IFS Taxation in the UK Stuart Adam IFS

IFS Taxation in the UK Stuart Adam (IFS) James Browne (IFS) Chris Heady (OECD)

The chapter • Overview of the UK tax system in historical, international and theoretical contexts: 1. Level and composition of revenues 2. Structure of the major taxes 3. Economic aspects of the overall tax (and benefit) system: – – – • • Effect on the income distribution Effect on work incentives How close to an expenditure tax? Watch for overlap with other chapters! See also IFS’s Survey of the UK tax system – © Institute for Fiscal Studies, 2006 www. ifs. org. uk/bns/bn 09. pdf

The tax burden in the UK © Institute for Fiscal Studies, 2006

Tax to GDP ratios Taxes and social security contributions © Institute for Fiscal Studies, 2006

Composition of revenues Current receipts © Institute for Fiscal Studies, 2006

Composition of revenues 2003 Taxes and social security contributions © Institute for Fiscal Studies, 2006

Income tax schedule For earned income, 2006 prices © Institute for Fiscal Studies, 2006

Changes to PIT 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, 2006

The income tax burden For single worker at multiples of average full-time earnings © Institute for Fiscal Studies, 2006

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 – major delivery problems with latest (2003) reforms © Institute for Fiscal Studies, 2006

National Insurance schedule Combined employer and employee NICs, 2006 prices © Institute for Fiscal Studies, 2006

Changes to NICs More like income tax: • Abolition of ‘entry fee’ • End of cap on contributions • Alignment of entry point with PIT allowance • Extension to benefits in kind • Erosion of the contributory principle © Institute for Fiscal Studies, 2006

The burden of PIT + SSC For single worker at multiples of average full-time earnings © Institute for Fiscal Studies, 2006

Main corporation tax rate © Institute for Fiscal Studies, 2006

Changes to corporation tax • • Main rate cut (52% 30%), part of a continuing international trend Small companies’ rate cut (40% 19%) – ill-fated experiment with 0% starting rate • Reduced capital allowances, part of an international trend of basebroadening to finance rate cuts – for plant and machinery, immediate 100% write-down replaced by 25% annual declining-balance • • R&D tax credit introduced 2000 Payments system reformed 1999 (abolition of ACT) Taxation of dividends at the shareholder level: • Tax credit cuts effective basic rate to 0%, higher rate to 25% • Not payable to tax-exempt shareholders since 1997 (2004 for ISAs) • Other EU countries have also reduced use of imputation, to finance rate cuts and comply with EU rules © Institute for Fiscal Studies, 2006

Taxation of corporations and shareholders 2005 © Institute for Fiscal Studies, 2006

The corporate tax burden Effective average tax rates and capital allowances 2005 Source: Klemm (2005) © Institute for Fiscal Studies, 2006

VAT • Main rate 8% 15% in 1979 and 17. 5% in 1991 – part of international move from excise duties towards VAT • Some base broadening overall – domestic fuel brought in at a reduced rate in 1994 – slight narrowing since 1997: reduced rate cut to 5% and extended to a few previously full-rate items – still very narrow by international standards • EU commitments • Serious concerns about ‘carousel fraud’ © Institute for Fiscal Studies, 2006

VAT rates and bases © Institute for Fiscal Studies, 2006

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, 2006

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 raises more than £ 1 bn – compared with £ 24 bn (+ VAT) from fuel duty © Institute for Fiscal Studies, 2006

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 • Local government finance currently under review – Reformed council tax, relocalised business rates, local income tax main options being considered © Institute for Fiscal Studies, 2006

Part of an international trend? YES: • Cuts in top and basic rates of income tax • Shift from duties on specific goods towards VAT • Corporate tax rates cut, base broadened • Shift from family to individual taxation • In-work support through the tax system • SSC rates up even as PIT rates down – But for different reasons: UK seems largely political, while elsewhere caused by rises in commitments (health, pensions etc) for which SSCs earmarked • Introduction of environmental taxes NO: • (Re-)introduction of starting rate of income tax – International trend (and UK in the 80 s) to reduce number of bands • • Unusual in removing mortgage interest relief Increasing centralisation not matched elsewhere © Institute for Fiscal Studies, 2006

Distributional effect of the tax and benefit system Excluding most ‘business taxes’ Source: Authors’ calculations from ONS (2006) © Institute for Fiscal Studies, 2006

