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Paul Lewis: Why do we value earnings less than wealth?

Paul Lewis

There are those who think any sort of taxation is unfair, especially when it applies to them. But one argument frequently used to object to taxes centres on double taxation. In other words, that they can tax the same income twice.

Take those who object to inheritance tax because their parents “worked hard and struggled to buy their home”. They argue the house was bought out of taxed income and so taxing it again when they die is taxing the same money twice.

But most of the value of a home today is a windfall gain due to the surrounding economy. And from 1983 until 2000, mortgage interest relief at source gave people tax relief on the interest they paid on their mortgage, so some of the cost was not paid out of taxed income at all.

IHT is, quite rightly, blind to the tax history of the assets taxed at death. In any case, only one in 23 estates pay IHT and new rules starting in April will exempt part of the value of a family home, keeping that percentage low despite rising house prices.

Also on double taxation, I came in for some stick recently after I wrote the tax on unearned income (savings interest and dividends on shares) was much less than the tax taken from a similar amount of earnings. In other words, income from work is taxed much more heavily than income generated by capital.

There are three specific rules that make unearned income worth a lot more after tax than earnings from work. First, interest on savings now has a specific tax-free allowance of £1,000 for basic rate taxpayers and £500 for those on higher rate, on top of the personal allowance of £11,500 (all figures 2017/18).

For those on very low incomes, up to £6,000 of interest can be tax-free. It works like this. If their other taxable income is the same as the personal allowance no tax is due on that. Another £5,000 of savings interest is then taxed at 0 per cent starting rate for savings and then another £1,000 is tax-free under the personal savings allowance. So, someone can have a total income of £17,500 entirely from savings and pay no tax. They could own around £1m in fixed-term cash deposits and pay no tax on the income. Second, dividends have a special allowance so the first £5,000 is tax-free (for now at least. From April 2018 this will drop down to £2,000). So, someone with no other income could have £16,500 of dividends and pay no tax. With typical FTSE dividend return around 3.5 per cent, that could mean shares worth almost £500,000 and no tax due.

Even when the dividends exceed £5,000 the balance up to £45,000 is taxed at just 7.5 per cent instead of the standard basic rate of 20 per cent. Someone whose only income is £45,000 of dividends from rather more than £1.25m of shares would pay just £2,138 income tax on it. Someone earning the same £45,000 would pay £6,700 income tax (£7,100 in Scotland as the threshold for earned income will be £43,000 in 2017/18).

Third, earnings also suffer the tax known as National Insurance. That would take another £4,420 from £45,000 earnings, leaving the worker with just £33,880 net income after all taxes compared with £42,863 net if the same income all came from dividends. So the person living entirely on investment income of £45,000 is £8,983 a year better off than the person who earns that money. Someone who works a full week to earn average pay of around £27,000 will pay £5,360 in tax and NI, leaving just £21,640 to spend. Someone sitting at home living purely on dividends of £27,000 will pay just £787 income tax, leaving them £4,573 better off than their working friend.

Now for the stick. A man called Mark emailed me the following: “Unearned income is derived from savings that have been made out of already taxed income. There is a limit to how many times tax can be applied to the same asset.” Mark concluded that favourable tax treatment of dividends and savings interest is, therefore, fair. His argument is faulty.

First, the savings or investments themselves are not being taxed. It is the interest or dividends they earn which are taxed. There is no double taxation of the same money.

Second, even if they were, double taxation is common in the tax system. When a basic rate taxpayer earns an extra £250 gross they pay £50 tax and £30 NI, leaving them with £170 net. If they then use that to buy a suit priced at £170, they are paying £141.67 to the shop and £28.33 VAT: tax taken from already taxed income. Finally, the money saved in a deposit account or invested in shares is not necessarily from earned or taxed income. It could be a windfall gain on the value of a home. It could come from an inheritance or untaxed capital gains. These are just as likely sources of wealth than saving up the taxed income from working.

Investment income used to be taxed more heavily than earnings because it was unearned. In 1972, Edward Heath’s government introduced a 15 per cent surcharge on investment income above £2,000. Add that to regular income tax between 30 per cent (up to £5,000 a year) and 75 per cent (over £20,000) to get a top tax rate on unearned income of 90 per cent. Two years later Denis Healey raised it to 98 per cent. In 1984, Nigel Lawson scrapped the investment income surcharge. Today, money earned by working is taxed more heavily than any other source of income. The conclusion? We value working and earning a living less than we value making money from wealth.

