Higher and lower
Reseach indicates that higher rates of tax can reduce the overall take as people look at reduction tactics
Well, the supposedly temporary 50 per cent additional rate of tax remains with us but is it performing its function? Is it achieving its objective?
We have had and considered (possibly not fully enough, given its depth) the Mirrlees review of taxation for the Institute of Fiscal Studies and there is a new(ish) report from the Centre for Economics and Business Research that casts further doubt on the effectiveness of the additional rate of tax. The said report looks into the impact of high-rate marginal tax on Treasury revenues.
The CEBR’s report, The 50p tax - Good Intentions, Bad Outcomes, examines how the revenue-maximising rate of income tax has changed since the 1980s. It has found that:
- A new generation of wealth creators has new legal choices because of digital banking and a creative wealth management industry which can mean that while their money is abroad they can remain working in the UK.
- New financial products now allow individuals to minimise their exposure to the 50 per cent rate of income tax.
- Britain has lost its place as an attractive, low-tax jurisdiction that welcomes wealth creators and has become one of the most punitive. Since 1997, the UK has already dropped from fourth position to 95th in the World Economic Forum’s tax competitiveness ratings.
- Other European countries are competing in a silent auction for the tax from high-earners.
- There is a danger that the 50p tax - combined with higher NICs and VAT, and restrictions on pensions - pushes British taxes over an important psychological threshold that breaks the covenant that wealth creators feel towards their domestic tax regime.
Britain’s 270,000 major wealth creators (the top 1 per cent of income taxpayers) contribute around £40bn of income tax a year, which is about 25 per cent of the £163bn paid in income tax to HM Revenue & Customs in total. The CEBR report suggests that a combination of higher VAT, higher National Insurance contributions and increased labour and capital mobility will push Britain’s wealth creators to use new tax-minimising opportunities and move their wealth else-where, leaving a vital gap in Britain’s revenue used to fund public services.
Furthermore, the CEBR’s calculations suggest that the revenue-maximising top rate of income tax is likely to be less than 40 per cent and that any taxation above this is likely to cost the Treasury billions of pounds over the coming years.
It predicts that even a conservative increase in the taxable income elasticity from 0.46 to 0.5 would reduce the revenue-maximising top rate of income tax to just 36 per cent, suggesting that the current 50 per cent rate of income tax does not raise any additional revenue for the Government.
Doug McWilliams, founder and chief executive of the CEBR, says: “Increased globalisation and easy access to wealth management services are enabling Britain’s wealth creators to minimise their tax liability in the UK.
“Our latest report concludes that the higher-rate 50p tax pushes Britain’s wealth creators past a psychological threshold that makes them more likely to explore and make use of these methods. In the long term, this could have devastating consequences for Government revenue as more money is likely to be lost rather than gained by the higher-rate tax.
“Our projections show that the 50p tax is set to lose the Treasury more than a billion a year by the middle of the decade.”
There is little doubt that the higher the tax rate the more likely individuals who are subject to it will be open to ways of avoiding and reducing it. The most drastic way may be to emigrate but, closer to home, the willingness to consider legitimate ways to reduce the effective rate of tax will increase.
Registered pensions together with the VCT and EIS (including the new SEIS) represent effective front-end tax-reducing investments.
For those couples with control over income and gains flow from their own business or investments, in addition to the tax-reducing capacity of investment in EISs and VCTs, there is likely to be some very low-hanging fruit in relation to tax reduction.
Don’t forget that, in the not too distant future, we are likely to see a £10,000 personal income tax allowance opening up the possibility of a meaningful, completely taxfree pension for a spouse who may otherwise have no or little otherwise taxable income in retirement.
Having a pension flow that is tax-free for a couple, as opposed to being taxable, could double the net pension received.
The Isa is a must on any tax planner’s list and the tax-deferment qualities of investment bonds and appropriate collectives are worthy of consideration. I could go on… but I think you get the picture.
Higher rates of tax encourage higher interest in legitimately avoiding or deferring it.