Effect of tax and benefit system on income inequality 1998, personal taxes and benefits only Source: Immervol, Levy, Lietz, Mantovani, O’Donoghue, Sutherland Verbist (2005) © Institute for Fiscal Studies, 2006

Effect of tax and benefit system on income inequality Excluding most ‘business taxes’ Source: ONS (2002, 2006) © Institute for Fiscal Studies, 2006

Effect of tax and benefit changes on income inequality Personal direct taxes and benefits only, 1997 -98 population Source: Clark and Leicester (2004) © Institute for Fiscal Studies, 2006

Work incentives among workers Personal taxes and benefits only Source: Adam (2005) © Institute for Fiscal Studies, 2006

Work incentives among workers 1998, personal taxes and benefits only Source: Immervol, Kleven, Kreiner and Saez (2005) © Institute for Fiscal Studies, 2006

Towards an expenditure tax How close is the UK? Different approaches: 1. Treatment of individual asset types – Uniformity of treatment may be as important as level of taxation – Hard to capture capital allowances etc – Little feel for the overall level of capital taxation © Institute for Fiscal Studies, 2006

Tax treatment of savings Income tax and NICs on contributions (saved income): - All taxed except pension contributions (exempt from PIT; employer contributions exempt from NICs too) Stamp duty on transactions: - 0. 5% on securities, 0 -4% on property depending on value Tax on returns: - Interest and rental income: income tax (0, 10, 20/22, 40%) except ISAs, pensions, and imputed rent from owner-occupied housing and other durables - Dividends: corporation tax (0, 19, 30%) on UK-resident companies; income tax (0, 25%) on dividend income except ISAs and pensions - Capital gains: corporation tax (0, 19, 30%) on UK-resident companies; CGT (0 -40%) except ISAs, pensions, and owner-occupied housing Income tax and NICs on withdrawals: - All exempt except pensions (taxed, but 25% tax-free lump sum and no NICs) Other taxes: - Council tax (about £ 1, 000 per year on average) on most housing - Inheritance tax (0 -40%) on assets transferred at or within 7 years of death © Institute for Fiscal Studies, 2006

Changes to treatment of savings Closer to uniform tax-free treatment at personal level: • Introduction of capped tax-free vehicles (PEPs, TESSAs and ISAs) • Removal of tax relief on life assurance and mortgage interest (previously more generous than expenditure tax treatment) – The removal of mortgage interest relief is an achievement that few countries have been able to emulate Further away at corporate level: • 100% capital allowances for plant & machinery ended © Institute for Fiscal Studies, 2006

Towards an expenditure tax How close is the UK? Different approaches: 1. Treatment of individual asset types – Uniformity of treatment may be as important as level of taxation – Hard to capture capital allowances etc – Little feel for the overall level of capital taxation 2. Effective tax rates on different investments (King & Fullerton) – Accurate measure for a particular investment – Endless possible permutations: different forms of investment, tax-exempt shareholders, foreign investors/companies, finance via debt vs equity vs retained profits, different assumptions (inflation, true depreciation, profits, etc), … © Institute for Fiscal Studies, 2006

Tax rates on investments Source: Klemm (2005) © Institute for Fiscal Studies, 2006

Towards an expenditure tax How close is the UK? Different approaches: 1. Treatment of individual asset types – Uniformity of treatment may be as important as level of taxation – Hard to capture capital allowances etc – Little feel for the overall level of capital taxation 2. Effective tax rates on different investments (King & Fullerton) – Accurate measure for a particular investment – Endless possible permutations: different forms of investment, tax-exempt shareholders, foreign investors/companies, finance via debt vs equity vs retained profits, different assumptions (inflation, true depreciation, profits, etc), … 3. Aggregate revenue-based measures – How much more revenue is raised than under expenditure tax treatment? – Compared with TEE (wage) expenditure tax (EC / Carey & Rabesona) or compared with EET (cash-flow) expenditure tax (Gordon & Slemrod)? – Ignores distortion from non-uniformity None so far deals well with treatment of savings in means tests, or changing tax rates faced over time © Institute for Fiscal Studies, 2006

Tax rates on investments Source: EMTRs from Klemm (2005), implicit tax rates from Carey and Rabesona (2002) © Institute for Fiscal Studies, 2006

Questions • Have we missed anything important? – Bear in mind space limitations! • What are the best measures for the economic characteristics? – In particular: how best to approach the expenditure tax question? © Institute for Fiscal Studies, 2006