Paul Lewis is a freelance journalist and presenter of BBC Radio 4’s ‘Money Box’ programmeYou can follow him on Twitter @paullewismoney

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  1. With dividends or income from savings here, isn’t the point that the money invested has already been taxed. So the government got their share when you were paid and should only be entitled to a relatively small amount from whatever you can generate from your net income?

    • As Paul says in the article, the capital isn’t being taxed, so the “already been taxed” argument is irrelevant.

      I absolutely agree with Paul that there is something fundamentally unfair about someone who has to work for a living having to pay much more tax than someone who doesn’t. Wouldn’t it be fairer to have a flat rate of tax, to include NI, for all earnings?

      • Yes, i understand that the capital isn’t being taxed, just the income produced by it but the potential for income produced by that capital has already been reduced by tax in the first plate. My point is purely that anything that you get in your pay packet is already taxed so whatever you can manage to produce form an already reduced amount you should be entitled to a larger proportion.

  2. It’s almost as if wealthy baby boomers had designed a system to grow wealth and enjoy pensions funded from heavily taxed incomes of the young.

  3. “Today, money earned by working is taxed more heavily than any other source of income. The conclusion? We value working and earning a living less than we value making money from wealth.”

    Paul Lewis, our chief correspondent from Non-Sequituria reporting.

    By this argument, since bottled water is subject to VAT but Jaffa Cakes aren’t, we value Jaffa Cakes more highly than water. And lottery winnings are more valued than insurance. And heroin is more valued than booze.

    The reason it is a non-sequitur is that the government taxing things has nothing to do with whether we value them or not. The government taxes things because it wants the money and it takes some things and not others because they sit still long enough to be taxed efficiently.

    • An ‘we’ vote for government and the govt enact/represent our ‘wants’. So if it hasn’t been changed them obviously ‘we’ want it.

      It is still a non-sequitur I agree but you can see the relatively simple mental gymnastic required to arrive at the point.

  4. If you spend you will most likely land up paying VAT at 20%. So to say the income/capital/savings are not being taxed twice is not true. You pay income tax then VAT if you spend or tax on interest or dividends then VAT when you eventually spend those savings.

    Everything is taxed, what is fair is another issue. Many in the UK keep bashing on about tax the rich more, the rule of 80 – 20 will always apply. Currently 20% pay 80% of the taxed raised, 1% paying 27% of the tax take. They are not the ones constantly moaning, its the rest who have a massive benefit for very little contribution that continue to shot its not fair.

    After 36 years of work what I have learned is, what ever you do, however you try, you will pay tax, just accept it, you cannot win. It is about as much use worrying about it then believing one day we will have a system that does not waste Billions each year, gives those that do not deserve money and deprives those that do as there will never be enough to go around.

    • Martin, if any of us were in the 1% of course we wouldn’t be moaning. We would be laughing wouldn’t we? While those paying 20% probably have naff all to their name. What do you expect?

  5. Paul, your comment about double taxation also is faulty. One has a choice if and where they wish to send their money and if one decides to purchase a new suit WE have made that decision to buy the suit and increase HMRC coffers. If the choice is made by the Govt if we should be double taxed on savings etc we are not at liberty to do much about it, especially if one is living off the savings for retirement.

    We really have to be careful not to tax people to such a point that any incentive to better themselves financially is questioned. What about the family that have decided not to go on holiday, not to buy that new car, not to have sky tv and such like items. Do we penalise them for living a frugal lifestyle because they want to save for their old age?

    There has to be an incentive so people want to work, want to better themselves and their families and yes also pay fair taxes to help society. However not too be taxed so such an extent that you question why am I doing this.

    • “There has to be an incentive so people want to work”… I agree, but taxing them (as now) at much higher rates than people who don’t want to work is hardly an incentive.

    • Which is why work – which produces growth and wealth – should be taxed more lightly than idleness – which doesn’t.

      • Surely the simple reason that earned income is taxed more than unearned income is that their is a greater opportunity to tax earned income than unearned. Tax is simply income generation for the government of the day, looking at it as a measure of value is flawed. It’s extreme but look at childrens clothing and food – 0% VAT applicable. Do we therefore consider the clothing and feeding of children to be more important than adults? (don’t answer that, it’s hypothetical). Also note that it isn’t a case of their being no VAT on childrens clothes or food, there is, it is just 0% currently. Leaving the door open for the next government to up it should they need more money. Tax = income not value.

