The day before the Autumn Statement, everything you need to know about tax in the UK

Chris Nicholas gives a primer of the state of tax in the UK.

The Chancellor’s Autumn Statement tomorrow will likely bring more economics by a thousand cuts, with the least well off and welfare budgets again under assault. And there’s to be no let up in the tax regime’s unfairness. 

Lacking any underlying rationale and subverted by habitual expediency and vested interests, the tax system can legitimately be characterised as inequitable and inconsistent. The Chancellor isn’t helping. 

Taxes for companies and the wealthy are being reduced, notwithstanding the deficit and their already favourable treatment. Meanwhile taxes for less well off continue to go up. These are against a backdrop of marked economically and socially damaging income and wealth inequalities. 

Work versus Wealth

Work  earned income  is disproportionately heavily taxed. Conversely, all the returns of wealth  interest, rents, company profits and capital gains  are favourably taxed by comparison.

National Insurance, the 25.8 per cent tax on employment, is only paid on earned income. Unearned earnings then often have lower tax rates as well, particularly for dividends and capital gains.

Together the total personal tax paid on unearned income at standard rates can be as little as a third of that on exactly the same earned income; and at higher rate tax can still be less than half of that on the same earned income. Conversely earned income is taxed at least twice the standard rate as any of the returns from wealth; and at higher rates between 50-100 per cent more.

Deductions and allowances then go from limited to lenient across the spectrum from earned income through unearned income to company earnings and capital gains. The returns from wealth can also take advantage of extensive legitimated means of avoiding tax. 

As a result income from wealth is 17.5 per cent of UK personal incomes, yet accounts for just 5 per cent of the tax from personal incomes (the rest from earned incomes). Similarly, company profits are equivalent to 20 per cent of GDP, yet provide just 8 per cent of tax receipts. By contrast, earned incomes are equivalent to 55 per cent of GDP, yet provide 45 per cent of tax receipts, well over double the proportionate burden. 

All of which is ignoring wealth’s unique socio-economic primacy and ability to generate returns again and again from ownership alone. Wealth (capital) itself is all but untaxed in the UK

Progressive Taxation

Progression is overwhelmingly concentrated on earned incomes and in the bottom half of the income, let alone wealth, spectrum. 

Income taxes alone provide nearly all the progression for the tax regime as whole. With earned incomes accounting for 95 per cent of all income taxes, this then translates into work/employment carrying virtually all the progressive load.

Tax rates for earned income are only really progressive between bottom and middle incomes, and that's being reinforced by the Chancellor. Top rate income tax has already been cut from 50 per cent to 45 per cent, a regressive tax giveaway to the highest earners of £1.8bn a year. Meanwhile, those earning between £30,000-150,000 p.a. have been squeezed by a combination of increases in NI and further reductions in higher rate thresholds (albeit partly offset by the initial tax-free allowance increasing).

 

As a result of this weighting of progression towards the bottom, someone on £15,000 p.a and then earning an extra £1,000 will see their overall rate of tax increase 30 times faster than someone earning £100,000 p.a who then earns an extra £10,000. There’s also an important anomaly for many middle incomes: If you include employee NIC, earnings between £32,245 p.a and £42,475 p.a are actually taxed at a 5 per cent higher rate than earnings over £150,000 p.a.

At the same time the threshold for higher tax (the 40 per cent rate) is to be reduced further to £32,245 in 2013-14. This is a fall of over 20 per cent in real terms since 2010-11, pushing yet more low to middle income households into higher rate tax. This is the real squeeze in the middle (again, notwithstanding the increased Personal Allowance).

As incomes and wealth increase, progression is further flattened and distorted by the increasing benefit of allowances and deductions; the greater proportion of earnings benefiting from more favoured rates and treatment; and greater use of tax avoidance. All the while the focus remains exclusively on just income, ignoring wealth.

