taxpayer.
Advocating a flat tax at this point and, following the above analysis, clearly needs a simultaneous reform of the National Insurance system – probably its abolition except in the pension field.
THE RICH
While degrees of wealthiness are in the eyes of the beholder, the earner of £107,000 per annum, say a successful hospital consultant, putting him in the top 1% of UK earners, would not normally consider himself rich. After all, his net earnings are reduced by taxation to £74,000 (Britain in Numbers); he pays a pension contribution, a mortgage, possibly private school fees between £8,000-20,000 p.a.
When one considers the seriously rich, those with substantial assets, the objections of Ken Clarke, the New Statesmen and the Financial Times to a flat tax look even more jaded.
The rich do not pay high taxes because they do not have high taxable incomes.
There are two reasons for this. If you are really rich and you are involved with yachts, race horses, old master paintings, grouse moors, antiques, expensive houses, hobby farms, etc. it is plain that these sort of assets do not generate substantial income. This is the lifestyle of the traditional rich British person. It is based now on inheritance and avoiding inheritance taxes by use of trusts.
Another reason, given to me by an IFA (Independent Financial Advisor), was that ‘the seriously Rich are offshore’. While this is not entirely true and many traditional British wealthy people do not have wealth offshore, most new entrepreneurial fortunes have at least some, if not all, their wealth offshore. Some of the rich have gone non-residential. When the Rolling Stones had to cancel a tour in the UK some years ago because they would have fallen foul of non-residence rules, it turned out that no less than 240 people in the Rolling Stones’ show were all going offshore, at least temporarily. Other big names offshore are Richard Branson, Philip Green, Sean Connery, Geoffrey Robinson, MP.
In the past, going offshore was to avoid paying British income tax on income earned in other parts of the world. Now being offshore minimises taxes on British income. Britain’s Corporation Tax regime, with a separate tax on dividends (32%) not paid by non-residents, contributes to a situation where over a third of dividends are now paid without tax deductions to overseas shareholders. Commonsense shows that such a situation where the non-British shareholder is financially better off than the British shareholder will gradually lead to the selling out of British shareholders to foreign based shareholders. This is happening now.
A reform of the domicile and residence laws was promised by Labour but, eventually, the government failed to act. The arrival of a low rate flat tax would be the opportunity to end much of this tax avoidance while offering such reasonable tax rates that all the cost and inconvenience of going ‘offshore’ would be avoided.
These should also be positive measures. In Sweden, taxpayers payments used to be published and, of course, were therefore published in newspapers. High tax contributions were a source of pride. The government here should consider publication of tax payments and go further. It should, for example, offer knighthoods each year to the top twenty taxpayers with lower honours for the next 500 as recognition of their contribution to the common good. This would be far more acceptable than the current system of offering honours to contributors to political party funds.
HEADLINES AND REALITY
The difference between the standard rate of 22% and the higher rate of tax at 40% seems large. In fact it is much less:
FUTURUS/13 March 2006
Unfortunately, many of the most eminent confuse the ‘rich’ with those with high incomes or even high earnings, let alone high taxable earnings or high taxable incomes.
EMBARRASSING QUOTATIONS
Let us examine a selection of quotations.
Kenneth Clarke in the Daily Telegraph, 22/9/05, is reported as addressing the Centre for Social Justice that the Tories: ‘had no licence from the voters to shake up public services because many people still suspect we just want to privatise them in order to save money and then cut taxes for our rich friends’. The former Chancellor, who should know better, confuses high taxable incomes with being rich and also seems to believe the rich pay high taxes.
One would expect the New Statesman (Nick Pearce, 12/9/05) to take the same view. ‘If a no-lose guarantee is introduced for low earners, then a flat tax simply becomes a tax cut for the rich’.
The same confusion occurred in Philip Stephens’ article in the Financial Times (13/9/05) ‘Conversely, the big gains from abolishing the top rate of income tax go to the richest’. Once again, high taxable incomes are confused with ‘riches’ and the assumption is that the richest pay the highest taxes.
Even the leaked Treasury Paper (Daily Telegraph 19/8/05) stated ‘opponents, therefore, argue that a flat tax structure is beneficial to the rich and damaging for the poor’.
