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  • The Budget – a missed opportunity

    The Budget – a missed opportunity

    Despite the Government’s stated commitment to growth, the Budget included no pro-growth tax reform, and its largest revenue raising measure is likely to reduce private sector employment and wages.

    The Budget continued a sad trend of tax policy driven by realpolitik rather than long term strategic thinking. It’s to be hoped we see something more substantive in future Labour Budgets.

    The need for tax reform

    Some of the worst features of the UK tax system are the product of short term political expediency:

    • The numerous high marginal income tax rates, often approaching 60% and sometimes over 100%, deter people at the £60k and £100k earning thresholds from working more hours. These rates are a product of “gimmicks” introduced into the tax system to raise more tax without incurring the political pain of increasing headline tax rates.
    • Council tax is based on 1991 valuations. A £100m penthouse in Mayfair pays less council tax than a semi in Skegness. The unfairness and inefficiency of council tax is a consequence of a post-poll tax political fear of touching local government taxation.
    • Stamp duty land tax reduces labour mobility, results in inefficient use of land, and plausibly holds back economic growth. There is a consensus amongst economists of Left and Right that an annual tax on land value would be fairer and more efficient. But there is a political fear of creating losers (and we are currently seeing how loud the complaints of a relatively small number of people can be, if they believe they’ve lost out from a tax change).
    • The rate of capital gains tax is too low, enabling owners of private businesses to convert what is realistically labour income (which should be taxed at 45%) into capital gains (recently taxed at 20%; now rising to 24%). But the rate of capital gains tax is also too high, taxing investors on paper gains even if in real terms they have lost money. Both problems could be fixed at the same time, but that requires taking on vocal interest groups.
    • The UK has the highest VAT threshold in the developed world. It deters small businesses from growing, and creates a competitive advantage for people who cheat. HM Treasury certainly understand the problem, and many across the political spectrum agree that the threshold needs to come down. However politicians are reluctant to act, in large part because of a reluctance to take on the small business lobby (which in my experience doesn’t represent its members, many of whom are frustrated by the competitive distortions created by the current high VAT threshold).
    • The UK has extensive VAT exemptions and special rates – more so than any other country with a VAT/GST system. They’re regressive and result in uncertainty and avoidance. We could restrict the special rates and raise significant revenue and/or cut the rate of VAT from 20%. But no politician feels able to explain this.
    • The UK has one of the highest rates of inheritance tax in the world, but collects comparatively little tax. Why? Because of the many exemptions (or, if you like, “loopholes”) which make tax planning IHT away very easy for the wealthy and well-advised. Perhaps for these reasons, it’s a very unpopular tax. The answer: scrap the exemptions and cut the rate. The complaints of the few who lose out would be drowned by the applause of those who gain. Or go for more ambitious reform still, and replace the tax with something entirely different (capital gains at death, perhaps).
    • The spiralling complexity in the tax system, and the fact that so few of the Office for Tax Simplification’s recommendations were implemented, is a product of a political failure to make tax simplification a priority. The state of corporation tax, in particular, is making the UK increasing uncompetitive, even compared to countries with significantly higher corporate tax rates than the UK.

    And last but not least:

    • Employer national insurance mean that we tax employment income much more than self employment income or investment income. That is economically damaging, and creates a huge amount of complexity, uncertainty, and tax avoidance and evasion. The tax has been irresistible to governments who want to raise tax on income in a way which is not very visible to most of the public. We should abolish employer national insurance (but working out exactly how is a very difficult problem).

    All of these problems, and many more, create a real need for tax reform. A Government committed to improving the UK’s poor recent growth record should be looking at tax reform very seriously indeed.

    The tax reforms in the Budget

    There were no tax reform measures in the Budget. Nor was there any tax simplification.

    All we saw were revenue-raising measures. That’s an important function of the tax system, but a Budget shouldn’t just be about raising tax.

    The need for revenue-raising

    Let’s look at the largest revenue raising-measure in the Budget, and the options that were available. I’ll proceed on the basis that the Government had to raise £10bn from somewhere, and ask what the most rational way to do that would be.

    What principles should have driven the decision as to which tax to raise? Particularly when it was a Labour government making that decision, and a Government which had said it was committed to growth?

    Presumably something like:

    • The tax increase should be disproportionately borne by people who are most able to pay it (the “broadest shoulders“).
    • The tax increase shouldn’t have a negative effect on economic growth, for example by creating incentives on businesses to reduce employment.
    • The tax increase shouldn’t be distortive – i.e. create incentives to do things that are artificial and/or would make no sense if it wasn’t for the tax increase.

    The simplest tax increase consistent with these principles would be to raise income tax – the Government could have raised about £10bn by increasing the rate of income tax by 1%. Those on very low incomes would have paid little or no additional tax (because income tax only starts at £12,570). The impact would have been greatest on those earning higher incomes. Employees, investors, landlords, pensioners – all would have shared the pain of the tax increase.

    Here’s a chart of the percentage reduction to employee take-home pay that would follow from a 1% income tax rise:

    Someone on minimum wage would see a reduction in after-tax pay of about 0.5%; someone on the median wage of about £37k the figure would see a reduction of 0.8%; for someone earning £150k the figure would be 1.65%. I’d think this would be the kind of gently progressive outcome that a Labour Government would be looking for from a tax increase.

    Or if that was too politically tricky, there were plenty of alternatives, albeit more complicated. The Government could have reformed capital gains tax, or made numerous small changes to taxes that mostly impacted the wealthy, but wouldn’t reduce their incentive to invest in the UK.

    The revenue-raising in the Budget

    Labour instead chose to raise £10bn by increasing employer’s national insurance.

    This fails all three tests above:

    • Employer’s national insurance applies only to employment, and not to self employment or investment income. Many of those with the highest incomes are unaffected.
    • For the same reason, employer’s national insurance creates distortions, and a powerful incentive to hire people as contractors rather than employees. There is a huge volume of anti-avoidance legislation that tries to prevent this, but when the lure is as great as a 15% saving, people will and do continue to try to avoid it. The OBR projects a £500m loss in tax from this.
    • Employer’s national insurance is a tax on employment, and it’s axiomatic that if you tax something you get less of it.

    The way Labour implemented the national insurance increase made it worse. There were two changes to employer’s national insurance in the Budget:

    The cut in the threshold disproportionately impacts employers with mostly low-paid staff.

    We can illustrate this by charting different wages levels against the increase in the total cost of employing someone at that wage.

    That spike is for those earning around the current £9,100 employer national insurance threshold – the cost of employing someone in this position goes up by almost 7%. The cost of employing a full time worker on minimum wage goes up by 3.5%; for a worker on the £37k median wage, the cost goes up by 2.5%. But the cost of employing someone on £150k goes up by only 1.5%.

    Why should the Labour Party care if the cost of employing someone on low wages rises?

    Because all the evidence shows that the economic impact falls on the employees, not the employer.

    The evidence

    There is extensive evidence that 60% to 80% of the economic cost of employer national insurance (and similar taxes) is borne by employees in the form of reduced wages. The rest of the cost is shared between reduced employment (again impacting employees, or people who don’t get to become employees), increased prices and reduced corporate profits. I set out some of the research on these effects here.

    It’s important to note that this doesn’t mean that an increase in employer’s national insurance causes wages to be cut and people to be sacked. It means that businesses increase wages less than they otherwise would, take on new employees on low wages less than they otherwise would, and/or take on fewer employees.

    The Office for Budget Responsibility agree that most of the burden of the tax increase falls on employees. Here’s their assessment of the Budget:

    If we look at the 2027/28 figures, the “static analysis” of the employer’s national insurance increase shows it creating £24.7bn of revenue. “Static” means this is a simple multiplication of current employer national insurance revenues to reflect the increased rate.

    The OBR then corrects the static figure to reflect behavioural changes. They project a loss in tax from reduced wages and reduced employment of £7.7bn, and a loss in tax from reduced corporate profits of £600m. Reversing-out these figures suggests that the OBR believes over 85% of the £24bn raised by the employer national insurance increase is coming from reduced wages and lost employment.

    And note the £5.6bn figure at the bottom – the cost to the Government and adult social care providers of covering the employer national insurance increase. This has two consequences. First, the £24bn static estimate of the revenue yield in fact ends up as under £10bn – it’s a remarkably inefficient tax increase. Second, whilst we can expect the private sector to mostly pass the cost of the tax increase to employees, the public sector mostly won’t.

    What’s happening in practice?

    Most of the research suggests it takes a year or more for increases in employer national insurance to be passed-through to employees. However things seem to be moving faster than that. In the last week I’ve spoken to:

    • A board member of a UK financial services business which had planned to increase wages by 5% for 2025; the increase will now be 3%. They will also be moving some jobs from the UK to Eastern Europe (“near-shoring”).
    • The CEO of a large retailer that had planned to increase wages by 4% for 2025; the increase will now be 2%.
    • A board member of a manufacturing company that had planned to increase wages by 5%; the increase will now be 2.5%.
    • The CFO of a large services business which will now be “near-shoring” hundreds of jobs to Eastern Europe.
    • A restaurant owner who has cancelled a plan to expand to a new site.
    • A farmer who will be cutting the hourly wage he offers to seasonal farmworkers this coming Spring.
    • The owner of a small business who had planned to take on a trainee; she now won’t be.
    • The owner of a shop who had been planning to expand out-of-season hours, but now won’t be.

    All of which suggests that the cost of the employer national insurance increase will be passed onto staff as soon as January 2025. Which is four months before the increase takes effect.

    This is a much faster transfer of the cost of the tax increase to employees than I expected.

    The overall picture

    Let’s assume 80% of the cost of the employer national insurance is 80% passed-through to private sector employees in the form of reduced wages. How does the reduction in their take-home pay compare with the effect of my hypothetical 1% income tax increase?

    Everyone earning less than £100k from employment income is better off with an income tax increase.

    How can this be? How can a 1p income tax increase raise the same revenue as a 1.2p employer national insurance increase, but have so much smaller an effect on most people?

    Because of the people not shown on this chart. The self employed, pensioners, partners in professional firms, investors, landlords… they’ll see no impact from the Budget employer national insurance changes, for the simple reason that they’re not employed. But they all pay income tax, and would very much see an impact from a 1p income tax increase.

    So why did Labour end up imposing a regressive tax increase?

    Two weeks before the Budget, I wrote that increasing employer’s national insurance was one of the worst possible tax increases. I didn’t think it was likely, but added a footnote that I was not very good at political prediction. That footnote was correct.

    The point remains: increasing employer’s national insurance as proposed in the Budget is worse in almost every respect than increasing income tax. It’s less progressive and more likely to reduce growth (because it reduces employment). So why do it?

    The obvious answer is: politics.

    Over the last two weeks, I’ve bemoaned the increase in employers national insurance to various people more politically astute than I am. Their response is that Labour had no choice. During the election campaign, Labour had to rule out increasing most taxes, or it would have risked losing the election. Employer national insurance was all that was left, and so it was employer national insurance that had to go up.

    On this version, bad tax policy was the price of election victory. If that’s right, it’s a pretty depressing conclusion.

    Why was there no tax reform in the Budget?

    One explanation is simply: there was no time. Whilst Labour had done some thinking in Opposition, the lack of technical resources available to an Opposition (particularly after the loss of seats in 2019) meant that the real work preparing detailed tax policy proposals had to start after Labour moved into Government on 5 July 2024, and Ministers got their feet properly under the desk in mid-July. With the Budget on 30 October 2024, that appears to give plenty of time – but the OBR has to be given 7-9 weeks’ notice of Budget proposals. So the deadline for finalising Labour’s proposals was early September. Then add the effect of August, and civil service holidays, and Labour really only had a few weeks to come up with the Budget. Expecting Labour to prepare detailed tax reform proposals in that time was unrealistic.

    I don’t really buy this. It’s hard to see there will ever be a better opportunity for tax reform than the first Budget of a new Government elected with a large majority. The Budget could have been later. Or there could have been a quick Budget implementing manifesto commitments, with a further “fiscal event” in March containing more detailed measures that weren’t in the manifesto. That’s exactly what we saw in 1997.

    The other explanation is that Starmer and his team were too cautious to go near tax reform. If so, they may the reaction to the modest tax changes that were contained in the Budget may make them more cautious still.

    My hope is that I am again completely wrong, and that we do see pro-growth tax reform in the next Budget.

    Photo by Vicky Yu on Unsplash.