Inequitable Company Taxes

Company earnings are particularly favourably taxed compared to other types of earnings. They are then taxed at significantly lower rates, with no increased rates for greater profits. And many companies, particularly the larger ones, make extensive use of legitimated tax avoidance, particular offshore status and profits/costs transfers. The end result is an average effective tax rate of just 11-12 per cent on company profits made in/by the UK.

The Chancellor is now steadily cutting headline corporation tax from 26 per cent in 2010-11 to 22 per cent by 2014-15 – a tax giveaway of over £800m a year (cumulatively £4bn a year by 2015-16). The amount of tax collected will therefore remain nominally flat and fall in real terms for at least five years even with the hoped for recovery. At 2.4 per cent of GDP this is one of the lowest company tax contributions among all developed economies.

As with earlier cuts in company taxes, however, these cuts will not in fact deliver the hoped for improvements in output, economic performance or growth. Nor will they make a significant difference to the UK’s competitiveness.

Company taxes also have their own inequities. Far from being progressive to offset the advantages of size and market power, corporation tax ends up highly regressive in practise. Many of the top 100 UK companies pay an effective rate of under 5 per cent and quite a few nothing at all; and the top 5,000 about 11 per cent; whereas the average SME pays 80-85 per cent of the headline tax rate.

While the Chancellor is reducing taxes for larger companies, the 20 per cent small company rate and marginal relief for SME businesses have been frozen – reducing the difference between the smallest and largest company to at maximum 2 per cent. There are equally marked variations between types of business. The tax regime generally biases heavily against substantively productive activities, particularly those involving employment, and in favour of rent-seeking ones. 

These discrepancies in turn overlap with how much companies use tax avoidance. This gives some a market as well financial advantage; while putting others at a disadvantage – particularly domestic UK companies trying to play with a straighter bat.  

Systemic Avoidance

A recurring theme in the unfairness and inequalities of UK tax is widespread avoidance.  This not primarily about clever schemes and loopholes, but the currently built-in legitimating means of mitigating and avoiding tax.

While the Chancellor is closing some blatant loopholes, the built-in mechanisms for avoidance have been surreptitiously reaffirmed. The entire edifice of differential tax rates and treatment, company sheltering of profits, offshore ownership, residency statuses, trusts, transferring of profits etc continues unabated. 

Conservatively the country is missing out on £40-45 billion in directly avoided company and personal taxes and over twice as much again in currently legitimated tax "mitigation". Even if only some of this was recouped, we are talking substantial sums – enough to make a significant dent in the public finances.

Meanwhile the shortfall leaves all the more to be met by those still fully caught in the tax net: it takes the income tax from two million average households to replace each £10bn lost through avoidance.

Photograph: Getty Images

One time Barrister, economist and media and technology entrepreneur, Chris Nicholas now writes and lectures on economic policy and political economy.

ANDREY BORODULIN/AFP/GETTY IMAGES
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Letter from Donetsk: ice cream, bustling bars and missiles in eastern Ukraine

In Donetsk, which has been under the control of Russian backed rebels since April 2014, the propaganda has a hermetic, relentless feel to it.

Eighty-eight year-old Nadya Moroz stares through the taped-up window of her flat in Donetsk, blown in by persistent bombing. She wonders why she abandoned her peaceful village for a “better life” in Donetsk with her daughter, just months before war erupted in spring 2014.

Nadya is no stranger to upheaval. She was captured by the Nazis when she was 15 and sent to shovel coal in a mine in Alsace, in eastern France. When the region was liberated by the Americans, she narrowly missed a plane taking refugees to the US, and so returned empty-handed to Ukraine. She never thought that she would see fighting again.

Now she and her daughter Irina shuffle around their dilapidated flat in the front-line district of Tekstilshchik. Both physically impaired, they seldom venture out.

The highlight of the women’s day is the television series Posledniy Yanychar (“The Last Janissary”), about an Ottoman slave soldier and his dangerous love for a free Cossack girl.

