IFS
Taxation in the UK
Stuart Adam
Outline
Overview of the UK tax system in historical, international and
theoretical contexts:
1.
2.
3.
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
© Institute for Fiscal Studies, 2007
The tax burden in the UK
46%
44%
% of GDP
42%
40%
38%
36%
34%
32%
30%
79
81
83
85
87
89
91
Public sector total receipts
Line 3
Source: HM Treasury
© Institute for Fiscal Studies, 2007
93
95
97
99
01
03
05
Net taxes and SSCs
Line 4
07
09
11
Tax to GDP ratios
Taxes and social security contributions
60%
1979
2003
50%
40%
30%
20%
10%
0%
UK
EU15 OECD
Source: OECD
© Institute for Fiscal Studies, 2007
USA
FRA
GER
JAP
SWE
IRE
AUS
CAN
ITA
Composition of revenues
Current 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
© Institute for Fiscal Studies, 2007
Composition of revenues
Current receipts
100%
Other receipts
90%
80%
Other capital taxes
70%
Recurrent buildings taxes
60%
Corporation tax
50%
Other indirect taxes
40%
VAT
30%
20%
National Insurance
10%
Income tax + CGT
0%
1978-79
Source: HM Treasury
© Institute for Fiscal Studies, 2007
2006-07
Composition of revenues 2003
Taxes and social security contributions
100%
Other taxes
90%
Other capital taxes
80%
Recurrent buildings taxes
70%
60%
Corporation tax
50%
Other indirect taxes
40%
VAT / retail sales taxes
30%
SSCs + payroll taxes
20%
Income tax + CGT
10%
0%
UK EU15 OECD USA FRA GER JAP SWE IRE
Source: OECD
© Institute for Fiscal Studies, 2007
AUS CAN
ITA
Income tax schedule
For earned income, 2006 prices
£60,000
1978-79
Income tax liability
£50,000
2006-07
£40,000
£30,000
£20,000
£10,000
£0
£0
£20,000
£40,000
£60,000
Gross income
© Institute for Fiscal Studies, 2007
£80,000
£100,000
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
© Institute for Fiscal Studies, 2007
The income tax burden
For single worker at multiples of average full-time earnings
Income tax as % of gross earnings
35%
@ 167% of AW
@ 100% of AW
@ 67% of AW
30%
25%
20%
15%
10%
5%
0%
UK
Source: OECD
© Institute for Fiscal Studies, 2007
EU15 OECD
USA
FRA
GER
JAP
SWE
IRE
AUS
CAN
ITA
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
© Institute for Fiscal Studies, 2007
National Insurance schedule
Combined employer and employee NICs, 2006 prices
Weekly NICs
£200
£180
1984-85
£160
2006-07
£140
£120
£100
£80
£60
£40
£20
£0
£0
£200
£400
£600
Weekly earnings
© Institute for Fiscal Studies, 2007
£800
£1,000
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
© Institute for Fiscal Studies, 2007
The burden of income tax + NICs
For single worker at multiples of average full-time earnings
@ 167% of AW
@ 100% of AW
@ 67% of AW
PIT + SSC as % of gross earnings
60%
50%
40%
30%
20%
10%
0%
UK
© Institute for Fiscal Studies, 2007
EU15 OECD
USA
FRA
GER
JAP
SWE
IRE
AUS
CAN
ITA
Main corporation tax rate
60%
50%
40%
30%
20%
10%
0%
1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
© Institute for Fiscal Studies, 2007
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
© Institute for Fiscal Studies, 2007
Taxation of corporations and
shareholders 2005
100%
90%
Top net income tax rate on dividends
80%
Main corporation tax rate
70%
60%
50%
40%
30%
20%
10%
0%
UK79 UK05 EU15 OECD USA
Source: OECD
© Institute for Fiscal Studies, 2007
FRA
GER
JAP
SWE
IRE
AUS
CAN
ITA
The corporation tax burden
Effective average tax rates and capital allowances 2005
100%
Capital allowances (p.d.v.), plant and machinery
EATR, equity-financed plant and machinery
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
UK79
UK05
Source: Klemm (2005)
© Institute for Fiscal Studies, 2007
USA
FRA
GER
JAP
SWE
IRE
AUS
CAN
ITA
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
© Institute for Fiscal Studies, 2007
VAT rates and bases
100%
main VAT rate