    Footnotes

    1. e.g. by splitting one business into several different companies. The rules don’t permit that, and it will often amount to (criminal) tax fraud – but it’s often hard for people to spot. ↩︎

    2. A more generous person than me might classify the changes to agricultural property relief and business property relief as tax reform. But I don’t think that would be right – the changes are a partial restriction of existing reliefs rather than actual reform, and they feel more symbolic than substantive (and also could be better structured; I’ll be writing more about that soon). ↩︎

    3. And a particularly generous person might say that the potential partial abolition of the UK-UK transfer pricing rules is “tax simplification”. But the details make it doubtful there will be much real effect, and in any cases the proposal was originally announced by the previous Government. ↩︎

    4. It could certainly be argued that the Government should have cut spending instead (at least in real terms), but that was never a very likely route for a newly elected Labour Government. ↩︎

    5. It is often said that all tax has a negative effect on economic growth. This is not correct – it depends both on the nature of the tax, and what the Government does with the revenue raised by the tax. This article from the National Institute of Economic and Social Research is an excellent discussion of both sides of this point. ↩︎

    6. The Liberal Democrats for many years had a policy of increasing income tax by 1p to pay for additional education spending. At one point the Conservative Party carried out polling which showed that most people misunderstood this to mean actually paying one penny more tax, not a 1% increase in the rate, This sounds incredible, but I’ve heard the story first hand. ↩︎

    7. For simplicity, this only shows part of the picture, because there would also have been an impact on pensioners and investors on high incomes. Both groups would have suffered a slightly higher decrease in take-home pay, because they don’t pay national insurance and so income tax changes have a slightly greater proportionate effect on them. ↩︎

    8. The spreadsheet with the calculations generating this chart can be found here. ↩︎

    9. The “total cost” here is the gross salary plus employer’s national insurance; I’m disregarding the apprenticeship levy in the chart because that only affects larger firms; it will very slightly reduce the % change. There will often be other costs, e.g. office space, pension, administration – these vary considerably between employers and so can’t realistically be included in the chart. ↩︎

    10. Again, the spreadsheet for this chart is here. ↩︎

    11. The minimum wage for a worker over 21 works out at an annual income of about £23,000 if they are working full time for the whole year. However some people working part time and/or for only part of the year can earn much less than that. ↩︎

    12. Higher paid workers are more likely to see a reduction in pay increases; lower paid workers a reduction in employment. We may see a particularly strong impact on low paid employment, given the relatively high level of the UK minimum wage. i.e. because wages cannot be reduced for many lower paid workers without either breaking the law (if they are at the minimum wage) or squeezing differentials (for those just above the minimum wage. ↩︎

    13. From page 55 of this document. ↩︎

    14. My working for this: the mean annual wage (as opposed to the median) is about £37,000. Employer national insurance on that is about £5,500 and employee tax is about £6,800 – so tax on the average wage is 33%. The £7.1bn figure therefore implies a reduction in gross wages of about £21bn; the £0.6bn figure implies a further loss of £1.8bn of gross wages through reduction in employment. The OBR also projects a loss in tax from a reduction in profits of £0.9bn. Profits are subject to corporation tax at 20-25% and (in a different form) VAT; all implying a drop in profits of somewhere around £2-4bn. Hence over 85% of the overall hit is borne by employees in the form of reduced/lost wages, and only around 15% by employers in the form of reduced profit. These are back-of-the-envelope estimates so we shouldn’t be surprised that the figures total £28bn rather than £24bn – the overall picture is reasonably clear. ↩︎

    15. Although that’s not necessarily the case in the long term. Public sector pay is impacted by private sector pay, both informally and (in many cases) formally given that that one of the key pieces of evidence considered by the Pay Review Bodies is the level of private sector pay. Hence public sector pay may well end up affected, in which case the RDEL compensation may prove too high, and the NICs increase may end up netting more than expected. ↩︎

    16. When I first saw the OBR figures I was surprised they were showing such a high percentage of the employer’s national insurance increase being passed to employees so quickly. I had assumed (from the research on previous similar tax changes) that this would take several years to work through, and in the meantime the costs would be borne by shareholders (through lower profits) and customers (in higher prices). These conversations suggest that the OBR may be correct, and the incidence transfers to employees much faster than most of the historic research suggests (and possibly more complete). I don’t know why this is. ↩︎

    17. See page five of this document, second paragraph. ↩︎

  • How to reform HMRC penalties for people on low incomes

    How to reform HMRC penalties for people on low incomes

    In the last few years, HMRC charged 420,000 people with £100 late filing penalties when they earned too little to pay tax. People earning under £6k received twice as many penalties as people earning more than £83k.

    Rachel Reeves should reform the penalties system.

    Our previous reporting on the impact of HMRC penalties on people on low incomes is here. As the Observer reported on Sunday, we now have better data, and the first data on the impact of the £300 penalties for filing one year late. It’s as concerning as our previous data on the impact of the £100 penalties.

    We’ve been presenting a series of tax reform proposals in the run-up to the Budget. This is the seventh – you can see the complete set here.

    The impact of penalties on the poor

    This chart shows the percentage of taxpayers in each income decile who were charged a £100 fixed late filing penalty:

    The green bars show where penalties were assessed but successfully appealed. The red bars show where the penalty was charged. The black vertical line shows the personal allowance, below which nobody should have any tax liability.

    • There are 420,000 penalties to the left of the black line. That means 420,000 £100 late filing penalties were assessed on people who earned too little to pay tax. Another 150,000 were charged with penalties but successfully appealed.
    • More than twice as many £100 penalties were charged on people in the lowest earning decile (earning less than £6k) than in the highest earning decile (earning more than £83k).

    There’s an even more extreme pattern in the £300 penalties for filing a year late: three times as many penalties in the lowest earning decile than the highest earning.

    Every penalty issued to the left of the “personal allowance line” is a policy failure. Those penalties should never have been issued.

    The full dataset and bar chart code is here, and there’s more detail on the technical background here.

    Why are people on such low incomes being asked to complete a self assessment return?

    We don’t know, but likely some mixture of:

    • People with self-employment income (which always requires self assessment),
    • People who had higher income the previous year, and
    • HMRC mistake.

    The human impact

    Several years of penalties can add up to thousands of pounds – here’s a typical example that was sent to us (digits obscured to preserve privacy):

    People are falling into debt, and in one case we’re aware of, actually becoming homeless, as a result of HMRC penalties.

    Even just the lowest penalty of £100 is a large proportion of the weekly income of someone on a low income (indeed over 100% of the weekly income for someone in the lowest income decile):

    A respected retired tax tribunal judge has described the current UK penalties regime as the most punitive in the world for people on low incomes.

    Since publishing our initial reports, we’ve been inundated with stories from people on low incomes affected by penalties when they had no tax to pay.

    These are vulnerable people, at a low point in their lives – and the same difficulties which meant they missed the filing deadline mean they often won’t lodge an appeal, and may take months before they pay the penalties (racking up additional penalties in the meantime). A successful appeal is not a success – it means that someone with limited time and resources has had to navigate what is to many a complex and difficult administrative system.

    Here are just two of the many responses we received:

    What should change

    Until 2010, nobody could be charged a penalty which exceeded the tax due. If you were issued a late filing penalty, and then submitted a return showing no tax was due, the penalty was cancelled.

    The data provides compelling evidence that the law should go back to how it was. We have more detailed recommendations here.

    This is one tax reform that should be easy for any Labour Chancellor. The cost is likely negligible; but there would be a real benefit to some of the poorest and most vulnerable in society.

    Many thanks to HMRC for their detailed and open response to our FOIA requests on penalties and income levels. And thanks to all the tax professionals who alerted me to this issue – otherwise I never would have been aware of it.

    All the data and code for these charts is here.

    Footnotes

    1. It’s for the most recent four years for which data is available ↩︎

    2. The top decile income threshold changed a little during this period – see the data here. ↩︎

    3. See Richard Thomas’ comments here ↩︎

  • Robert Venables, senior tax KC, is being prosecuted by HMRC for tax evasion

    Robert Venables, senior tax KC, is being prosecuted by HMRC for tax evasion

    HMRC is alleging Mr Venables evaded nine years’ tax in his personal tax returns.

    Tax evasion (technically “cheating the revenue”) is a criminal offence. Tax avoidance is not. The key difference is that tax evasion involves dishonesty. There’s more on what that means in our tax avoidance/evasion FAQ.

    Barristers have been prosecuted for tax evasion before; I can’t remember a tax KC being prosecuted. It’s quite hard to believe, so here is confirmation from HMRC, and comment from Venables’ chambers, Old Square:

    Venables has a reputation for enabling aggressive tax avoidance schemes. Until now, I hadn’t heard any suggestion of tax evasion/dishonesty. It’s important to note he is denying the allegations.

    Barristers and solicitors facing HMRC prosecution have historically stepped down or been suspended from their chambers/law firm. However, Venables is still a full member of Chambers and is still practising/advising clients.

    Old Square Tax Chambers told me “Robert continues to be a member of chambers, continues to practice and has the full support of chambers”.

    I don’t know if Venables’ clients have been informed about the prosecution. I wrote to one (Less Tax for Landlords) and asked if they knew their barrister was on trial for tax evasion; I didn’t receive a reply.

    We don’t know anything about the facts of the prosecution, what HMRC’s case is or what Venables’ defence is (other than that he contests the charges). Given the contempt of court rules and reporting restrictions, I’d suggest people are very cautious when commenting, online or offline.

    Comments on this post are turned off.

    Footnotes

    1. There was a court hearing last week (and a previous one last year) so it’s public information, although not easy to spot. HMRC confirmed, entirely properly, when we asked. ↩︎

  • What is tax avoidance? How’s it different from tax evasion? A short FAQ.

    What is tax avoidance? How’s it different from tax evasion? A short FAQ.

    This is an updated version of an article first published in 2023.

    What’s the very short answer?

    It’s this:

    (click to make bigger)

    But what is the legal definition of “tax avoidance”?

    There isn’t one.

    More precisely, there isn’t a single legal definition of “tax avoidance”. If there was, life would be easy: we’d pass a law saying that if you do tax avoidance, you lose, pay lots of extra tax, and maybe go to jail as well.

    If you ask a lawyer for advice on a complex arrangement or transaction, they will go through many rules, some of which they may call “anti-avoidance rules”. But they won’t write an analysis on whether the arrangement is “tax avoidance” because there is no legal test that works that way.

    So why am I bothering to use the term at all? Because if you do something most people regard as tax avoidance then some or all of the following will happen:

    • People won’t like you. Newspapers will write bad things about you. Consumers might even stop buying your products.
    • You will probably be caught by one of those “anti-avoidance rules” – approximately 64,000 have been enacted by Parliament over the years. So what you hoped would avoid tax in fact won’t avoid anything at all. The phrase used by most practitioners and HMRC is that your scheme “didn’t work”.
    • Even if you brilliantly escape the letter of the 64,000 anti-avoidance rules, you’ll run into the problem that judges really, really, don’t like tax avoidance (and haven’t since the late 1990s). So if you end up in court, the judge will probably magic some way for you to lose anyway (perhaps applying “common law anti-avoidance principles”). This annoys some legal purists, but doesn’t make me particularly unhappy.
    • For all these reasons, if HMRC finds out about your tax avoidance, they will challenge it, and – almost all of the time – they will win. You will end up paying the tax you tried to avoid, very possibly other tax you picked up along the way, plus interest and (potentially) penalties of up to 100% of the tax due.

    So I would strongly advise individuals and businesses not to do tax avoidance, or anything that HMRC will consider is tax avoidance.

    No really – what is “tax avoidance”?

    The conventional view – shared by most advisers, academics and HMRC – is that tax avoidance is using “loopholes” or other features of the tax system to save tax (“obtain a tax advantage”) in a way that wasn’t intended by Parliament. This is not a legal definition, and probably can’t be – but it’s a workable rule of thumb.

    So here are some things that are not tax avoidance, even though (in the usual meaning of the term) you are “avoiding” tax:

    • Investing through a pension or ISA. Yes, it avoids tax, but that was absolutely intended by Parliament. Not tax avoidance. Anyone who says otherwise is very silly.
    • Buying chocolate cake. Cake has 0% VAT. A chocolate-covered biscuit has 20% VAT. If you are pondering whether to buy a cake or a biscuit, and buy a cake because it’s cheaper, you are (in the most literal sense) avoiding VAT. But this is a legitimate choice – Parliament has drawn a stupid line in the sand, and you’re free to walk either side of it. The world is full of such choices, and none of them are tax avoidance.
    • Avoiding 39.35% income tax on dividends by investing in a “growth” company/index, so most of your return will be capital gain (taxed at only 20%, at least prior to the Budget). Another stupid line in the sand, but not tax avoidance.
    • Being genuinely self-employed Self-employed people get to claim deductions for expenses. More importantly, there’s no 13.8% employer national insurance (because there isn’t an employer)

    It seems profoundly illogical that not everything that avoids tax is “tax avoidance”, but it is also correct. All of these examples fit neatly in box 1 of the infographic at the top of the page – “normal tax planning”.

    And here are some things that are definitely tax avoidance:

    • Investing £10,000 in a film and claiming £50,000 film tax relief (i.e. so you had £50,000 of taxable income; you now have zero taxable income, saving around £20k of tax). Where does the other £40,000 come from? It’s borrowed from a bank, but actually goes round in a big complicated circle, so it’s as if it doesn’t exist. Absolutely tax avoidance. Didn’t work.
    • Paying £95,000 to magically create £1m of tax relief through a complex transaction which threw large amounts of money round in a circle, supposedly linked to a second hand car business. Didn’t work.
    • Avoiding £2.6m stamp duty on the purchase of the Dickins & Jones building on Regent Street by taking advantage of a complex interaction between the partnership and subsale SDLT rules. The taxpayer thought it was a simple and elegant scheme. The Court of Appeal took about two pages to kill it.
    • Having your wages paid to an offshore trust which then makes a “loan” to you (scare quotes because it never has to be repaid and there’s no interest on it, so it’s no more a loan that it is a bicycle). Instead of paying income tax on your wages, you pay either nothing or a very small amount. Tax avoidance. Doesn’t work. Amazingly, people still flog these schemes.

    All these schemes had two things in common: they were trying to achieve a result that wasn’t intended by Parliament, and they were highly complex and roundabout ways of achieving something that should be simple (buying a house; receiving a wage; investing in a business).

    Also, none of them worked. Almost no tax avoidance schemes work these days – meaning that the courts decide that the “trick” the taxpayer thought they’d found didn’t actually avoid tax at all.

    So each of these is in box 3 of the infographic (“failed tax avoidance”).

