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.

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Q&A: What are tax credits and how do they work?

All you need to know about the government's plan to cut tax credits.

What are tax credits?

Tax credits are payments made regularly by the state into bank accounts to support families with children, or those who are in low-paid jobs. There are two types of tax credit: the working tax credit and the child tax credit.

What are they for?

To redistribute income to those less able to get by, or to provide for their children, on what they earn.

Are they similar to tax relief?

No. They don’t have much to do with tax. They’re more of a welfare thing. You don’t need to be a taxpayer to receive tax credits. It’s just that, unlike other benefits, they are based on the tax year and paid via the tax office.

Who is eligible?

Anyone aged over 16 (for child tax credits) and over 25 (for working tax credits) who normally lives in the UK can apply for them, depending on their income, the hours they work, whether they have a disability, and whether they pay for childcare.

What are their circumstances?

The more you earn, the less you are likely to receive. Single claimants must work at least 16 hours a week. Let’s take a full-time worker: if you work at least 30 hours a week, you are generally eligible for working tax credits if you earn less than £13,253 a year (if you’re single and don’t have children), or less than £18,023 (jointly as part of a couple without children but working at least 30 hours a week).

And for families?

A family with children and an income below about £32,200 can claim child tax credit. It used to be that the more children you have, the more you are eligible to receive – but George Osborne in his most recent Budget has limited child tax credit to two children.

How much money do you receive?

Again, this depends on your circumstances. The basic payment for a single claimant, or a joint claim by a couple, of working tax credits is £1,940 for the tax year. You can then receive extra, depending on your circumstances. For example, single parents can receive up to an additional £2,010, on top of the basic £1,940 payment; people who work more than 30 hours a week can receive up to an extra £810; and disabled workers up to £2,970. The average award of tax credit is £6,340 per year. Child tax credit claimants get £545 per year as a flat payment, plus £2,780 per child.

How many people claim tax credits?

About 4.5m people – the vast majority of these people (around 4m) have children.

How much does it cost the taxpayer?

The estimation is that they will cost the government £30bn in April 2015/16. That’s around 14 per cent of the £220bn welfare budget, which the Tories have pledged to cut by £12bn.

Who introduced this system?

New Labour. Gordon Brown, when he was Chancellor, developed tax credits in his first term. The system as we know it was established in April 2003.

Why did they do this?

To lift working people out of poverty, and to remove the disincentives to work believed to have been inculcated by welfare. The tax credit system made it more attractive for people depending on benefits to work, and gave those in low-paid jobs a helping hand.

Did it work?

Yes. Tax credits’ biggest achievement was lifting a record number of children out of poverty since the war. The proportion of children living below the poverty line fell from 35 per cent in 1998/9 to 19 per cent in 2012/13.

So what’s the problem?

Well, it’s a bit of a weird system in that it lets companies pay wages that are too low to live on without the state supplementing them. Many also criticise tax credits for allowing the minimum wage – also brought in by New Labour – to stagnate (ie. not keep up with the rate of inflation). David Cameron has called the system of taxing low earners and then handing them some money back via tax credits a “ridiculous merry-go-round”.

Then it’s a good thing to scrap them?

It would be fine if all those low earners and families struggling to get by would be given support in place of tax credits – a living wage, for example.

And that’s why the Tories are introducing a living wage...

That’s what they call it. But it’s not. The Chancellor announced in his most recent Budget a new minimum wage of £7.20 an hour for over-25s, rising to £9 by 2020. He called this the “national living wage” – it’s not, because the current living wage (which is calculated by the Living Wage Foundation, and currently non-compulsory) is already £9.15 in London and £7.85 in the rest of the country.

Will people be better off?

No. Quite the reverse. The IFS has said this slightly higher national minimum wage will not compensate working families who will be subjected to tax credit cuts; it is arithmetically impossible. The IFS director, Paul Johnson, commented: “Unequivocally, tax credit recipients in work will be made worse off by the measures in the Budget on average.” It has been calculated that 3.2m low-paid workers will have their pay packets cut by an average of £1,350 a year.

Could the government change its policy to avoid this?

The Prime Minister and his frontbenchers have been pretty stubborn about pushing on with the plan. In spite of criticism from all angles – the IFS, campaigners, Labour, The Sun – Cameron has ruled out a review of the policy in the Autumn Statement, which is on 25 November. But there is an alternative. The chair of parliament’s Work & Pensions Select Committee and Labour MP Frank Field has proposed what he calls a “cost neutral” tweak to the tax credit cuts.

How would this alternative work?

Currently, if your income is less than £6,420, you will receive the maximum amount of tax credits. That threshold is called the gross income threshold. Field wants to introduce a second gross income threshold of £13,100 (what you earn if you work 35 hours a week on minimum wage). Those earning a salary between those two thresholds would have their tax credits reduced at a slower rate on whatever they earn above £6,420 up to £13,100. The percentage of what you earn above the basic threshold that is deducted from your tax credits is called the taper rate, and it is currently at 41 per cent. In contrast to this plan, the Tories want to halve the income threshold to £3,850 a year and increase the taper rate to 48 per cent once you hit that threshold, which basically means you lose more tax credits, faster, the more you earn.

When will the tax credit cuts come in?

They will be imposed from April next year, barring a u-turn.

Anoosh Chakelian is deputy web editor at the New Statesman.