They leave the dog-walking to Irina’s daughter, Galya, who comes back just in time. We turn on the TV a few minutes before two o’clock to watch a news report on Channel One, the Russian state broadcaster. It shows a montage of unnerving images: Nato tanks racing in formation across a plain, goose-stepping troops of Pravy Sektor (a right-wing Ukrainian militia) and several implicit warnings that a Western invasion is nigh. I wonder how my hosts can remain so impassive in the face of such blatant propaganda.

In Donetsk, which has been under the control of Russian-backed rebels since April 2014, the propaganda has a hermetic, relentless feel to it. If the TV doesn’t get you, the print media, radio and street hoardings will. Take a walk in the empty central district of the city and you have the creeping sense of being transported back to what it must have been like in the 1940s. Posters of Stalin, with his martial gaze and pomaded moustache, were taboo for decades even under the Soviets but now they grace the near-empty boulevards. Images of veterans of the 1941-45 war are ubiquitous, breast pockets ablaze with medals. Even the checkpoints bear the graffiti: “To Berlin!” It’s all inching closer to a theme-park re-enactment of the Soviet glory years, a weird meeting of propaganda and nostalgia.

So completely is the Donetsk People’s Republic (DPR) in thrall to Russia that even its parliament has passed over its new flag for the tricolour of the Russian Federation, which flutters atop the building. “At least now that the municipal departments have become ministries, everyone has been promoted,” says Galya, wryly. “We’ve got to have something to be pleased about.”

The war in the Donbas – the eastern region of Ukraine that includes Donetsk and Luhansk – can be traced to the street demonstrations of 2013-14. The former president Viktor Yanukovych, a close ally of Vladimir Putin, had refused to sign an agreement that would have heralded closer integration with the EU. In late 2013, protests against his corrupt rule began in Maidan Nezalezhnosti (“Independence Square”) in Kyiv, as well as other cities. In early 2014 Yanukovych’s security forces fired on the crowds in the capital, causing dozens of fatalities, before he fled.

Putin acted swiftly, annexing Crimea and engineering a series of “anti-Maidans” across the east and south of Ukraine, bussing in “volunteers” and thugs to help shore up resistance to the new authority in Kyiv. The Russian-backed rebels consolidated their power base in Donetsk and Luhansk, where they established two “independent” republics, the DPR and its co-statelet, the Luhansk People’s Republic (LPR). Kyiv moved to recover the lost territories, sparking a full-scale war that raged in late 2014 and early 2015.

Despite the so-called “peace” that arrived in autumn 2015 and the beguiling feeling that a certain normality has returned – the prams, the ice creams in the park, the bustling bars – missiles still fly and small-arms fire frequently breaks out. You can’t forget the conflict for long.

One reminder is the large number of dogs roaming the streets, set free when their owners left. Even those with homes have suffered. A Yorkshire terrier in the flat next door to mine started collecting food from its bowl when the war began and storing it in hiding places around the flat. Now, whenever the shelling starts, he goes to his caches and binge-eats in a sort of atavistic canine survival ritual.

Pet shops are another indicator of the state of a society. Master Zoo in the city centre has an overabundance of tropical fish tanks (too clunky to evacuate) and no dogs. In their absence, the kennels have been filled with life-size plastic hounds under a sign strictly forbidding photography, for reasons unknown. I had to share my rented room with a pet chinchilla called Shunya. These furry Andean rodents, fragile to transport but conveniently low-maintenance, had become increasingly fashionable before the war. The city must still be full of them.

The bombing generally began “after the weekends, before holidays, Ukraine’s national days and before major agreements”, Galya had said. A new round of peace talks was about to start, and I should have my emergency bag at the ready. I shuddered back up to the ninth floor of my pitch-dark Tekstilshchik tower block. Shunya was sitting quiet and unruffled in his cage, never betraying any signs of stress. Free from Russian television, we girded ourselves for the night ahead.

This article first appeared in the 05 February 2015 issue of the New Statesman, Putin's war