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Sunday, 18 March 2012

Why a 50% top rate for income tax is too low. And how the government provides a sneaky unlimited 32.5% avoidance route for the über-wealthy already

As the 2012 Budget approaches, Tory ministers and their cohorts argue for the abolition of the 50% income tax rate. They claim it fails to achieve the objective of raising more tax, and acts as a disincentive to wealth creating businessmen.

The falsity of these claims is easily demonstrated:

a) Should the 50% rate of tax result in significant extra tax collection?
Yes it should. According to HMRC figures for 2010-11 £23.3 billion was expected to be collected at the 50% rate. This means £46.6 billion of taxable income at this top rate. Reducing the top rate from 50% to 40% would mean £4.66 billion of taxes would be lost, handed back to Britain's wealthiest. Except the wealthy know how to dodge the tax. Cutting the tax would be a reward for bad behaviour!

b) Does the 50% rate of tax discourage creative dynamic entrepreneurs?
No it doesn’t. Nearly 60% of employment in this country is provided by small and medium businesses. The directors of these firms earn on average £90,000 – well below the 50% tax band. Creative dynamic entrepreneurs rarely sit on the boards of FTSE100 companies, or in the banking halls of the City. Creative dynamic entrepreneurs tend to reinvest their profits in their companies, rather than extract them as 'remuneration'. They do the extraction once their creativity and dynamism has faded.

In any case, the government provides the wealthy with many loopholes to circumnavigate this tax. The 50% rate only applies to employment income and interest on savings - the only sources of income most Britons have. Tax on dividend income, while not exactly an enigma wrapped in a puzzle, is just obscure enough to escape general notice. According to the HMRC figures for 2010-11, those earning over £150,000 slipped more than £14 billion of dividends through this particular diversion, taxed at 32.5%.

Although the top rate on dividend income is published by HMRC at 42.5%, dividends are paid with a 10% ‘tax credit’. Rather like the rip-off permanent sales found at some furniture warehouses – everything is permanently “reduced” - the pretence of the 42.5% plus 10% tax credit results in an actual 32.5% tax rate. There is no limit on the amount of money that can be pushed through this route. Similarly, the 28% top rate of Capital Gains Tax provides yet another little escape route for the asset trading classes, including company executives cashing in their share options.

Making the tax on dividend income equal to that on salary and savings income would have raised an extra £5.2 billion in 2010-11. The argument that corporation tax has already been paid on the dividends, so income tax is a double tax is itself another smokescreen. When I buy a hamburger the burger joint doesn’t claim that my money has already been taxed, so why should they pay tax. Far from reducing the 50% rate on salary and savings income, it should be extended to all income including dividends. That would pull in a worthwhile additional chunk of revenue.

In any case, is the prime reason for high top-rate tax to collect more tax? Even if it was bad at doing that, there are important collateral benefits. Sometimes things that work very inefficiently can be very effective. 


A good example is the Child Maintenance and Enforcement Commission, which took over from the Child Support Agency. It aims to ensure that absent parents contribute to the financial costs of bringing up their children. The Commission, like its predecessor the Agency, is often criticised because it costs far more money to run the Commission than the amount of child support it extracts from reluctant parents. According to its press release in December 2011

“Almost £2.5 million has been secured for deduction from parents’ bank accounts since new powers were introduced in 2009.”

The Commission’s budgeted operating cost for 2010/11 was £577 million. One might say a huge disparity in cost over benefit. But such a criticism would entirely miss the point. The success of this organisation is measured not in the amounts it collects, but in the amounts it doesn’t have to collect. Many absent parents willingly and sometimes generously support their children. However, the Commission should take credit for the financial support from those absent parents who fear the consequences of not paying up. And perhaps should also take the credit for the contraceptive precautions taken by people who would otherwise casually produce children were there no long term liabilities for themselves.

As another example, the cost of running the police force is vastly greater than the loot they recover from arrested villains. The true value of the police is not measured in the crimes they solve, but the crimes that don’t happen because the criminally inclined fear the consequences.

We hear a lot about ‘unintended consequences’ – the indirect results of policing and child support are examples of ‘intended consequences’. The reason to do a particular thing is not only to get that particular thing done – the reason is also the intended indirect consequence.

Hence the purpose of the 50% tax rate is not merely to increase the nation's tax revenue. It is also to decrease the amount the overpaid get to keep. An intended consequence is to decrease their incentive to rip us off. While a tasty bonus may incentivise many an energy company executive to push up prices, leaving 22,000 pensioners to freeze to death - perhaps the thought of paying 50% in tax would ignite his humanity, and let them live.

The frenzied ripping-off that goes on in certain sectors – exemplified by the “muppet-gate” resignation letter of Greg Smith, an executive director of Goldman Sachs, claiming a culture of “ripping the eye-balls” out of clients – is fuelled by excessive pay. The leaders of companies have declined to cut pay, including their own. The surest alternative is to tax it away - to raise revenue, but also to reduce the incentive to rip-off.

Ripped-off Brits: Goldman Sachs

6 comments:

  1. What about a Flat Tax 10% , same with VAT , Corporation Tax the lot 10% . No Allowances , No Refund's , No Accountants , No Black-market , But a Very Big Fine if you cheat . At 10% there would be No Hidden Cash Economy , because it's Fair . No Foreign Aid , No Trident , No Hand Out's , just a Hand Up . Cuba Steve

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  2. The entries here about the rate of tax on dividends is wrong.

    The tax credit uplifts the taxable income so 1/9th more income is taxable. Ultimately it's a 36.11% rate of tax.

    Also dividend income has been subject to corporation tax. A company must have distributable reserves (ie profits, more than likely taxable profits) in order to pay a dividend. Therefore, with 20% paid already, only 80% is available to pay out as dividends.

    Retained profit via dividends at additional rate is 51.11%. The effective rate of tax works out as 48.89%.

    The argument is not a "smokescreen" as you call it. You need to compare like for like. This is compared against a sole trader whose profits would be taxed at 50% income tax and 2% NICs (above the Class 4 upper profits limit).

    The point is you compare the taxation of profits.

    If the company pays a salary instead, they get a deduction for tax purposes. None is afforded for dividends because they are an allocation of profits.

    This isn't something used by the "uber-wealthy". It is used by business owners of all sizes. Suggesting that a legitimate trading company that pays a dividend is somehow a tax dodge is utter nonsense.

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    Replies
    1. Being a simple fellow - no CTA to my name - I regard the tax rate as the percentage of what is paid to me that is taken away by HMRC as tax.

      But your clarification is appreciated.

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    2. People take tax advice less seriously from me when they think I'm Ben Saunders the ultimate fighter...

      The rates I've cited here are exactly that - the actual amount taken by HMRC as tax.

      Small profit rate, additional rate taxpayer - 48.89% rate of tax. Not 32.5%.

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  3. Mike Truman CTA7 August 2012 10:00

    To add to Ben's comments (who I work with and follow on Twitter), most 'company executives cashing in their share options' will not pay capital gains tax, and the page linked to above in HMRC guidance is the wrong one. The basic principle is set out here:
    http://www.hmrc.gov.uk/manuals/ersmmanual/ERSM20020.htm

    As it says, the idea is to charge income tax and national insurance when shares are acquired free or cheaply as a reward for employment, except when part of an approved scheme. Those who want the full details can wrap a wet towel round their head, take a couple of aspirin, and plunge into ITEPA 2003, Part 7A.

    if you are interested in the issue of tax avoidance, try Taxation magazine's 'How Far Would You Go questionnaire, bit.ly/TaxHowFar

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    Replies
    1. That questionnaire was interesting. Do you have a link to the survey results?

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