  6. Everybody will have a different perception of what is ‘fair’ ‘irrespective of whether this is a tax on ‘earnings’ or a tax on returns made on ‘wealth’ that may, or may not, have been accumulated from income or elsewhere.

    As a nation we have bills to pay. If we can pay them off, we can probably have less tax and also have the further debate about what is taxed, and whether we are better making the decisions ourselves rather than parting with as much cash and having politicians make decisions for us – the ideological arguments.

    Or we can default like Greece and never get a loan again when we might need one!

  7. We under value work and innovation, a mistake compounded in the recent hike in N.I. on self employed. Wealth generation and self-sufficiency on a micro basis makes for the most resilient economy..
    The dire consequences of favouring wealth over income are clearly seen in property – where non-productive assets suck all the reward of work in a fatally unjust way. The system has allowed the majority of property to be concentrated in very few hands, conspiring to rob the meagre wealth of the average person through exorbitant rent coming from constantly rising valuations. 2/3rds of the property (40m acres) in UK is owned by 6k people. If people lost less of their income in rent the economy would be stronger. Though not always, P Lewis is exactly on track here.

  8. Ah Paul Lewis, otherwise known as the Sheriff of Nottingham. lock up your chickens and turnips. there is no such thing as windfall profit with regard to this subject. Sucessisve governments encouraged people to buy houses, so offered tax relief on some of the interest, this eventually became known as MIRAS. No one said at the time the government would take it all back plus more form IHT, it was a very cheap option to help house building in the UK and it worked well. Money shouldn’t be taxed just because the government thinks it can, you cant just reach in and steal like the Sheriff Of Nottingham. The same with pensions, why is there a cap, we can understand the government wants to limit the amount of tax relief and there are many ways of achieving that outcome. So limit the tax relief but let people have as large a pension fund as they desire, not tax the excess at 55%. Lets have some common sense, and go away Paul Lewis with your left wing ideas, go back to being a hack and stop annoying the people who do a good job of offering advice.

    • History does indeed show the Sheriff of Nottingham as left-wing if not a Communist! Aren’t you confusing him with Robin Hood – steals from the rich gives to the poor? I agree with what you wrote about the Lifetime Allowance. Though I didn’t mention it in this piece. But you may have given me an idea. And I loved the demand that I should stop writing articles and “go back to being a hack”, and, er, write articles! I hope you are more accurate and logical in your professional life. As an IFA – which I always recommend – I am sure you are.

  9. Stuart Rathbone 9th March 2017 at 7:03 pm

    Dear dear Paul,

    You either are incredibly naive, lying through your teeth, or truly a useful idiot.

    It is obvious to anyone who understands how our society is constructed that those with power have the wealth and do not rely on income, so why when you control the levers of power would you set the system to your own disadvantage.

  10. Tax tax and more tax and that’s how most people see it. A 20% flat rate tax system would reduce the amount of tax for the majority and increase the overall tax take. As most higher earners wouldn’t try and dodge a fair system.

  11. My understanding is that taxation is the art of plucking as many feathers as is possible from the Goose without the Goose actually noticing. Bearing in mind a tax rate of 100% would gain nothing (as would a tax rate of 0%) each government surely looks to set tax rates as to take as much as possible for its own spending plans and for redistribution of wealth both for worthy reasons and less worthy reasons without being voted out at the following election (and the problem is everyone has a different definition of what is worthy). The tax take also reflects our own wealth and expectations as taxpayers of the society we want to live in. Our benefits and health system has grown due to what we consider to be normal for our society being of a higher level than it was previously and therefore so has it’s cost (anyone who feels the lower earning part of society of today are hard put upon needs to see what absolute poverty similar individuals of within living memory existed in).

    The problem with taxes is not how much overall is taken but the complexity which is baked in every budget and the level of ignorance of basic principles which exists amongst the general populace (for example not understanding the difference between deficit and debt, so they are not aware if the deficit is eliminated the debt remains). Simple and lower, but not lowest, rates tend to produce the higher levels of tax income.

    • Agree with that. Don’t let the ‘nationalisation’ of the population happen, the more ‘the government’ takes from us all because they know better how to spend it, the weaker the economy and the poorer we will all be. Take a look at France, very low growth, high unemployment, low inward investment etc…

      Do we want UK to become like that?