The reality is that the rich are not heavily taxed. It is the middle classes who pay for the poor, especially the educated upper income middle classes. For example, we read that the average GP gets £100,000p.a. and consultants average £90,000p.a. and there are around 56,000 of these. Yet only 1% of UK incomes (about 300,000) are over £107,000 per annum. The medics probably just fall outside the top 1% of UK incomes but certainly fall into the top 2%. However, it would be hard to call most GPs and consultants ‘rich’ even if, for a time in their working lives, they may have high earnings.
HISTORY OF TAXES
The history of taxes is instructive. They were indeed originally levied on the rich via land taxes. The idea of taxes as a good was made popular and sold progressively to the increasing electorate of the nineteenth and twentieth centuries by promoting the idea that taxes were to be paid by the better off, comprising the rich and high income earners which was, of course, popular with the mass electorate. In reality taxes ended up punishing those who voted for them, the poor and the middle classes.
The problem was that governments measured their success by expanding into new spending areas and as their appetite grew, taxes soon needed to be levied on the middle classes and the poor.
Every time governments tried to take money from the rich or the tiny echelon of high income earners, these people did not simply comply, they acted. They had the money, the power and the motivation to do something. They did not simply pay up, they acted perfectly legally to minimize their tax burdens with professional help by using tax concessions, promoting new tax loopholes and so arranging their affairs as to minimize the tax take.
REGRESSIVE TAXATION
So, high taxation became regressive taxation. The fact that the ‘rich’ pay less proportionate tax is hardly novel. Nick Pearce of the New Statesman refers to it without putting forward any alternatives and taking it as a mater of fact. Even Mathew Taylor, MP, at the LibDem Conference stated, also quite as a matter of fact, that ‘the rich are paying right now less tax as a proportion of their income’ even though apparently he was referring to the sum of direct and indirect taxation. To be fair to the LibDems, there are stirrings among their better thinkers that the idea of a flat tax is worth examining. At the other end of the scale in passivity, we have a combination of Ken Clarke, the New Statesman and the Financial Times, confusing a flow (of income) with a stock (of riches).
It is unclear what taxes Mathew Taylor was referring to at the LibDem Conference but it is a matter of fact that the percentage of total income paid in total taxes is higher for lower incomes than higher incomes, mainly because indirect taxes fall most heavily on poorer groups.
Britain in Numbers analyses the figures for total taxes paid of total income per quintile groups of households as:
Bottom quintile 37.9%
Second 32.2%
Third 34.7%
Fourth 35.5%
Fifth 35.1%
But we are not concerned here with the impact of total taxation, but of income tax and also National Insurance Contributions, which are the main direct taxes on income.
DIRECT TAXES
While it is generally known, although a reality hardly promoted in political discussions, that, taking all taxes together, the tax burden proportion to income is ‘flat’ in total including all taxes, both direct and indirect, there seem to be a number of myths regarding the direct tax burden widely believed by politicians and the commentariat. These are:
- The rich have high taxable incomes.
- The rich pay high taxes.
- There is a big difference in rates of tax between what is paid on marginal income by the standard rate taxpayer and the higher rate taxpayer..
FLAT TAXES
Taking direct income tax and employee national insurance contributions, together, the difference between the rate of tax on marginal income between standard rate and higher rate taxpayer, is not as great as thought.
Standard Rate Taxes on Incomes:
Income Tax 22.0%
Employee’s National Insurance 11.0%
Total marginal tax rate 33.0%
A. Higher Rate Taxes on Earnings (PAYE)
Income Tax 40.0%
Employee’s National Insurance 1.0%
41.0%
B. Higher Rate Taxes on (Non PAYE) Earnings
Income Tax 40.0%
NIC 1.0%
41.0%
Interest saved by paying in arrears:
7 months (gross interest at 4.5% less 40% tax for 7 months) (0.63%)
Effective Rate 40.37%
C. Higher Rate Taxes on Incomes from Property, Interest, etc.
Income Tax 40.0%
Interest Saving, as above (0.63%)
Effective Rate 39.37%
D. Dividend Income. This is the only class of income where there is a substantial difference in tax rates between the standard rate and higher rate taxpayer. The standard rate taxpayer pays an effective rate of 30% on corporate income distributed in dividends while the higher rate taxpayer pays 47.5% (large companies rate) (including Corporation Tax on profits).
So, even looking at direct tax, the effective tax and National Insurance Contribution rates for higher rate taxpayers are 7.37% on average higher than for a standard rate taxpayer, except for dividend income.
Additionally, most tax concessions are far more useful to, and much more used by, higher rate taxpayers.