90%
c-efficiency ratio: revenue / (main rate x national accounts consumption)
80%
70%
60%
50%
40%
30%
20%
10%
0%
UK1980 UK2003 EU15
Source: OECD
© Institute for Fiscal Studies, 2007
OECD
FRA
GER
JAP
SWE
IRE
AUS
ITA
NZ
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
© Institute for Fiscal Studies, 2007
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
© Institute for Fiscal Studies, 2007
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
© Institute for Fiscal Studies, 2007
Environmental tax revenue, 2006-07
Fuel duty (+ VAT on duty)
Vehicle Excise Duty
Other
© Institute for Fiscal Studies, 2007
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
© Institute for Fiscal Studies, 2007
Distributional effect of the tax and
benefit system
Excluding most ‘business taxes’
80%
Benefits - Taxes as % of original (private) income
60%
40%
20%
0%
-20%
-40%
Poorest
2nd
3rd
4th
5th
6th
7th
8th
9th
Decile group of equivalised household disposable income
Source: Authors’ calculations from ONS (2006)
© Institute for Fiscal Studies, 2007
Richest
Effect of tax and benefit system on
income inequality
1998, personal taxes and benefits only
0.6
Private income
Disposable income
Gini coefficient
0.5
0.4
0.3
0.2
0.1
0.0
UK EU15 Aus
Bel
Den
Fin
Fra
Ger
Gre
Ire
Ita
Lux Neth Por
Source: Immervol, Levy, Lietz, Mantovani, O’Donoghue, Sutherland and Verbist (2005)
© Institute for Fiscal Studies, 2007
Spa Swe
Effect of tax and benefit system on
income inequality
Excluding most ‘business taxes’
0.6
Gini coefficient
0.5
0.4
0.3
Private
Private
Private
Private
0.2
0.1
income
+ benefits
+ benefits - direct taxes
+ benefits - all taxes
0.0
79
81
Source: ONS (2002, 2006)
© Institute for Fiscal Studies, 2007
83
85
87
89
91
93
95
97
99
01
03
05
Effect of tax and benefit changes on
income inequality
Personal direct taxes and benefits only, 1997-98 population
relative to RPI uprating
relative to RPI uprating of taxes, GDP uprating of benefits
Cumulative change in Gini
0.06
0.05
0.04
0.03
0.02
0.01
0.00
-0.01
79
81
83
Source: Clark and Leicester (2004)
© Institute for Fiscal Studies, 2007
85
87
89
91
93
95
97
99
01
Work incentives among workers
Personal taxes and benefits only
70%
Mean effective marginal tax rate
65%
Mean participation tax rate
60%
55%
50%
45%
40%
79
81
Source: Adam (2005)
© Institute for Fiscal Studies, 2007
83
85
87
89
91
93
95
97
99
01
03
Work incentives among workers
1998, personal taxes and benefits only
80%
Mean effective marginal tax rate
Mean participation tax rate
75%
70%
65%
60%
55%
50%
45%
40%
35%
30%
UK EU15 Aus
Bel
Den
Fin
Fra
Source: Immervol, Kleven, Kreiner and Saez (2005)
© Institute for Fiscal Studies, 2007
Ger
Gre
Ire
Ita
Lux
Neth
Por
Spa Swe
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
© Institute for Fiscal Studies, 2007
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: NICs
2. Tax expenditure, ignore income completely: VAT
3. Tax expenditure, calculated as:
earnings – net contributions into saving accounts
© Institute for Fiscal Studies, 2007
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
© Institute for Fiscal Studies, 2007
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:
•
•
© Institute for Fiscal Studies, 2007
different types of investment (plant & machinery, buildings, R&D,…)
different methods of finance (debt, equity)
Company-level EMTRs, 2005
80%
60%
Equity-financed plant and machinery
Debt-financed plant and machinery
Equity-financed industrial buildings
40%
20%
0%
-20%
-40%
-60%
-80%
UK1979
Source: Klemm (2005)
© Institute for Fiscal Studies, 2007
UK2005
USA
FRANCE
GERMANY
JAPAN
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
© Institute for Fiscal Studies, 2007
IFS
Taxation in the UK
Stuart Adam