Why is tax avoidance a reason for letting people off tax?

Tax dodging, the Laffer curve, and the 50p rate

The reason given for cutting the 50p rate of tax to 45p was avoidance. It wasn't clearly phrased as such – most of the talk was about how it had raised less money than expected, or had changed behaviour in ways that harmed growth – but that is what it was nonetheless. To many, this will seem strange. "You avoided tax, so we will make you pay less". But it is an integral part of the line of thought that lies behind the cut.

Art Laffer first made the argument that cutting tax rates could boost revenue. The reasoning is broadly that, when the marginal tax rate (the amount you pay on each extra pound earned) gets too high, people start doing things to reduce their taxable income.

The palatable version is that they work less, because an extra hour of work no longer pays as well as it did, and this is probably true; there are certainly anecdotal tales of highly paid consultants turning down work later on in the year to spend more time at home.

The less palatable version is that they avoid more tax, because spending the money and effort required to set up a limited company, be paid "overseas", or funnel your income through a Swiss bank account in the name of your dog becomes more worthwhile the more it saves you.

Both of these "behavioural changes" are factored in to the Laffer curve, the rough prediction of how much revenue will be gained at various marginal tax rates. HMRC produced three such curves, each based around a different "taxable income elasticity" (TIE), a measure of how much an individual's behaviour changes given the tax rate:

They based their analysis around a TIE of 0.45 (a figure basically plucked from thin air – HMRC admit the evidence to choose is "extremely limited", and the studies they cite range from -0.6 to 2.75), which showed a peak of revenue at around 48 per cent. Quite why this then led the Chancellor to cut the rate to three per cent below that is unclear. If he wanted to raise revenue, his own analysis is showing that he's done it wrong.

The problem is, one thing which affects the TIE is the ease with which one can avoid tax. Make tax avoidance harder, TIE goes up, and the peak revenue rate increases. In fact, given the anti-avoidance measures announced at the budget yesterday, TIE will already be higher than it was at the time of the analysis, boosting the argument for keeping the 50p rate.

There is one massive category of avoidance which can't be cited as a reason for cutting the rate, however. The HMRC's stats show that £6.6bn less income was declared in 2010-11 due to it being "forestalled" – paid the year before, so as to take advantage of the lower rate. This is avoidance on a massive scale (Richard Murphy points out that it is £1.6bn more than the estimation for all tax avoidance in 2011), yet, contra Tim Worstall, it has no bearing on the decision on whether or not to cut the rate, because it can only ever be done once. 

By cutting the tax so early in its life, Osborne has ensured that we make the decision unable to know the full effect of cutting it. We can guess at how much will have been raised for the 2011-12 tax year, when forestalling was harder (although not impossible, and HMRC warn that it "continues to reduce revenues in 2011-12 and beyond"), but by the time we know for sure, it will be too late. The 45p tax will be in, and there won't be a "normal" year of the 50p rate to compare it to.

Tax dodging is an emotive issue. Credit: Getty

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

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Why it's a mistake to assume that Jeremy Corbyn has already won

The shadow chief secretary to the Treasury on why the race to be Labour's leader is far from over.

They think it’s all over.

But they’re wrong.

The fat lady has yet to sing.

The commentary and reporting around the Labour party leadership campaign has started to assume we have a winner already in Jeremy Corbyn. The analysis, conjecture, predictions/complete guesswork about what happens next has begun in earnest. So we have seen speculation about who will be appointed to a Corbyn shadow cabinet, and “meet the team” pieces about Jeremy’s backroom operation.

Which is all very interesting and makes for the usual Westminster knockabout of who might be up and who might be going in the other direction pdq...

But I think it’s a mistake to say that Jeremy has already won.

Because I hear that tens of thousands of Labour party members, affiliates and registered supporters are yet to receive their ballot papers. And I am one of them. I can’t remember the last time I checked my post quite so religiously! But alas, my papers are yet to arrive.

This worries me a bit about the process. But mostly (assuming all the remaining ballots finally land in enough time to let us all vote) it tells me that frankly it’s still game on as far as the battle to become the next leader of the Labour party is concerned.

And this is reinforced when we consider the tens of thousands who have apparently received their papers but who have yet to vote. At every event I have attended in the last couple of weeks, and in at least half of all conversations I have had with members across the country, members are still making their minds up.

This is why we have to continue fighting for every vote until the end – and I will be fighting to get out every vote I possibly can for Yvette Cooper.

Over the campaign, Yvette has shown that she has a clear vision of the kind of Britain that she wants to see.

A Britain that tackles head-on the challenges of globalisation. Instead of the low-wage low-skill cul-de-sac being crafted by the Tories, Yvette's vision is for 2m more high skill manufacturing jobs. To support families she will prioritise a modern childcare system with 30 hours of fully funded child care for all 3 and 4 year olds and she will revive the bravery of post war governments to make sure 2m more homes are built within ten years.

It's an optimistic vision which taps into what most people in this country want. A job and a home.

And the responses of the focus groups on Newsnight a few days ago were telling – Yvette is clearly best placed to take us on the long journey to the 2020 general election by winning back former Labour voters.

We will not win an election without winning these groups back – and we will have to move some people who were in the blue column this time, to the red one next time. There is no other way to do it – and Yvette is the only person who can grow our party outwards so that once again we can build a winning coalition of voters across the country.