    This seems easy enough – what’s so hard about defining tax avoidance?

    How about these examples?

    • Incorporation. A plumber makes £50k/year. He sets up a company and starts working through that, paying himself dividends from the company. Nothing much changes, but he now doesn’t pay Class 4 National Insurance contributions – saving him about £3k/year. This is incredibly common.
    • Salary sacrifice. A [insert sympathetic employee of choice] earns £60,000. She’s offered a £5k pay rise – but that will be taxed at an almost 60% marginal rate, as she loses child benefit. So she uses a “salary sacrifice” scheme to make larger pension contributions, and gets the benefit of the £5k (eventually) without a high marginal tax rate.
    • Listing. A large plc is about to issue bonds to European pension funds. At the last moment, a tax lawyer spots that the bonds are unlisted, and so will be subject to 20% withholding tax – nobody will buy them. The obvious solution is to list the bonds, even though it serves no commercial purpose. A withholding tax exemption will then apply. Was the decision to list tax avoidance? It certainly avoided tax.
    • Taxable presence. A French champagne company sends a Paris marketing team on a promotional tour of the UK. They worry they might accidentally create a taxable presence in the UK, meaning that a chunk of their profits become subject to UK corporation tax. So they ask their accountants to draw up a list of dos and don’ts for the team to follow. Is that tax avoidance? It could avoid a whole bunch of tax.

    I would say none of these cases are tax avoidance, because in each one a person is making a choice that is anticipated and permitted by tax legislation, and which has actual consequences. They are all in box 1 of the infographic at the top of the page (“normal tax planning”). Other people may disagree.

    And then we get to the really difficult edge cases, where no tax system can produce sensible answers. Like exotic financial products and buying children’s clothes.

    • Sometimes it’s obvious what was intended by Parliament – e.g. your earnings should be taxed. The problem with complex financial products and other esoteric commercial products is that the legislation is often so arcane, and the results completely unintuitive, that the question of whether you’re in box 1 (“normal tax planning”) or box 2 (“successful avoidance”) becomes meaningless.
    • Much more difficult is VAT on clothing. It’s usually subject to 20% VAT, but children’s clothing has 0% VAT. The only person liable for the VAT is the retailer, and they determine the correct rate following HMRC guidance which mostly looks at sizing and whether clothing is sold as children’s clothing. Some smaller-sized women can save 20% of the price by buying children’s clothes (I know someone who does this; it’s not just an urban myth). This result really wasn’t intended by the legislation, but calling it “tax avoidance” feels daft.

    So you can’t realistically define tax avoidance in a legally robust way – and that’s why, as far as I’m aware, no country has managed to do so successfully.

    Doesn’t the GAAR define tax avoidance?

    Since 2013, the UK has had a “general anti-abuse rule” – the GAAR. Note the term is “anti-abuse” not “anti-avoidance”. This isn’t an accident – it reflects the impossibility of comprehensively defining avoidance. Instead the GAAR applies only where a scheme is so outrageous that it can’t reasonably be regarded as a reasonable course of action to take. This is called the “double reasonableness test“.

    The GAAR has in practice had very little effect, as the courts were happily striking down avoidance schemes for 57 different reasons well before the GAAR came in, and they’re equally happy to continue doing so. HMRC have in practice been using it as a shortcut, to save all the time/cost of taking a case to trial. There is an excellent article on the GAAR here, from Tax Adviser magazine.

    But we can be reasonably confident that, even if the four “definitely tax avoidance” examples above had somehow made it through every other anti-avoidance rule and principle, the GAAR would have kiboshed them. However, it wouldn’t have touched my four “maybe tax avoidance” examples – and that’s sensible (because otherwise no plumber would ever know if it’s safe to incorporate, and that would be unfair, and the resultant uncertainty would be bad for all of us).

    Doesn’t some tax avoidance work?

    Perhaps. Here are some things many people would say are tax avoidance but which normally work:

    • A US digital company makes lots of money from customers in the UK, but as it has only a very limited presence in the UK, it pays only a very limited amount of corporation tax. Its huge profits should be taxed in the US, but because the US tax system is broken, they’re largely not (particularly prior to US tax reform in 2017). Most laypeople people would say it’s tax avoidance; most advisers would say it isn’t. I’d say it’s a big problem either way: we’ll see in a year or so how effective the new OECD global minimum tax has been at changing things.
    • A company reducing its profits by borrowing from its shareholders. Fair enough that interest paid to a bank reduces a company’s taxable profit, but we also permit this for interest paid to shareholders. There are now rules that limit the tax benefit, but there’s definitely still a benefit.
    • Non-dom excluded property trusts. Being a non-dom is a perfectly legal way not to pay tax on foreign income for 15 years. After that, they’re fully subject to UK tax. But if they’d prefer not to be then, just before the 15 years is up, they can put their foreign assets into an “excluded property trust”, and keep them outside UK tax forever. Sure seems like tax avoidance, but it’s an inevitable consequence of the ways trusts are taxed, and so not something HMRC can usually challenge. The 2024 Budget seems likely to change that.
    • There’s 5% SDLT when you buy commercial real estate. So most commercial real estate is held in “special purpose vehicles” – offshore companies whose only activity is holding the real estate. Then instead of selling the real estate, you can sell the shares, with no SDLT. Seems fair to say it’s avoidance, but it’s an inevitable consequence of the way SDLT works, and so there’s no chance of HMRC challenge.

    None of these would be stopped by the GAAR, which is reasonable given that each is a choice that Parliament has intentionally made available to taxpayers.

    I think these are within box 1 of the infographic at the top of the page (“normal tax planning”). Others will disagree, and say they are within box 2 (“successful tax avoidance”). But that’s just a moral/ethical/political judgment – no legal or tax consequences follow from which of those two boxes these arrangements are actually in.

    What is the difference between tax avoidance and tax evasion?

    The classic tax lawyer answer is: “the thickness of a prison wall”. Like most classic lawyer answers, it isn’t of any help at all.

    In theory, the difference is simple. Tax evasion is dishonestly failing to pay tax. Usually there is an element of concealment or deception. Tax evasion is illegal – i.e a criminal offence, punishable with jail time and an unlimited fine.

    Here are some classic examples – and let’s assume for now that in each case the people involved know full well what they’re doing:

    • Having “cash in hand” income you don’t declare to HMRC. Easily the most common form of tax evasion.
    • Opening a Monaco bank account in the name of your dog, using it to receive “bungs”, and deliberately not declaring the bung or the bank account to HMRC. This is a hypothetical example.
    • Claiming film tax credits on expenses that never existed.
    • Doing an elaborate tax avoidance scheme, but where the key element is deceiving HMRC about the value of some shares.
    • Doing an elaborate tax avoidance scheme, where a key element is lying about the residence of a company.
    • Holding large amounts in an offshore trust, which you don’t disclose to HMRC even after you are caught evading tax on other offshore accounts.

    These are all clearly tax evasion, and people can and do go to jail for them. It’s box 5 of the infographic (“tax evasion”).

    If they didn’t know, and it was an accident (even a negligent one) they’re in box 4 (“non-compliant”), and may pay penalties, but escape criminal sanctions.

    What is “dishonesty” in this context?

    So it becomes very important whether someone acted dishonestly. In practice that means: whether HMRC think they can prove dishonesty to a jury.

    The modern approach to “dishonesty” applied by UK courts is to ask whether the conduct was dishonest by the standards of ordinary decent people (regardless of whether the individuals in question believed at the time they were being dishonest). The leading textbook of criminal law and practice, Archbold, says:

    “In most cases the jury will need no further direction than the short two-limb test in Barton “(a) what was the defendant’s actual state of knowledge or belief as to the facts and (b) was his conduct dishonest by the standards of ordinary decent people?”

    It used to be different. A jury had to be persuaded not only that an objective person would think I was dishonest, but that I knew I was dishonest. So I could say that I was acting in line with what others in the sector were doing, and thought it was perfectly fine. That no longer helps me if a jury decides that objectively I was being dishonest.

    What’s the difference between tax avoidance, tax mitigation, tax shelters and tax planning?

    All are undefined vague terms that can mean what we want them to mean.

    I usually use the terms like this, but you should feel free to disagree with me:

    • Tax mitigation = a polite term for tax avoidance
    • Tax shelters = a term that the US tax avoidance industry has successfully used for years, so that US media usually refers to “tax shelters” (which sound nice!) rather than “tax avoidance schemes” (which don’t).
    • Tax planning = chosing to walk on on one side of a line that has been drawn by Parliament, and being careful not to step over the line.

    So is tax avoidance legal or illegal?

    It depends:

    • John and Jane both enter into the same tax avoidance scheme. John believes it works. Jane knows it doesn’t, but thinks HMRC won’t spot it. HMRC do spot it, challenge the scheme, and win.

    The result, in theory, is that John and Jane both filed an incorrect tax return, and so owe the tax, interest and (if they were careless) penalties. They got their tax wrong, and that’s not illegal.

    But Jane was dishonest. She committed tax evasion and so did act illegally. The question is: can HMRC prove it?

    Here’s another, and more realistic, example:

    • Catherine devises an elaborate “tax avoidance scheme” which she knows in her heart-of-hearts has no chance of working, but by the time HMRC come round to challenging it, Catherine (and her fees) will be long gone.
    • Catherine flogs the scheme to hundreds of taxpayer clients, assisted by an opinion she somehow obtained from Thelma, a tax QC.
    • Thelma is politically hostile to the idea of taxation, and takes positions on the legal analysis which very few tax advisers would share. In her heart of hearts, she knows the courts won’t agree – but she thinks the courts are wrong.
    • The clients all believe the scheme works.

    This is definitely tax evasion – Catherine was dishonest, because she knew the scheme didn’t work. Thelma was probably dishonest (because her advice was not caveated with “this is my view but you should be aware that the courts will likely disagree”). The question is whether we can prove this.

    Other tax advisers may say the scheme had no reasonable prospect of success, and we can suspect that Catherine and Thelma knew this, but Catherine will say she had an opinion from Thelma. Thelma’s advice is probably legally privileged, so neither HMRC nor the courts will ever see it. If they did, Thelma will say she was advising on the basis of her good faith view of the law.

    I think a jury might well say that, by the standards of ordinary decent people, it’s dishonest to take tax positions that 99% of tax advisers would say are wrong. But HMRC has, to my knowledge, never tested this, and there’s never been a prosecution with facts anything like this. I would like that to change.

    But the key point: it’s incorrect to say that tax avoidance is per se “legal” or “illegal”. Much of the tax avoidance I’ve seen in the last few years falls into the Catherine/Thelma category. It’s really tax evasion, but there’s no prosecution.

    Who will end up out of pocket here? Catherine, Thelma or the clients? Usually the answer is: the clients. HMRC recovers the tax from them. Possibly they try to recover penalties from Catherine, but there’s a good chance she winds up the business and walks away. Thelma is untouched.

    So why do almost all articles about tax avoidance say “there’s no suggestion this was illegal”?

    I’ve no idea.

    Do companies have a legal duty to minimise their tax?

    Directors have a broad duty to promote the success of their company, and tax is just one of the many factors directors should consider in making a decision. A director may well be failing in their duties if they blunder into a large unnecessary tax charge. But in no sense does this create a duty to minimise tax, anymore than it creates a duty to minimise employees’ pay or maximise consumer prices. This is very clear under the Companies Act 2006, and was clear enough under the old common law rules.

    Why do so many people appear to think this is a live issue? I’ve no idea. In 25 years of practice, I didn’t once come across a client or lawyer who thought directors had a duty to minimise tax. So this appears to be a political/ideological point rather than a legal one.

    Did [politician I don’t like] commit tax evasion?

    One consequence of political polarisation is an eagerness to use terms like “tax evasion” to describe what is almost certainly a mistake, if the taxpayer in question is a politician who we don’t like.

    Nadhim Zahawi certainly got his taxes wrong. There was at one point good reason to believe that Angela Rayner go her taxes wrong (although she says HMRC has now confirmed that she didn’t). I once made a small mistake on my own tax return.

    It is, however, not a criminal offence to pay the wrong amount of tax by accident. It’s not even a criminal offence to pay the wrong amount of tax because you were careless (although that can trigger penalties).

    It’s only a criminal offence if you fail to pay tax deliberately and dishonestly. There was never any evidence that Zahawi or Rayner acted dishonestly (or me, for that matter). No jury would have convicted either, and no responsible tax authority or prosecution authority would have brought a prosecution.