These include:
- Tax relief on pension contributions
- The annual exemption on Capital Gains Tax
- Investments Relief on VCT’s
- Sheltering of income by ISA’s
- Capital Gains Tax is paid in arrears (16 months average) meaning the effective rate is about 38.5%, not the nominal 40%
- Numerous other reliefs and concessions.
So, the higher rate taxpayer can shelter some of his income in pension contributions, gradually build up a dividend stream which does not bear higher rate tax in ISA’s and get relief on his savings via VCT investment and CGT reliefs.
When one takes all the above into account, the effective tax rate difference is likely to be already very small between a standard rate taxpayer and a higher rate taxpayer.
Advocating a flat tax at this point and, following the above analysis, clearly needs a simultaneous reform of the National Insurance system – probably its abolition except in the pension field.
THE RICH
While degrees of wealthiness are in the eyes of the beholder, the earner of £107,000 per annum, say a successful hospital consultant, putting him in the top 1% of UK earners, would not normally consider himself rich. After all, his net earnings are reduced by taxation to £74,000 (Britain in Numbers); he pays a pension contribution, a mortgage, possibly private school fees between £8,000-20,000 p.a.
When one considers the seriously rich, those with substantial assets, the objections of Ken Clarke, the New Statesmen and the Financial Times to a flat tax look even more jaded.
The rich do not pay high taxes because they do not have high taxable incomes.
There are two reasons for this. If you are really rich and you are involved with yachts, race horses, old master paintings, grouse moors, antiques, expensive houses, hobby farms, etc. it is plain that these sort of assets do not generate substantial income. This is the lifestyle of the traditional rich British person. It is based now on inheritance and avoiding inheritance taxes by use of trusts.
Another reason, given to me by an IFA (Independent Financial Advisor), was that ‘the seriously Rich are offshore’. While this is not entirely true and many traditional British wealthy people do not have wealth offshore, most new entrepreneurial fortunes have at least some, if not all, their wealth offshore. Some of the rich have gone non-residential. When the Rolling Stones had to cancel a tour in the UK some years ago because they would have fallen foul of non-residence rules, it turned out that no less than 240 people in the Rolling Stones’ show were all going offshore, at least temporarily. Other big names offshore are Richard Branson, Philip Green, Sean Connery, Geoffrey Robinson, MP.
In the past, going offshore was to avoid paying British income tax on income earned in other parts of the world. Now being offshore minimises taxes on British income. Britain’s Corporation Tax regime, with a separate tax on dividends (32%) not paid by non-residents, contributes to a situation where over a third of dividends are now paid without tax deductions to overseas shareholders. Commonsense shows that such a situation where the non-British shareholder is financially better off than the British shareholder will gradually lead to the selling out of British shareholders to foreign based shareholders. This is happening now.
A reform of the domicile and residence laws was promised by Labour but, eventually, the government failed to act. The arrival of a low rate flat tax would be the opportunity to end much of this tax avoidance while offering such reasonable tax rates that all the cost and inconvenience of going ‘offshore’ would be avoided.
These should also be positive measures. In Sweden, taxpayers payments used to be published and, of course, were therefore published in newspapers. High tax contributions were a source of pride. The government here should consider publication of tax payments and go further. It should, for example, offer knighthoods each year to the top twenty taxpayers with lower honours for the next 500 as recognition of their contribution to the common good. This would be far more acceptable than the current system of offering honours to contributors to political party funds.
HEADLINES AND REALITY
The difference between the standard rate of 22% and the higher rate of tax at 40% seems large. In fact it is much less:
- Most standard rate taxpayers’ income comes from earnings.
- Employees’ National Insurance contributions are paid at 11% up to £32,760 and 1% above £32,760.
- Many higher rate taxes are paid in arrears with consequent reductions due to interest receivable while tax payments are delayed.
- Most tax concessions are more useful to, and more used by, high rate taxpayers.
- The real difference between standard income marginal rate and higher income marginal rates for tax and National Insurance combined (except for dividends) is between 33% and 40.37% respectively.
- Much of serious wealth is offshore and protected by the domicile and residence laws.
- Many of the assets of the rich are low income providers but tend to appreciate their value in capital terms.
- Flat Tax Reform must include reform of Employees National Insurance Contributions or else it would, indeed, be ‘unfair’.
- Those who pay high taxes should be recognised with public honours.
FUTURUS/13 March 2006