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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Italian PM Matteo Renzi resigns after referendum No vote

Europe's right-wing populists cheered the result. 

Italy's centrist Prime Minister Matteo Renzi was forced to resign late on Sunday after he lost a referendum on constitutional change.

With most ballots counted, 60 per cent of Italians voted No to change, according to the BBC. The turn out was nearly 70 per cent. 

Voters were asked whether they backed a reform to Italy's complex political system, but right-wing populists have interpreted the referendum as a wider poll on the direction of the country.

Before the result, former Ukip leader Nigel Farage tweeted: "Hope the exit polls in Italy are right. This vote looks to me to be more about the Euro than constitutional change."

The leader of France's far-right Front National, Marine Le Pen, tweeted "bravo" to her Eurosceptic "friend" Matteo Salvini, a politician who campaigned for the No vote. She described the referendum result as a "thirst for liberty". 

In his resignation speech, Renzi told reporters he took responsibility for the outcome and added "good luck to us all". 

Since gaining office in 2014, Renzi has been a reformist politician. He introduced same-sex civil unions, made employment laws more flexible and abolished small taxes, and was known by some as "Europe's last Blairite".

However, his proposed constitutional reforms divided opinion even among liberals, because of the way they removed certain checks and balances and handed increased power to the government.

 

Julia Rampen is the editor of The Staggers, The New Statesman's online rolling politics blog. She was previously deputy editor at Mirror Money Online and has worked as a financial journalist for several trade magazines.