    Photo by Maxim Babichev on Unsplash

    Footnotes

    1. I’m probably supposed to say this is not legal advice, but I’m a lawyer, and this is my advice. ↩︎

    2. This link goes to a page on the former website of accounting firm Aston Shaw. When that link was included, we had no idea who they were. We subsequently found they were part of a corporate group engineering what appears to be large-scale tax fraud, and 11 directors/employees have been arrested. ↩︎

    3. Where exactly you draw the boundary between employed and self-employed is a fascinating and difficult question which I am absolutely not going to get into here. Similarly, I’m not even touching IR35. ↩︎

    4. I go into the loan schemes in more detail here. I’m aware lots of people say they were hoodwinked into the schemes and didn’t realise what they were. But one thing is clear and inarguable: they were tax avoidance ↩︎

    5. In principle tax treaty claims could be made, but that’s often commercially undesirable due to the hassle and potential cashflow cost whilst treaty relief is pending. It also potentially makes the bonds hard to sell/illiquid. ↩︎

    6. Unless the diverted profits tax applies. That’s an anti-avoidance rule that, like many anti-avoidance rules, doesn’t require HMRC to prove that there was intentional avoidance. ↩︎

    7. This is definitely not legal advice – if you do this without taking independent advice, you are crackers ↩︎

    8. Or at least some people intended it ↩︎

    9. That quote originates with Denis Healey ↩︎

    10. Actually there isn’t a single criminal offence of “tax evasion” in the UK. There is a common law criminal offence of “cheating the Revenue” and numerous statutory offences covering different taxes; but all share the key feature I mention here. ↩︎

    11. The subjective element of the test for dishonesty (see Ghosh (1982)) was removed by Ivey [2017] for civil cases, and that decision was confirmed to apply to criminal cases in Barton [2020]. ↩︎

    12. Jolyon Maugham wrote an excellent summary of the issues here – he also thinks it is a non-issue. ↩︎

  • The public’s surprising choice of tax increase, and why we should ignore it

    The public’s surprising choice of tax increase, and why we should ignore it

    Gabriel Milland of Portland Communications has published polling conducted by the Portland research team in early October. Gabriel takes some interesting political conclusions from the polling (and I’d recommend his article). However, my focus is what the polling says about tax policy, and about polling on tax policy.

    Amended to include the answers – apologies for missing this out first time

    What do people want?

    Here’s the result of asking the public which tax they’d prefer to put up:

    It’s a surprising win for taxes on betting, with Conservative voters in particular strongly in favour. Capital gains tax runs a close second, and bank taxes and VAT on private schools are tied for third.

    And who do the public think should take the burden of any tax rises?

    People who are not them. Specifically, people earning £75k, second home-owners, non-doms, businesses and shareholders.

    About a quarter want to increase taxes on business. But, if we focus on business tax specifically (and ask the question in a certain way), there’s a large majority that’s against raising business tax, because they think the cost will be passed on to them:

    Should we pay attention to these results?

    In my view we should not, for two reasons.

    First, there is widespread misunderstanding of tax and spending.

    Portland asked respondents to list the top three things Government spends money on:

    Total Government spending is around £1,200bn. Spending on asylum seekers and migrants amounts to about £4bn (0.3% of all spending). Spending on MPs’ expenses and staff costs amounts to about £150m each year (0.01% of all spending).

    Here’s an approximate chart with the actual figures, thanks to ten minutes of very fast work by Maxwell Marlow. Maxwell stresses that we shouldn’t treat it as more than indicative:

    So why do people think that MPs’ expenses are in the top three spending items, when they’re not in the top three hundred?

    Because most people don’t understand the size of the Government budget. Only one in six people got the right order of magnitude:

    The correct answer is £1 trillion (more precisely, around £1.2 trillion).

    And this result in turn may be because most of the population don’t understand billions and trillions:

    There are a thousand millions in a billion, and a thousand billions in a trillion.

    And there is also widespread misunderstanding of one of the simplest feature of the income tax system – the way that bands work:

    The second answer is correct. You pay 40% tax on your income above the 40% band (which for most people is £50,000, but that threshold drops for high earners as the personal allowance is reduced).

    This reflects our earlier polling – the question is intentionally different from last time, but the result is consistent.

    I’d repeat our earlier point that there is a risk this is changing peoples’ real world behaviour – for example causing some people to turn away work for fear of entering the 40% tax band. It would seem prudent for HMRC to investigate if there is a real effect here.

    Second, these are three second conversations

    Tony Blair talked about the fallacy of polling individual policies and thinking that you’re learning something from peoples’ three second take on complex issues. In the real world, they may have a different view after a thirty second conversation, and a very different view after a three minute conversation. Blair’s point was that election campaigns, where policies are contested, are likely to reflect the three minute view more than the thirty second view (where policies are presented without context).

    So, for example, we suspect that the popularity of raising tax on people earning £75k would fall upon realisation that their marginal rate is already often pushing 60%. The consistent popularity of wealth taxes would be unlikely to survive presentation of the history of faliure of previous wealth taxes. People may be attracted to the idea of charging VAT on private school fees, but the amount it raises is economically insignificant. And that interesting finding about the unpopularity of tax on business may well be significantly influenced by the very “three second” framing with which it was presented.

    Should we ignore popular views of tax?

    If most people don’t understand the tax system, or government funding, should tax policy simply ignore popular views of tax and the tax system?

    That would be a mistake, and perhaps even dangerous. Our political system, and our tax system, needs popular consent. And ignoring popular views on tax would give space for populists, of Left and Right, to pursue tax policies that could be highly destructive.

    Tax policy therefore has to be informed by the public mood – but it shouldn’t be led by three second conversations, which confuse public sentiment for public opinion. And tax policy, and tax educators, should seek to challenge popular misapprehensions.

    However there is a wider problem.

    Robert Colville recently wrote in The Times that much bad tax policy is driven by politicians’ fear that they can’t tell voters the truth about the real constraints on tax and spending. He may be right. But how can politicians tell voters the truth about what may have to change, if voters don’t understand the basics of how things work at the moment?

    It seems trite and inadequate to say that we need more education around finance and tax. Right now I don’t have any other suggestions.

    Many thanks to Gabriel Milland and Portland Communications – they ran the tax band question, and shared with polling data with us, entirely pro bono.

    Photo by Red Dot on Unsplash.

    Footnotes

    1. Who already face a top marginal rate of almost 60% ↩︎

    2. It comes out of the foreign aid budget ↩︎

    3. This is a better result than we’d expect if people were guessing (a z-score of approximately 3.355 corresponds to a p-value less than 0.001), but still depressing. ↩︎

    4. The UK used to use a “long billion” of a million millions, but that ceased being used for Government statistics in 1975. We can probably discard the possibility that some of the wrong answers are from people remembering the old billion, because the results vary little across age groups. ↩︎

    5. If you look at the data, linked in Gabriel’s article, people on higher incomes, the self-employed and graduates are more likely to know the correct answer, but not by much. Some of the subgroups have samples too small to be statistically significant. ↩︎

  • Witness tampering from tax avoidance firm Property118?

    Witness tampering from tax avoidance firm Property118?

    HMRC has designated two structures used by the adviser ‘Property118’ as “tax avoidance schemes”. Property118 are appealing to a tax tribunal, and have asked their clients to provide witness statements. That’s perfectly normal. But what’s not normal at all is that Property118 are directing the content of the witness statements.

    It would be serious professional misconduct for a solicitor or barrister to coach a witness in this manner, and the witness statements may now be inadmissible.

    The background to the Property118 tax appeal can be found in our previous reports here.

    The request for witness statements

    It’s usual for a party to a dispute to ask interested third parties to provide witness statements. Court rules require that witness statements from a person should be made in their own words.

    That’s not the approach Property118 took in a message they sent their clients on 18 September:

    This is not merely asking for witness statements; it’s directing what they should say: “In these witness statements, we want to highlight that the decision to use [the structure] was primarily based on commercial practicality – not on tax advantages”.

    Mark Alexander, the founder of Property118, then provided his clients with a list of points to add into their witness statements:

    And Property118 have a template they have “95% prepared”:

    There seems to be some awareness that it is improper to template witness statements – “similar is good, identical is not”:

    The messages above come from Property118’s client forum. Two Property118 clients were so alarmed at what they were being asked to do that they (independently) spoke to lawyers, who contacted us with their clients’ permission.

    The consequences

    We discussed the likely consequences of Property118’s approach with two tax KCs and two solicitors specialising in tax litigation.

    Solicitors and barristers have a duty not to mislead a court or tribunal. It would be serious professional misconduct for a solicitor or barrister to coach a witness or seek to influence the content of a witness statement. The courts have been very unhappy when presented with witness statements which were in reality written by a legal team, not the witness.

    We and the lawyers we spoke to thought it was highly unlikely that Property118’s legal team had agreed to this approach. It was much more likely that Property118 were obtaining the witness statements behind the backs of their legal team.

    That, however, presents a problem. When and if Property118’s legal team becomes aware of how the witness statements were obtained, it is unclear how they will be able to present them to the tribunal.

    Witness statements drafted in this way would probably not be admissible in a civil court. Tax tribunals have more flexibility, but we would expect a barrister to be required to, at the least, draw the tribunal’s attention to the fact that a witness statement was, to a significant degree, prepared by Property118 and not the witness. That would then likely undermine the weight the Tribunal gave to the witness statement.

    The substance of the issue

    The difficulty Property118 are having reflects a common problem faced by promoters of tax avoidance schemes. A judge will expect an answer to the question: “why did you enter into this transaction?” The real answer is: to avoid tax. But if the promoter gives that answer, they’ll likely lose. So they struggle to find some other answer – anything, other than tax. Property118’s attempt to construct witness statements should be seen in this context.

    Property118 marketed a structure for landlords. The structure involved the landlords declaring a trust in favour of a company. This supposedly enabled landlords to achieve all the benefits of incorporating their business – lower tax rate, full deduction for mortgage interest, and capital gains tax and potentially inheritance tax advantages. But it avoided all the messy disadvantages of incorporation: needing a new mortgage, having to tell tenants, and moving all the contracts associated with the business.

    None of that actually worked as a technical matter. But even if it had, there’s a basic problem with the proposition. The trust structure has no benefit other than tax.

    If you incorporate a business in the usual way, that will have a large number of legal and commercial implications. Some are desirable; some are not. But the many changes that flow from the incorporation mean that you can’t usually look at someone incorporating a business and say “this is mainly being done for tax reasons”. There’s too much going on.

    Property118’s trust structure had only one benefit: a tax advantage.

    Property118 are trying to coach their witnesses into answering the question: “why did you use the Property118 structure instead of incorporating?” That’s the wrong question. The correct question is “why did you use this structure instead of keeping things as they were?”

    The only answer to that is: tax.

    The main benefit, and perhaps sole benefit, of the structure was tax, and that’s why Property118’s appeal will likely fail.

    Photo by Scott Graham on Unsplash

    Many thanks to K, H, D, V and T for their help with this article.

    Footnotes

    1. See e.g. paragraph 18.1 of Practice Direction 32 of the CPR: “The witness statement must, if practicable, be in the intended witness’s own words and must in any event be drafted in their own language”. The recent MacKenzie v Rosenblatt case (also linked above) shows how courts can be expected to react when a legal team prepares witness statements. ↩︎

    2. See rule 15 of the First-Tier Tribunal Rules ↩︎

  • Budget Prediction Quiz

    Budget Prediction Quiz

    Nobody’s looking forward to tax rises in the Budget.

    To create at least some upside, we’ve made a simple Budget prediction quiz.

    We’ve listed 34 potential ways the Chancellor could raise tax. Go to the quiz (link below), and tick the tax rises that you predict will happen. For every prediction you get right, you win two points. For every prediction that doesn’t pan out, you lose one point.

    Of course there will probably be tax rises that aren’t in our list – you can add additional predictions in the text box at the end of the quiz, and that will be used to resolve any tie on points (but otherwise will be ignored).

    Winner gets (at their option) a bottle of decent wine or large box of chocolates. Plus bragging rights.

    There’s a catch (there’s always a catch). You have to subscribe to our Substack to enter the quiz. It’s free to join, and you then receive our reports and articles ahead of the crowd.

    The link to the quiz is here.

    Footnotes

    1. All judging decisions made at the sole discretion of Tax Policy Associates Ltd. If you disagree with our decision, you can file an appeal with the First Tier Tribunal (Tax Chamber), but we cannot guarantee they will accept jurisdiction. ↩︎

    2. Or you can remain anonymous – up to you. ↩︎

    Graphic by DALL-E 3: “A large Rubik’s cube on a traditional wooden desk, with papers on either side. The cube should have financial figures on it. Widescreen.”

  • The tax longlist – 35 ways Rachel Reeves could raise £22bn

    The tax longlist – 35 ways Rachel Reeves could raise £22bn

    Rachel Reeves has said there is a £22bn “black hole” in the public finances, and that she’ll have to raise tax to fill it. Labour are heavily constrained by their pre-election promises, and that makes raising £22bn a challenging endeavour. But certainly not impossible.

    This is an updated version of my August article.

    I’ve previously written about the case for tax reform, and argued for eight specific tax cuts. This article solely looks at potential tax-raising measures. I’m not an economist, and I won’t discuss the question of whether this level of tax increase at the present time is necessary or desirable.

    The problem

    How much room for manoeuvre does Rachel Reeves have?

    Here’s how UK tax receipts looked in 2023/24 – about a trillion pounds in total:

    During the election campaign, Labour ruled out increasing income tax, national insurance, VAT or corporation tax. They’ve committed to reform business rates, so an increase there seems unlikely. The promise not to increase tax on “working people” probably rules out council tax and air passenger duty. Stamp taxes and bank taxes are already probably past the point where more can be raised. Customs duties are complicated by trade treaties. Raising insurance premium tax without raising VAT would be distortive. Raising alcohol duty would be unpopular out of all proportion to its significance. Labour have already planned an increase to oil/gas taxation.

    What does this leave? About £100bn of taxes:

    It’s hard and perhaps impossible to find £22bn there.

    Two solutions we probably won’t see

    One solution is to simply break the pre-election promises. It’s happened before. However the promises this time were repeated so often, and made so clearly, that breaking them feels (at least to me) out of the question.

    Another solution: radical tax reform.

    This could mean land tax reform – for example replacing business rates, stamp duty land tax and council tax with a land value tax. Most people would pay broadly the same tax as before, but those owning valuable land would pay a lot more. I wrote about that here. Sadly I don’t think this is likely to happen – the poll tax casts a long shadow over anything that affects local government taxation.