  12. Paul argues dividends are not being double-taxed, but he’s wrong, just not in the way he mentions in the article. Dividends are paid by companies from profits, and profits are taxed, so dividends are received by investors from money that has already been taxed at company level. The issue with regard to savings income is interesting, as I would argue there is considerable evidence that George introduced the additional tax-free allowances to help compensate for the artificially low rates of interest being earned on cash deposits as a result of QE – a political act to correct the adverse effects of another political act!

  13. On reading this I had to wonder if Paul had joined Jeremy Corbyn’s team.
    Sure there is inherited wealth and some people live on what is termed unearned income. So what!

    You work hard for (say) 45 years (or more) build up a business, save assidiously and then retire on the proceeds. (All having had tax deducted) You made the effort so that you could eventually benefit your children. They will probably pay a proportion in IHT, but why disparage them for thir good fortune? The politics of envy run rampant!

  14. Yes yes yes we know that companies pay dividends out of taxed income. But (usually) the company is a separate entity from the shareholder. So tax the company on its profits and the person on their income. Otherwise, to use my analogy, anyone who came in with taxed income to buy a suit should be exempt from VAT. A good, though standard, try to argue for the tax privileges for those who do not work to get their income but a moment’s clear thought demolishes it.

    • I think you also overlook the fact that for much of the working life of a Baby Boomer tax rates were staggeringly high. Top rate 83%. Basic rate 34% Then 40% with 5% increments up to 75% and then the jump to 83%.
      Many were caught in 45% band. Probably more than today. Add horrendius interest rates, credit control, currency restrictions. Investment income surcharge @ a further 15% making a total potential tax rate of 98%. Add in the top rate of CGT @ 50%.
      And who says that all businesses were incorporated and even if incoropoated the business owner and the company are not separate entities.
      These people are entitled to every penny and then if the choose to invest in the stockmarket with the money they have made why should the be pilloried as bloated plutocrats instead of being lauded as pillars of society. Your socialist utopia is not to everyone’s taste.

  15. This concept of houses making people a “Windfall” is overused. If you invest in a property portfolio then perhaps it is valid, but if I bought a house 15 years ago and its “price” doubled I still gave a house … I am no more wealthy regardless of the price. If I want my offspring to have that house when I die it matters not to me whether that house is priced at £200k or £400k, its a house & I didn’t benefit by the price going up.

    Govt’s and central banks manufacture inflation and then tax us on it (be it CGT or IHT) and people fall for it as a tax on a “Windfall”.

  16. The starting point for all governments and taxation should be ‘What is the least we can tax to best provide the basic level of services the economy requires, a ‘safety net’ for people who need help to get back to work and those who cannot afford healthcare, a defend the country from attack, provide infrastructure to move goods and people around, basic state pension if you have worked to earn it.
    What we actually get is successive governments from both sides coming up with more ways to increase the tax-take and decide on how OUR money, whether it’s earned or from investment, because they know how best to spend it.
    Higher taxation is part of the ‘nationalisation’ of the population, taking more and more decisions away from individuals and handing those decisions to various authorities and government bodies. The likes of Paul Lewis and others on the left love this as they are want this form of socialism to succeed.

  17. So, what about sitting at home day trading to earn unearned income? Does that not count as “work”?

  18. I think that Sascha protests too much… When presented with a threatening viewpoint – befuddle the masses with obscurity and scream “nonsense” or foul play?! Clearly governments want money so will tax anything they can but they also create perverse incentives for people not to work, not to invest and not to employ anyone! One of the biggest problems is that real work & earnings are taxed so heavily. Therefore sane people reduce their productivity or simply stop working as they are less likely to reap the rewards of their labour. I guess if you are not a self interested ‘baby boomer’ you might accept the sagacity of Paul Lewis’ article. Hmmm….

  19. All; this talk of income tax is a bit off beam. In fact 43% pay no income tax at all. This is approaching the Greek situation where 50% pay none (IMF).

    Our tax base is much wider than most and Income Tax only accounts for 27% of revenues. (compared to Denmark where the figure is 54% – how about that Paul!)

    Here in the UK we now have the highest tax burden for 40 years. All made up of a panoply of other taxes and stealth taxes.

    The upshot is that we are ALL too highly taxed, but our Governments (not just this one) don’t have the wit to square the circle and lower taxes and improve the economy.

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