    Another would be radical reform to personal taxation, ending the distortive, unfair and economically damaging gap between the tax treatment of employment income and the tax treatment of other kinds of income. Again, this would be politically challenging.

    Tax reform would be welcome – and I’ll be writing more about it soon – but I fear we won’t see much of it in this Budget. And some would say (not unreasonably) that the Government has no mandate for radical changes to the tax system.

    The solutions we probably will see

    If Ms Reeves isn’t going to break pre-election promises, or opt for radical tax reform, then it’s a matter of scrabbling for relatively small tax increases here and there. Here are items I’d expect to be on the Chancellor’s longlist, in a roughly descending order of likeliness:

    • Fiscal drag – £7bn. The FT is reporting that Rachel Reeves is considering freezing tax thresholds until 2028. The idea is that inflation/earnings growth mean we’re all earning more in cash terms, but not in real terms – however tax thresholds stay the same. The result: more and more income, and more and more taxpayers, get dragged into higher rate tax bands. Fiscal drag was very successfully deployed by Blair/Brown (with limited resistance at the time), but then became less relevant as inflation fell. With the resurgence of inflation, and need to raise funding to pay for Covid, the Johnson and then Sunak Governments raised very large amounts with fiscal drag – over £29bn by 2027/28. This has only a limited effect on median earners, but significant tax increases for higher earners. It would be surprising if this new Government doesn’t do the same. Further fiscal drag feels so inevitable that it barely deserves to make this list.
    • Pension tax relief – £3-15bn. Lots of people are predicting this. Right now, contributions to a pension are fully tax-deductible. If you’re a high earner, paying a 45% marginal rate, you get 45% tax relief on your pension contributions. Some view this as unfair, and suggest limiting relief to 30%, or even the 20% basic rate. That could raise significant amounts – £3bn (if limited to 30%) or up to £15bn (if limited to 20%). But withdrawals from a pension, after the tax free lump sum, are taxable at your marginal rate at the time. Offering a 20% or 30% tax deduction for pension contributions, but taxing withdrawals at 40%, isn’t a great deal. High earners may shift their investments to other products. There could be complex second and third order effects. I’d say this is streets ahead of all other tax raising candidates given the large amounts that can be raised, and the ease of implementation. But there’s a catch – applying to defined benefit schemes (meaning, in practice, public sector pensions) is more complicated. And exempting defined benefit/public sector schemes from new rules would be widely – and correctly – seen as unfair. One alternative – fairer, but more complicated – would be to end or restrict the national insurance exemption for pension contributions – the IFS has written about this here and/or impose national insurance on pension drawdowns.
    • End AIM IHT relief – c£100m. It’s daft that my estate would pay 40% inheritance tax on my share portfolio, but if I move it into AIM shares and live for two more years, there would be no inheritance tax at all. Commercial providers sell portfolios designed solely to take advantage of this. But it’s not just AIM shares – if, like Rishi Sunak’s wife, I hold shares in a foreign company that’s listed on an exchange that isn’t a “recognised stock exchange” then those shares would also be entirely exempt. It’s unclear how much tax would be raised by this; the £1bn figure sometimes quoted appears to be incorrect, as that’s looking solely at the total cost of business relief across all unlisted shares, which will include completely unlisted private companies (which we discuss below). A more accurate figure is likely around £100m. Some people are warning it would crash the market. The flipside: AIM yields are currently depressed by market valuations driven by the tax benefit, not fundamentals. This is an unhealthy state for any market to be in.
    • Limit business and agricultural property relief – £1-2bn. Most private businesses – of any size – are exempt from inheritance tax. Protecting small businesses and farms makes sense, but why should the estate of the Duke of Westminster pay almost no tax? And why should we be creating a weird tax-driven market in woodland? There’s potential for £2bn or more here, for a measure that could fairly be presented as closing loopholes. Other reliefs, e.g. heritage relief, could also be looked at.
    • Tax large gifts – £?. The problem with reducing inheritance tax reliefs is that people will rationally respond by giving property to their children. That’s hard for a moderately wealthy person to do with their house, because the “gifts with reservation of benefit” rules mean that you’d then struggle to still live in it. But a very wealthy person owning a large private business could pass it to their children and, provided they live for seven years, the business would completely escape inheritance tax. So, whilst there is already a lot of tax planning around gifts to children, that would explode if BPR/APR were curtailed. There’s also an exemption for gifts which classify as “normal expenditure out of income“, which in practice enables people with large amounts of investment income to make very large untaxed gifts. So those reforms are only rational if at the same time we tax lifetime gifts and cap the “normal expenditure” exemption. To prevent difficult compliance (and difficult politics!) this should only be for large gifts, say over £1m. It would raise additional sums, beyond closing any loophole in new APR/BPR restrictions… but how much is hard to say.
    • Pensions inheritance tax reform – £100m to £2bn. If you inherit the pension of someone who died before age 75, it’s completely tax free. But if they died aged 75 or over, the pension provider deducts PAYE, which means up to 45% tax if the beneficiary takes a lump sum (or less if they drawdown the pension over time). This is a very odd result. Simply applying the usual 40% inheritance tax rules could raise about £2bn in the long term (and in some cases would be a small tax cut for beneficiaries of the over-75s).
    • Increase capital gains tax – £6bn+. The Lib Dems proposed equalising the rate with income tax, and said it would raise £5bn. At the time I said that, on the basis of HMRC figures, this would cost around £3bn in lost tax. There is a better way, to cut the effective rate of CGT for investors putting capital at risk, but increase it for others. That could even be combined with an income tax cut, and still raise significant sums. I talk about it in detail here.
    • Eliminate the stamp duty “loophole” for enveloped commercial property – £1bn+. It’s common for high value commercial property to be sold by selling the single-purpose company in which it’s held (or “enveloped”). So instead of stamp duty land tax at 5%, the buyer pays stamp duty reserve tax at 0.5% of the equity value or if (as is common) an offshore company is used, no stamp duty at all. This practice has been accepted by successive Governments for decades. It would be technically straightforward to apply 5% SDLT to such transactions, and this would raise a large amount – over £1bn.
    • Increase ATED – £200m+. The “annual tax on enveloped dwellings” is an obscure tax that was introduced to deter people from holding residential property in single purpose companies to avoid stamp duty. As we explain here, it’s currently failing because it’s been set too low, and raises a derisory £111m. There’s a case for tripling it.
    • Increase inheritance tax on trusts – £500m. When UK domiciled individuals settle property on trust, the trust is subject to a 6% tax every ten years, and another 6% charge when property leaves the trust (broadly pro rata to the number of years since the last ten yearly charge). These taxes currently raise £1.3bn, on top of the 20% “entry charge” when property goes into trust. This all seems rather a good deal if we compare it to the 40% inheritance tax paid by estates on property that isn’t in trust. So there’s an argument for increasing the rate from 6% to 9% – and that should raise somewhere north of £500m.
    • Reform R&D tax relief – £3bn. We’ve had series of tax reliefs designed to incentivise research and development. They now cost £7bn per year, but I fear most of this is wasted. R&D tax relief is highly complex – only the most sophisticated companies able to plan R&D with confidence that the relief will apply. And they have been widely abused, with perhaps as much as £10 billion wasted in wrong and fraudulent relief claims; HMRC’s response to that is now blocking legitimate claims. The people who could really do with the relief aren’t getting it. Rachel Reeves could solve all these problems at once. Focus the relief narrowly on significant projects aimed at science and development innovation, with harsh penalties for companies and advisors making indefensible claims. Create a simple and fast pre-clearance process to provide certainty. The aim should be to provide more generous relief for, e.g., bio science, engineering, and tech companies, and no relief for anybody else. Simultaneously promote growth and stop wasting taxpayer funds.
    • Push the Bank of England to stop paying interest on some of the QE bonds it holds -c£5bn. This is somewhat esoteric and not strictly tax – but it does represent a relatively pain-free to raise somewhere around £5bn each year (for the short to medium term). The Bank of England currently pays interest on the reserves that commercial banks place with it. In theory it could raise up to £23bn by dividing the reserves into “tiers”, ceasing to pay interest on one tier, and requiring the banks to continue to keep that tier with the. BoE. Reform UK thought that £35bn could be raised this way – but most observers believe that would destabilise the BoE’s control of interest rates, and somewhere around £5bn is more reasonable. I can’t do justice to this point – there’s a pair of excellent FT articles by Chris Giles and (in more detail) Toby Nangle. Rachel Reeves warned against some of the more maximalist variants of this policy, but has perhaps left the door open to a more minimal approach. What’s not clear is who would ultimately bear the economic cost of such a change (the “incidence” in tax wonk-speak). The banks’ shareholders? Or their customers?
    • Council tax increases for valuable property – £1-5bn. It’s indefensible that an average property in Blackpool pays more council tax than a £100m penthouse in Knightsbridge. The obvious answer is to “uncap” council tax so that it bears more relation to the value of the property – either by adding more bands, or applying say 0.5% to all property value over £2m. Depending on how it was done, this could raise several £1bn. The argument seems compelling for any Government, and particularly a Labour government. And whilst Labour promised not to change the council tax bands, that was in the context of revaluation, not adding more bands at the top.
    • Introduce an exit tax – £unknown. There are two features of the UK capital gains tax system which practitioners take for granted, but which non-specialists often think are peculiar. First, if you arrive in the UK, become UK tax resident, and then immediately dispose of an asset, the UK taxes you on the entire lifetime gain of that asset (even if almost all of that gain accrued when you lived abroad). This is rather unfair and deters some entrepreneurs from moving to the UK. Second, if you spend years building up a business in the UK, then leave the UK and dispose of the business in the next tax year, then the UK taxes none of that gain (even if almost all of it accrued when you live here). It would be rational to end both anomalies, so that the UK fairly taxes UK gains. We should measure the gain from the point at which someone arrives in the UK and when someone leaves the UK, the gain they accrued here should still be taxable here as and when they sell. This would overall be a fairer system. It would also likely raise some tax, because entrepreneurs would no longer be able to escape UK CGT by moving to Monaco five minutes before selling their business.
    • Abolish business asset disposal relief – £1.5bn. This is a capital gains tax relief supposedly for the benefit of entrepreneurs. But the Treasury officials forced to create it named it “BAD” for a reason. The benefit for genuine entrepreneurs is limited (a 10% rather than 20% rate). It’s widely exploited. Abolition would raise £1.5bn.
    • Increase vehicle excise duty – £200m+. VED currently applies at various rates for different vehicles, depending on the type of vehicle, registration date and engine sizes. The average for a car is about £200. A £5 increase would raise £200m, and raising £1bn wouldn’t be terribly challenging. However it would impact “working people“.
    • Reverse the Tories’ cancellation of the fuel duty rise – £3bn. For years, Governments have been cancelling scheduled (and budgeted) rises in fuel duty. Most recently, the Conservative Government did that in March, forgoing £3n of revenue. There is an infamous OBR chart showing the effect of this. It would be easy to reverse that – but (unlike most of the other tax changes listed here) it would definitely affect “working people“.
    • Review VAT exemptions – £1bn+. Many of the VAT exemptions/special rates make little sense and should be abolished. The 0% rate on children’s clothes should be first to go, with child benefit uprated by 10% so that people on low/moderate incomes don’t lose out. This change alone would yield about £1bn.
    • Increase the digital services tax – £400m. The digital services tax is a flat % tax on large internet businesses’ income from digital services. So, for example, advertising revenue paid to search platforms and fees paid to marketplaces. The rate is currently 2%, and it raises around £800m, so a 1% increase should raise £400m. On the face of it, an easy tax to increase. However there are two good reasons not to. First, most of the economic burden of the tax falls on UK businesses. Second, there are geopolitical complications given that the DST is part of a complex and still-moving international negotiations over the future of international tax. I discussed these in more details when the Lib Dems proposed tripling the tax in their 2024 manifesto. There is a good analysis from TaxWatch here, a House of Commons Library introduction to the tax here, and a National Audit Office assessment of the tax here.

    These changes could raise between £21bn and £41bn, depending on how each were implemented, and with significant uncertainties around many of the estimates.

    Here are a few more possibilities, which could raise very significant sums but which I think are (for various reasons) unlikely:

    • Increase employer national insurance – c£8.5bn per % increase.. Employer national insurance is currently 13.8%. It’s technically very easy to increase and would raise large sums (the £8.5bn figure comes from the HMRC “ready reckoner“). But employer national insurance is one of the worst taxes to raise; it exacerbates the already highly problematic bias against employment in the tax system. The economic burden would mostly fall on employees, and any increase probably breaks a pre-election promise. I wrote about these issues here.
    • End the pension tax free lump sum – £5.5bn. On retirement, we can withdraw 25% of our pension pot, up to £268k, as a tax free lump sum. The argument for abolition is that most of the benefit goes to people on higher incomes paying a higher marginal rate. The argument against is that people have been paying into their pensions for decades on the promise of the rules working a certain way, and it’s unfair to now change that (and I agree with this position). Labour also seemed to rule out the change. But it’s an “easy” way to raise lots of tax – limiting the benefit to £100,000 would raise £5.5bn.
    • Introduce “sin taxes” on unhealthy food – £3.6bn. An IPPR report recently proposed a “10 per cent tax on non-essential, unhealthy food categories including processed meat, confectionary, cakes and biscuits”, modelled on successful taxes in Hungary and Mexico. As a tax lawyer, my instinct is to be sceptical of such proposals; decades of VAT cake litigation attest to the difficulty of clearing defining different categories of food. There is a concerning gap between the claims from health advocates and the IPPR, and the actual evidence So whilst taxing “unhealthy food” would be an effective way of raising tax, it is questionable if there would be any health benefits, and the tax would overall be regressive.
    • Tax gambling winnings £1-3bn. The US taxes gambling winnings. The UK doesn’t (unless you are a professional gambler so gambling becomes your trade or profession). In theory this would raise £1-3bn. It would have two ancillary benefits: (1) discourage gambling (in a way that raising betting duties would not), (2) end the oddity that spread betting isn’t taxable when equivalent derivative transactions are. But there are three big downsides. First, it would be (in my view) unfair to tax gambling winnings without giving relief for gambling losses (as the US does). That reduces the yield. It also creates a relief that would be exploited for tax avoidance and tax evasion. Second, it would in practice be regressive, hitting the poor disproportionately. Third, the tax would realistically need to be withheld at source (as it is in the US), which requires a new taxing infrastructure to be created. So, whilst an interesting thought, I can’t see this happening.
    • Increase taxes on gambling – up to £2.9bn. The recent IPPR report also proposes increasing gaming duties. This would raise significantly more tax than taxing gambling winnings, and be easy to implement but (I expect) be less effective at reducing gambling (if that is the aim). Taxing gambling winnings has a direct economic and psychological impact on gamblers, and therefore plausibly reduces gambling. Gaming duties reduce supplier profits, and so only reduce gambling if suppliers respond by closing businesses or increasing odds to protect their margin (and gamblers are price-sensitive).
    • Cap tax relief on ISAs – up to £5bn. Cash and shares/stocks in ISAs is exempt from income tax and capital gains tax. This tax relief costs about £7bn of lost tax each year. Most ISAs are small – only 20% hold more than £50,000. But I expect this 20% receive around 80% of the benefit of ISA relief. So in principle the Government could save £5bn by capping relief for the first £50k (or some lesser amount for a higher cap, with diminishing returns setting in fast). However many would regard this as unfair – they took advantage of a widely promoted Government saving scheme, and now the rules are being changed after the event. I think that’s a compelling argument. An alternative approach would be to reduce the £20k annual allowance, which naturally benefits people with the highest disposal income. This however wouldn’t raise very much in the near term; Rachel Reeves may regarding the negative optics as outweighing the small financial benefit.
    • Reduce the VAT registration threshold – £3bn. There is compelling evidence that the current £90k threshold acts as a brake on the growth of small businesses, as they manage their turnover to stay under the threshold. Reducing the threshold so everyone except hobby businesses are taxed would raise at least £3bn, and in the view of many people across the political spectrum, could increase growth. The economy as a whole would benefit, and small businesses would benefit in the long term. But in the short term there would be many unhappy small businesspeople. I fear this is, therefore, too difficult for any Government to touch. It would also take time to put into effect – APIs/apps would need to be ready to assist micro-business compliance, and HMRC would need to significantly gear up.
    • Raise the top rate of income tax – <£1bn. The top rate of income tax (outside Scotland) is currently 45%. The rate was briefly 50% under Gordon Brown – could we return to that? I would be surprised. The previous 50p rate was in place so briefly that nobody’s quite sure what effect it had… but even in a best case analysis it would raise very little. Raising the top rate is a political signal more than it is a fiscal policy. And any increase would probably break Labour’s campaign pledge not to increase income tax.
    • Raise the rate of income tax on dividend and/or interest income – £unknown. It’s sometimes suggested it’s unfair that the top rate of income tax is 45%, but the top rate of tax on dividend income is 39.35%. However dividends are usually paid out of income that’s been subject to corporation tax, meaning the actual effective rate of tax on dividends is around 56%. And even the 39.35% rate is one of the highest in the developed world.
    • CGT on death – £unknown. There’s been considerable focus in the US on the ability of the very wealthy to use a “buy, borrow, die” strategy to avoid tax. A wealthy tech entrepreneur (for example) could be sitting on shares with a large capital gain, and so would face a considerable capital gains tax bill if they sold their shareholding. So what they do is borrow against their shares. They then receive a lump sum, just as they would if they had sold the shares, but with no tax at all. Of course they are paying a funding/interest cost, but this will usually be much lower than the CGT. Eventually they die, their children inherit the shares, but the historic capital gain disappears, so when the children sell, they are only taxed on the gain during their period of ownership. The original capital gain is wiped out. The same strategy works in the UK. One option for Rachel Reeves would be to trigger a CGT charge on death. However, the high resultant overall rate (up to 52%) could be politically unattractive. The alternative would be to change the law so that, when you inherit property that is sitting at a capital gain, you inherit the capital gain too. So if you sell the property immediately you pay the same CGT as the original owner would have done. That seems a pretty rational change.
    • Wealth tax – £1bn to £26bn. Many campaigning groups are keen on a wealth tax targeted at the very wealthy – e.g. people with assets of more than £10m. But the practical experience of wealth taxes is that they’ve been failures, with only a handful of countries retaining a wealth tax. The recent Spanish tax – which adopted the modish idea of only hitting the very wealthy – raised a pathetic €630m. It’s another failed wealth tax to join a long list. The academics on the Wealth Tax Commission recommended against an annual wealth tax, but supported a one-off retrospective tax raising up to £260bn over ten years. My feeling is that such an extraordinary tax would require a specific political mandate, which Labour do not have. And one-off taxes have a habit of not in fact being one-offs.
    • CGT on unrealised gains – £unknown. Another proposal popular with campaigners is to tax capital gains annually, regardless of whether they are realised. No developed country has implemented such a tax. The Dutch tried, but their Supreme Court held it was contrary to the European Convention on Human Rights. Kamala Harris is currently proposing a similar tax in the US, albeit only for taxpayers with wealth of $100m or more. There are four significant problems: valuation, dealing with unrealised losses, people leaving the UK before they hit the threshold, and other avoidance if (as is probably inevitable) some asset classes are excluded. If the US tax is implemented, and proves a success, then the UK (and others) may follow. Until then, I doubt Rachel Reeves would want to experiment with this one.
    • Financial transaction tax – £7bn+. This is another very popular tax amongst campaigners. The usual argument goes: there is a huge volume of financial transactions. Placing a small tax on each of them would be barely noticed, but raise a lot of money. In 2019, Labour claimed they could raise £7bn. The catch lies in what precisely a “financial transaction tax” is. The idea was originated by James Tobin in 1972 – his idea was to “throw sand in the wheels” of international currency markets and tax every currency transaction in the world. The tax would “cascade” as trades flowed through currency markets, essentially ending them in their current form. That was Tobin’s aim – he wasn’t trying to raise revenue. Existing taxes on financial transactions, like UK stamp duty or the French, Italian and Spanish taxes, are quite different. They apply once, to the end-purchaser of securities, and not to market-makers and intermediaries – there is no “cascade effect”. They are designed not to deter transactions (although they have this effect to some degree) but to raise revenue. An actual FTT would necessarily end markets in their current form. The European Union spent years fruitlessly trying to come up with an FTT that didn’t have that effect – it failed, and gave up on the project. In my past life, I wrote about the problems with Labour’s proposal, and the problems with the EU proposal. UK stamp duty is already the highest such tax in any large economy. The question isn’t whether it should be increased – it’s whether we’d raise more tax revenue by abolishing it.
    • CGT on peoples’ homes – £31bn. We have a complete and unlimited capital gains tax exemption on homes – our “main residence”. On the face of it, that costs £31bn – quite the sum. So why not remove or limit the exemption? Because then you’re creating a cost for people moving house. Even if they’re moving from one house to another that’s similarly priced, they’d potentially have a large tax on their historic gain (a gain which has done them no good). It would make the current problems with stamp duty even worse. So realistically you can’t just tax all home sales – you have to introduce exemptions of some kind… so the £31bn figure is illusory. For this reason, those countries that in theory impose CGT on homes, in practice end up collecting little, thanks to a variety of exemptions, loopholes, and rules that let you roll the gain into your next house. Some people have suggested we just tax someone’s “final” sale. Good luck defining that. And the problem then is that people simply won’t sell, as death/inheritance wipes out all gains. You’re locking up the housing market, increasing what’s already a serious problem. Or you just tax at death, which is better dealt with by a general CGT reform. None of these ideas are very workable. This, plus the political reaction such a change would make, means I’d be amazed if it ever happens… although possibly maybe it’s something we could see for the very highest value properties?
    • Means test the State pension – £1bn+. The State pension pays out about £11,500 per year. It’s easy to think that’s an irrelevant amount to wealthy retirees, and we should means test the pension to stop them benefiting. Given the Government spends about £138bn each year on pensions, blocking even just the wealthiest 1% from pensions would raise over £1bn. It seems a slam dunk. But that makes an elementary mistake – a pension of £11,500 per year, updated with the “triple lock“, is actually a highly valuable asset. It would cost the average 66-year old somewhere over £250,000 to buy an asset like that. A family “just” in the wealthiest 1% has average assets of £1.9m per adult. So removing their pension would effectively expropriate over 10% of their wealth. That feels unjust. I doubt any Chancellor would do this.
    • Increase the rate of VAT – £8bn+. This is one of the easiest way to raise significant sums – HMRC estimate that a 1% increase in VAT raises £8.6bn. The Cameron and Major Governments raised VAT upon coming into office, after saying they wouldn’t during the previous election campaign. But this feels very unlikely now.

    My estimate of the actual yield of these “unlikely” items is between £18bn and £25bn, although some of the figures used by campaigners are much higher (£72bn+)

    I believe this covers most of the serious suggestions that are out there – but if I’ve missed anything, or you have any new ideas, do please get in touch (or comment below).

    Image by LGNSComms – own work, CC BY-SA 4.0, and photo-edited by Tax Policy Associates Ltd.

    Footnotes

    1. There were originally 29 proposals here; but someone in the comments pointed out I’d missed the, often suggested, idea that we tax capital gain on peoples’ homes. Another noted the financial transaction tax, and another tax on dividend/interest income. Then I added the DST and employer national insurance. Then fiscal drag. That takes us to 35. ↩︎

    2. The source is the latest ONS data. ↩︎

    3. Disclosure: my previous attempt to predict the tax actions of this Government was a dismal failure. So please take with a pinch of salt. I’m a tax lawyer, not a political columnist… ↩︎

    4. Subject to an annual £60k limit, tapering down to £10k for high earners. ↩︎

    5. Or indeed someone on £60k, with an anomalously high marginal rate of 57% thanks to child benefit clawback, or someone on £100k with an anomalously high marginal rate of 20,000%. ↩︎

    6. Which has the disadvantage of in practice only applying to defined contribution pensions. ↩︎

    7. We can roughly ballpark this if we assume £5-10bn of AIM/etc shares are held for IHT purposes, and 3% of all holders die each year in a non-exempt IHT event (i.e. excluding the first spouse). These figures come from discussions with private wealth and AIM specialists – note that Octopus alone manages £1.5bn in an AIM inheritance tax fund. Some AIM investors would move into EIS investments, but they are considerably more volatile and hence less attractive (even dangerous) from an IHT planning perspective. ↩︎

    8. The headline and start of the article is misleading – trusts aren’t the reason the Duke of Westminster’s estate paid so little tax – it’s all about APR/BPR. ↩︎

    9. The IFS and others believe the HMRC figures overstate the cost of a significant CGT increase; my understanding is that the dramatic HMRC figures reflect people accelerating gains to escape the increase, and then (after it comes in) deferring gains to try to wait it out. The first effect could be negated if the CGT rise was instantaneous, rather than taking effect from the next tax year. ↩︎

    10. We could find no figures that enable a proper estimate to be produced – the £1bn is no more than an educated guess at the lower end of the yield – see the discussion here. ↩︎

    11. Taxpayer responses, and the complexity of trust taxation, mean that determining the actual yield would be complicated. ↩︎

    12. although it is economically akin to one. ↩︎

    13. When the numbers get large, the answer can’t be the shareholders, because the bank profits aren’t enough to cover the figure. When the numbers are smaller, the answer depends on how competitive the market is for each of the banks’ products – in less competitive areas, banks have more scope to pass on the cost. ↩︎

    14. i.e. the base cost should start at market value on the date a taxpayer becomes UK tax resident, not the historic base cost from when they lived abroad ↩︎

    15. In other words, a deferred “exit tax”. ↩︎

    16. The source for this and the other reliefs are the tables found here – this one is the CGT tab on the December 2023 non-structural reliefs table. ↩︎

    17. 0% on children’s clothes costs £2bn/year. It’s hard to find good sources on the average spend on children’s clothes, but estimates range between £380 and £780, suggesting the VAT saving is around 10% of child benefit. ↩︎

    18. However, please note the caveat about taking my predictions with a pinch of salt – I am not a political columnist. ↩︎

    19. I said £7bn on Times Radio on 15 October off the top of my head – my apologies for the error. ↩︎

    20. There isn’t just legal pedantry; there’s evidence that definitional problems meant that Mexican consumers switched to equally unhealthy but untaxed products, so that calorie consumption did not change (but there was an impact on sugary soft drink consumption, with a resultant improvement in dental health). ↩︎

    21. Papers from health organisations report the Hungarian tax positively, but the evidence is much less conclusive. A study in 2021 found that the Hungarian tax had been effective in depressing consumption in economic downturns (when households are economising) but not at other times; and a more recent longitudinal study found that, over the long term, prices were higher but consumption returned to its previous level (and indeed increased). A systematic review in 2021 looked at over 2,000 studies and found no clear effect. The two studies cited by the IPPR are a theoretical modelling study and a review, neither of which refer to the contrary Mexican and Hungarian papers. ↩︎

    22. Rather unsatisfactorily the source is a private conversation with someone knowledgeable and I can’t provide any further information. ↩︎

    23. Although one could imagine designing a tax to minimise these effects, e.g. automatic deduction of 40% tax from winnings, with winnings and losses reported to HMRC by regulated gambling businesses, and no other losses permitted. ↩︎

    24. The IPPR’s £2.9bn figure suggests no fall in gambling at all – this appears to be an error. ↩︎

    25. Those who say that ISAs should be capped at £1m are engaging in symbolism not tax policy – there are only a few thousand people with £1m ISAs, and most of those will be only a little over the cap. A £1m cap would raise little. ↩︎

    26. Disclosure: I have an ISA, but not a terribly large one. ↩︎

    27. The £20k allowance was very generous when introduced in 2017/18, but has since been eroded by inflation. It’s fully used by about 7% of ISA holders, i.e. about 3% of all adults. ↩︎

    28. Tax people would say it is “rebased” to current market value. ↩︎

    29. Although it is less significant at the top end given we have fewer entrepreneurs, and less significant at the “bottom” end of wealth because it’s harder to obtain a margin loan. But people certainly do it with real estate. ↩︎

    30. The political problem is that if someone owns a £1m portfolio that they bought for, say, £100,000 20 years ago, capital gains on death would be £252k and inheritance tax would be £400k – an overall effective tax rate of 65%. That is actually a rational result, because that’s what the rate would have been if they’d sold their house before dying. But politically I suspect the fear of an upfront high rate means this is a non-starter. ↩︎

    31. With the inheritance tax liability then slightly lower to reflect the fact that the asset being inherited is pregnant with CGT. Alternatively the inheritance tax liability could be unchanged, but the CGT base cost adjusted to “credit” the IHT paid on the gain – a messier result. ↩︎

    32. The exception is the Swiss wealth tax – but that is charged at a low rate on most people, not just the very wealthy, and so has little in common with the campaigners’ proposals. Switzerland has no capital gains tax or inheritance tax, and income tax on dividends is easily avoided. So the Swiss wealth tax in practice operates as a kind of minimum tax on wealth – but even with that tax, many Swiss cantons tax wealth much less than the UK (which is why so many very wealthy people move there). ↩︎

    33. I am sceptical this is consistent with ECHR caselaw and I doubt a UK court would take the same approach, although I am sure it would consider the Dutch Supreme Court’s reasoning carefully. ↩︎

    34. This was added thanks to a comment on X. ↩︎

    35. I confess I find this depressing. The problems with an FTT are not obscure; they’re well known amongst economists and tax policy specialists. The question isn’t whether you agree or disagree with the tax, it’s whether it’s workable – and I’m not aware of anyone with expertise who thinks it is. NGOs like Oxfam wasted many £m of their donors’ money on a hopeless and counterproductive cause. And columnists who should have known better hailed the politics without thinking about the actual impact. ↩︎

    36. The French, Italian and Spanish taxes were called “financial transaction taxes” to catch the wave of popularity of such taxes at the time. They are, however, essentially more limited versions of UK stamp duty reserve tax, and nothing like actual FTTs. ↩︎

    37. This one wasn’t in the original list, but was picked up in a comment below – for which, thank you. ↩︎

    38. Which I made myself until looking into the figures properly ↩︎

    39. Annuities can be purchased in the market, but none have anything like the “triple lock”, so precisely pricing such a product is hard. A number of people with expertise kindly commented when I asked about this on social media, with estimates ranging from £250,000 to £400,000. ↩︎

    40. An important caveat is that whilst this figure fairly reflects the commercial cost of such a pension, it doesn’t reflect the cost to the Government of providing it. In part because the Government has access to much cheaper funding than any commercial provider; in part because government will usually collect tax from the pension that it is paying (perhaps income tax on the pension itself; definitely VAT on purchases). ↩︎

    41. Some people thought that a pension can’t be valued in this way, because the government could stop paying it at any time. That’s true in principle, but it’s also true in principle that a commercial annuity could stop paying, e.g. because the insurer goes bust. That is probably more likely than government suddenly ceasing to pay existing pensions. ↩︎

  • How to reform property tax

    How to reform property tax

    Property taxes are probably more in need of reform than any other area of UK tax. We have three taxes on property: stamp duty (SDLT), council tax and business rates. They’re bad taxes: they’re unpopular, inequitable, and they hold back growth.

    There is a way to change this, and tax land in a way that encourages housebuilding and economic growth. But that requires smart thinking and brave politics.

    This Government was elected on a platform of kickstarting economic growth. It has a large majority, and four or five years until the next election. It’s a rare chance for real pro-growth tax reform. That’s all the more necessary if we are going to see tax rises.

    We’ll be presenting a series of tax reform proposals over the coming weeks. This is the sixth – you can see the complete set here.

    Abolish stamp duty

    Stamp duty land tax (SDLT) is a deeply hated tax.

    This is well-deserved. Stamp duty reduces transactions. There’s an excellent HMRC paper summarising research on the “elasticity” (i.e. responsiveness of transactions to changes in the tax) for residential transactions, and looking at new data for commercial transactions. A 1% change in the effective tax rate results in almost a 12% change in the number of commercial transactions and a 5-20% change in the number of residential transactions (different effects for different price points/markets).

    This all creates a distortion in the property market, and often stops businesses and families moving when otherwise would. So stamp duty reduces labour mobility, results in inefficient use of land, and plausibly holds back economic growth.

    It also makes people miserable.

    And the rates are now so high that the top rates raise very little; HMRC figures suggest that increasing the top rate any further would actually result in less tax revenue.

    Stamp duty only exists because, 300 years ago, requiring official documents to be stamped was one of the only ways governments of the time could collect tax. We have much more efficient ways to tax today – but stamp duty remains. Until four years ago HMRC still used a Victorian stamping machine.

    Transaction taxes are generally undesirable from a tax policy perspective. The tax system shouldn’t discourage people from transacting.

    We should abolish stamp duty.

    The problem with abolishing stamp duty

    Abolishing SDLT would result in some additional tax as the pace of transactions picks up, and research in 2019 suggested abolition of SDLT wasn’t too far off from paying for itself. However, at that point SDLT raised £5bn. Subsequently rises in SDLT rates and property values mean that it now raises £12bn each year – an amount that’s hard to ignore. The trouble with many bad taxes is that, as they become more and more significant over time, HM Treasury becomes addicted to them.

    Unfortunately there’s an even worse problem than the cost: abolition would inflate property prices.

    The link between stamp duty and prices is clear when we look at the impact of the 2021 stamp duty “holidays” on house prices.

    The spikes in June and September coincide with the ends of the “holidays”. People rushed to take advantage of the discounted stamp duty, and prices rose accordingly.

    Of course the “holidays” were temporary – but the chart suggests that there was a permanent upwards adjustment in house prices (probably due to the “stickiness” of house prices).

    Previous stamp duty holidays had less dramatic effects. There’s good evidence that the 2008/9 stamp duty holiday did lead to lower net prices, but 40% of the benefit still went to sellers, not buyers. I’d speculate that the difference is explained by the much lower stamp duty rates at the time.

    A detailed Australian study looked at longer-term changes than the recent UK “holidays” – it found that all the incidence of stamp duty changes fell on sellers (and therefore prices). This is what we’d expect economically in a market that’s constrained by supply of houses.

    These effects mean that stamp duty cuts aimed at first time buyers may end up not actually helping first time buyers. An HMRC working paper found that the 2011 stamp duty relief for first time buyers had no measurable effect on the numbers of first time buyers.

    Abolition would just create a windfall for existing property owners. We need something smarter.

    Abolish council tax

    Stamp duty isn’t our only broken property tax. Council tax is hopeless – working off 1991 valuations, and with a distributional curve that looks upside down.

    We can see the problem immediately from the Westminster council tax bands:

    The bands cap out at £320k – equivalent to about a £2m property today. So there are two bedroom apartments paying the same council tax as a £138m mansion.

    And the top Band H rate of £1,946 – restricted by law to twice the Band D rate, is pathetically small compared to the value of many Westminster properties.

    The problem is then exacerbated by the fact that poorer areas tend to have higher council taxes. Here’s Blackpool:

    So that £138m mansion pays less council tax than a semi in Blackpool.

    That’s why, if we plot property values vs council tax, we see a tax that hits lower-value properties the most:

    In a sane world, this curve would either be reasonably straight (with council tax a consistent % of the value of the property), or it would curve upwards (i.e. a progressive tax with the % increasing as the value increases). This curve is the wrong way up.

    Some people look at this and say it’s missing the point – that council tax is a charge for local services, and the owner of the £138m mansion doesn’t use services any more than a tenant in a bedsit. I don’t understand this argument. We don’t view other taxes as charge for local services – why should local taxation be any different?

    The problems of council tax are deep-rooted in its design. The solution: abolition.

    Abolish business rates

    Business rates are based on rateable values, which represent the annual rental value of the property as assessed on a specific valuation date. The rateable value is multiplied by the “multiplier”, currently 54.6% in England and Wales.

    This cost will often be higher than it should be.

    Rateable valuations are only updated every three years (it used to be every five). That understates the degree to which they are out of date – 2017 revaluation applied rental values as of 1 April 2015 and the 2023 revaluation (delayed by Brexit) applies rental values as of 1 April 2021.

    In many retail markets, rents dropped significantly between 2015 and 2019. A landlord could drop the rent to attract tenants, but business rates wouldn’t fall (they’d be “sticky”) and could often end up higher than the rent, making the property unrentable (often with unfortunate consequences). Clearly many factors are responsible for the decline of the high street, but business rates are an important element.

    There’s a further problem with business rates. If a tenant improves a property, that increases its rentable value and therefore increases business rates. This creates a disincentive to improve properties – the opposite of what a sensible tax system should do. The previous Government recognised this problem when it introduced an “improvement relief” – but that only delays the uplift in business rates for a year.

    The good and bad way to reform business rates

    The bad approach is to try to create a level playing field between retailers (who generally occupy high value property, and therefore pay high business rates) and digital businesses (who use out-of-town warehouses with low values, and therefore pay low business rates).

    This would be a serious mistake because, while business rate bills are paid by tenants, in the long term the economic incidence of business rates largely falls on landlords. In other words, business rates reduce the level of market rents.

    Rents are usually renegotiated only every 3-5 years, and often upwards-only, so in the short-to-medium term it can be tenants who bear the cost. But a long-term systemic change like increasing business rates on warehouses and reducing it on retail would mostly benefit landlords (after an initial transition period). It would be a spectacular waste of taxpayer funds.

    The other not-good approach is a series of sticking-plaster measures bolted onto business rates, none of which deal with the two fundamental problems. That was the previous Government’s approach. It remains to be seen if the new Government will be any better – pre-election, Labour promised to overhaul business rates, but details at this point are scant.

    What’s the good way to reform business rates?

    Abolition.

    A new modern tax on land

    There is a much fairer and more efficient way to tax land.

    The correct and courageous thing to do is to scrap council tax, business rates and stamp duty – that’s about £80bn altogether – and replace them all with “land value tax” (LVT). LVT is an annual tax on the unimproved value of land, residential and commercial – probably the rate would be somewhere between 0.5% and 1% of current market values. This excellent article by Martin Wolf makes the case better than I ever could.

    LVT has many advantages. Because it’s a tax on the value of the raw land, disregarding improvements/buildings, it creates a positive incentive to improve land (unlike existing taxes, which do the opposite). And because there is a fixed supply of land (unlike buildings!) the cost of land, i.e. rents – should not increase in response to land value tax. The legal liability to pay would be with the beneficial owner of land, and they shouldn’t be able to pass that economically onto tenants. All taxes hold back economic growth to some degree, but there is good evidence that recurrent land taxes are the most efficient and least harmful.

    There are two surprising things about LVT.

    The first is that it has support from economists and think tanks right across the political spectrum. How many other ideas are backed by the Institute of Economic Affairs, the Adam Smith Institute, the Institute for Fiscal Studies, the New Economics Foundation, the Resolution Foundation, the Fabian Society, the Centre for Economic Policy Research, and the chief economics correspondent at the FT?

    The second is that, despite this academic consensus, conventional wisdom says LVT is politically impossible.

    I wonder how true that is?

    So let’s definitely not implement land value tax. Let’s instead abolish stamp duty and fund it by adding some bands to council tax, so it more closely tracks valuations. Most people will pay a bit more tax, but most people won’t pay much more – hopefully they’ll agree it’s worth it to get rid of the hated stamp duty. We’d calibrate this to be neutral overall, so that the end of stamp duty doesn’t just send house prices soaring. This is not an original proposal – it was one of the recommendations of the Mirrlees Review in 2010. Paul Johnson of the Institute of Fiscal Studies has also written about it.

    Whilst we’re at it, let’s make council tax and business rates both work off the value of the underlying land, disregarding improvements – so people aren’t punished for improving their property.

    And let’s update valuations more regularly, so the taxes are fairer. And introduce fair transitional provisions so that nobody is hit by a huge tax increase. We should, in particular, make sure that anyone who recently bought a property and paid SDLT gets a reduction in their LVT for the next few years.

    What we end up with won’t be called “land value tax”, and won’t exactly be a land value tax. But it’s getting awfully close.

    These reforms could all be neutral overall, so the same amount of tax is collected across property taxes. That would be my preference. Or some tax could be raised; or there could be tax cuts.

    However you do it, there is an opportunity for a big pro-growth tax reform. It might even be popular.

    Photo by Sander Crombach on Unsplash

    Many thanks K for assistance with the economic aspects of this article.

    Footnotes

    1. Apologies to all tax professionals, but I’m going to call SDLT “stamp duty” throughout this article. ↩︎

    2. Strictly semi-elasticities because they are by reference to absolute % changes in the tax rate, not percentage changes in the % tax rate. ↩︎

    3. Another apology to tax professionals. Yes, I know stamp duty and SDLT parted ways in 2003… but the point about the antiquated nature of stamp taxes remains valid. ↩︎

    4. There’s some published research on the 2021 holiday, but it’s qualitative as it was completed too soon to catch the September heart attack. I’m not aware of anything more recent, which is a shame – 2021 was a brilliant double natural experiment. ↩︎

    5. i.e. because tax incidence theory says that where supply is inelastic and demand is elastic, the seller bears the incidence. ↩︎

    6. A quick health warning: many of the people and websites promoting land value tax are eccentric. I once had a lovely discussion with someone from a land value tax campaign. After a while I asked what kind of rate he expected – 1% or 2% perhaps? His answer was 100% (to be fair, 100% of rental value not capital value). Land value tax’s supporters remain one of the biggest obstacles to its adoption. They often suggest income tax/NICs, VAT and corporation tax could all be replaced with LVT – a look at the numbers suggests this is wildly implausible. ↩︎

    7. i.e. as if there was nothing built on it. ↩︎

    8. Meaning a higher % of the unimproved value; but it’s the % of market value that people will care about when the tax is introduced. ↩︎

    9. Failure to pay could result in HMRC automatically gaining an interest in the land via the land registry. ↩︎

    10. A report from the New Economics Foundation suggests landlords will pass on the rent; none of the economists I’ve spoken to agree with that. ↩︎

    11. Significant changes would be required to local government funding formulae, so that the income was pooled appropriately between local and central government, and that Westminster didn’t get an enormous windfall. The wide differentials in property values between local authorities would need to be reflected in the bands, to prevent a scenario where some local authorities have essentially no local property tax at all. ↩︎

    12. i.e. because economically we can expect the present value of future council tax payments to be priced into house prices, and if we increase council tax slightly at the low end and significantly at the high end, we should be able to undo the price effects of abolishing stamp duty. ↩︎

    13. For example allowing the last ten year’s SDLT to be written off over the next over ten years worth of neo-council tax/LVT. So for example someone who paid SDLT nine years ago could get 1/10th of that credited against the new tax (keeping going until the SDLT credit was exhausted). Someone who paid SDLT yesterday could get all of that credited. But this is one of many ways it could work. ↩︎

  • How to reform income tax: end the high marginal rate scandal

    How to reform income tax: end the high marginal rate scandal

    It is a national scandal that teachers, doctors and others earning fairly ordinary salaries can face marginal tax rates of more than 60%, and sometimes approaching 80%. It’s inequitable and holds back growth. Rachel Reeves should commit to ending these anomalies.

    This Government was elected on a platform of kickstarting economic growth. It has a large majority, and four or five years until the next election. It’s a rare chance for real pro-growth tax reform. That’s all the more necessary if we are going to see tax rises.

    We’ll be presenting a series of tax reform proposals over the coming weeks. This is the fifth – you can see the complete set here.

    Marginal rates

    The “marginal rate” is the percentage of tax you’ll pay on your next £1 of income. It therefore affects your incentive to earn that £1.

    If you doubt that, imagine that you pay tax at 20% on your £30k income, but the next £1 you earn will be taxed at a marginal rate of 100%. Would you work extra hours for zero after-tax pay? I think most people would not. The overall tax you pay would only be a bit over 20%, but your decision to work more hours is affected by your after-tax pay for those hours.

    That seems a silly example (although we can find worse ones in our own tax system – see below). But a marginal rate below 100% will also change your incentives.

    Perhaps you are only just managing to afford childcare, and every hour you earn increases your childcare costs? A marginal rate of 70% might mean your take-home pay is less than that childcare cost.

    Or it may just be that you value your own time so that, if your take-home pay from working additional hours drops below a certain point, it’s not worth it to you.

    Marginal rates – a normal example

    In the current, 2024/25 tax year, combined income tax and national insurance rates for an employee look like this:

    • No tax on incomes below the £12,570 personal allowance.
    • £12,570 to £50,270 – a combined income tax and employee national insurance rate of 28%
    • £50,271 to £125,140 – a combined rate of 42%
    • Above £125,140 – a combined rate of 47%.

    It’s important to realise that the different tax brackets only apply to income in that bracket. If you earn £50,271 you’re in the higher tax bracket, but you only pay 42% tax on £1. You still pay 28% tax on everything you earned before above the personal allowance. This is unfortunately not very well understood.

    Imagine Bob is an employee earning £12,569. None of his income is taxed. Bob has the opportunity to earn an additional £1,000, putting him in the 28% tax bracket.

    There are three ways we could describe Bob’s position after earning that £1,000.

    1. The applicable headline rate. Bob is a basic rate 28% taxpayer.
    2. The overall effective tax rate. This is the total tax paid divided by Bob’s income. Total tax paid = £1,000 x 28% = £280. Income = £13,570. So effective tax rate is 280/13570 = about 2%.
    3. The marginal rate – the percentage tax you’re paying on that new £1,000. This is 280/1000 = 28%.

    Each of these has their uses.

    The first figure is simple.

    The second is useful for assessing how much tax Bob pays overall. If a political party proposed a sweeping set of tax reforms, Bob would be very interested in the impact on his effective rate.

    But the third – the marginal rate – is important, because it affects Bob’s incentive to earn the additional pound. Right now it’s the same as the headline rate – but that’s not always the case…

    Marginal rates – the problem

    Jane is earning £60k and claiming child benefit for three children. That’s worth £3,094.

    She’s now in the 42% tax band. Jane still pays basic rate tax for her income between £12,570 and £50,270, but now pays 42% tax for everything over that. So her total tax bill is (50270 – 12570) * 28% + (60000-50270) * 42% = £14,643 and Jane takes home £45,357.

    Jane is thinking of working a few more hours to earn another £1,000. She’s in the higher tax band – so in a sane world she’d expect another £420 of tax, and a marginal rate of 42%.

    But that is not the result. Once Jane’s income hits £60,200, the “High Income Child Benefit Charge” (introduced by George Osborne) starts to apply to claw back her child benefit – 1% for every £200 of earnings.

    So that £1,000 of additional earnings costs Jane HICBC of £154.70, on top of the £420 of “normal” tax. A total of £565.

    So how do we describe Jane’s position after earning that £1,000?

    1. The applicable headline rate. Jane is a higher rate 42% taxpayer.
    2. The overall effective tax rate – the total tax paid divided by Jane’s income. That’s 15207/61000 = about 25%.
    3. The marginal rate – the tax Jane is paying on that new £1,000. This is 56.5% – and we will have the same result for all incomes between £60k and £80k.

    As I mentioned at the start, there can be practical reasons for people to turn down work if the marginal tax rate gets too high – but there are also psychological factors. For many people, 50% feels like a high rate.

    Charting the effect

    We can chart Jane’s marginal rate for each pound of income she could earn. Incomes along the bottom, marginal rate along the top:

    You can see the HICBC as the “tower” between £60k and £80k, which should be a smooth 42% plateau. Instead it hits 57%. (I’m hiding what happens after £100k)

    The HICBC is a gimmick which enabled George Osborne to somewhat-surreptitiously raise tax on people on high incomes without raising the tax rate itself.

    It’s a really bad policy:

    • It means that Jane pays a higher marginal rate rate than someone earning £90k, or indeed £900k. Where’s the logic in that?
    • The way in which HICBC works creates a nasty trap for the unwary, with thousands of people accidentally incurring HMRC penalties.

    The politics are nice and intuitive – surely it’s not right for people on high incomes to receive child benefit? But the reality is that this logic inexorably leads to a high marginal rate, and a cumbersome and sometimes unjust collection mechanism.

    Can it get worse?

    Very much worse.

    George Osborne’s HICBC was copying a trick invented by Gordon Brown to clawback the personal allowance for people earning £100k.

    Again, the politics are nice, but the consequences are a mess.

    If Jane starts earning between £100k and £125k then she faces a marginal tax rate of 62%. It then drops to 47% from £125k. Her marginal rate chart looks like this:

    Needless to say, 62% is a very high rate.

    The graduate tax

    And if Jane has a student loan, that will add on 9% to the marginal rate, meaning that her marginal rate chart now looks like this:

    The student loan system behaves like a crude graduate tax so that, between £100k and £125k, Jane’s marginal rate reaches 71%.

    The anomalous marginal rates

    Student loan repayments, personal allowance tapering and child benefit clawback all result in high marginal rates. But the rates are at least within “normal” bounds – they don’t exceed 100%.

    There are points at which the marginal rate sails way over 100%, meaning that you are actually worse off after a pay rise. This occurs when tax benefits/allowances have a “cliff edge” after which they disappear completely:

    • The £1,000 personal savings allowance drops to £500 once you hit the higher rate band, and to zero once you hit the additional rate band.
    • The marriage allowance lets a non-working spouse transfer £1,260 of their unused personal allowance to their partner, if they’re earning less than the £50,270 higher rate threshold. So it’s worth £252 – and it disappears once the higher rate band is hit.

    These are irrational rules, but the tax at stake is small, and so the high marginal rate is limited to a small range of incomes. The significance is limited.

    A much more significant cliff-edge effect results from the childcare schemes created by the previous Government. These provide generous subsidies that are removed suddenly when your wage hits £100,000. That creates a marginal rate that is truly anomalous – so high it is hard to calculate.

    The childcare support scheme for parents with children under 3 could be worth £10,000 per child for parents living in London. And it vanishes once one parent’s earnings hit £100k. Here’s what that does to the marginal tax rate:

    The 20,000% spike at £100,000 is absolutely not a joke – someone earning £99,999.99 with two children under three in London will lose an immediate £20k if they earn a penny more. And the negative spike at £8,668 is because it’s at that point you qualify for the scheme – you have a huge negative marginal tax rate (which has the potential to create obvious distortions of its own).

    The practical effect is clearer if we plot gross vs net income:

    After-tax income drops calamitously at £100k, and doesn’t recover to where it was until the gross salary hits £145k.

    This is ignoring the pre-existing tax-free childcare scheme, which also vanishes at £100k. The amounts are less (usually under c£7k/child) so the curve would look less dramatic. However, as the scheme applies to children under 11, taxpayers feel these effects for many more years.

    Marginal rates for high earners

    If Jane started earning beyond £145k, all of these problems go away, and she has a nice straightforward marginal rate of 47% forever. 

    What kind of tax system creates complexities and high marginal rates for people earning £60-125k, and simplicity and lower marginal rates for people earning more than £125k?

    The complete picture

    Here’s an interactive chart showing all the UK and Scottish marginal rates. You can click on the legend at the bottom to see the effect of child benefit clawback and student loans. Or you can view in fullscreen here.

    You’ll see that if you are a recent graduate living in Scotland with three children under 18, between £100k and £125k you face a marginal rate of 78.5%.

    The chart doesn’t include marriage allowance, childcare subsidies and the other extremely anomalous marginal rates, as the rates are so high that they make the chart unreadable.

    The effect

    We’ve received many reports saying that high marginal rates affecting senior doctors/consultants are an important factor in the NHS’s current staffing problems – exacerbated by the fact that the starting salary for a full time consultant is just under £100,000.

    But it’s important not to just focus on the impact on jobs that we might think are of particular societal importance.

    It’s also problematic if an accountant, estate agent or telephone sanitiser turns away work because of high marginal rates – it represents lost economic growth and lost tax revenue. It also makes people miserable.

    Sometimes people take the work, but use salary sacrifice or additional pension contributions so their taxable income doesn’t hit the threshold. But that doesn’t work for everyone; sometimes they’ve hit the pensions allowance; sometimes it doesn’t always make sense to work harder now, for money that they can’t touch for years.

    We can see the effect in this chart from the Economist, based on data from the Centre for the Analysis of Taxation:

    That cliff at the £100k point is people holding back their earnings so they don’t hit the £100k marginal rates. That represents a loss of working hours to the public and private sectors and a macroeconomic impact on the UK as a whole. Quite how large an impact is an interesting question, which I hope someone looks at.

    What’s the solution?

    These problems are getting worse over time, as fiscal drag takes more and more people into the thresholds that trigger these high marginal rates.

    When Gordon Brown introduced the personal allowance taper in 2009, only 2% of taxpayers earned £100,000; by 2025/26 over 5% of taxpayers will. When George Osborne introduced child benefit clawback a year later, only 8% if taxpayers earned £50,000; by 2025/26 over 20% of taxpayers will (which is likely what motivated Jeremy Hunt to increase the threshold to £60,000).

    This creates a double problem. First, the economic distortions created by the high marginal rates start to impact into mainstream occupations (doctors, teachers). Second, the revenues raised by the marginal rates are now so great that they become hard to repeal.

    Ending the high marginal rates in one Budget is, therefore, not realistic – particularly in the current fiscal environment. The cost of making child benefit, the personal allowance, and childcare subsidies universal, would be expensive (somewhere between £5-10bn, depending on your assumptions). The obvious way of funding this – increasing income tax on high earners, appears to have been ruled out.

    We would suggest four modest steps:

    • An acknowledgment that the top marginal rates are damagingly high, and that the Government will take steps to reduce them when economic circumstances permit.
    • Some immediate easing of the worst effects, at minimal cost to the Exchequer, for example by smoothing out the personal allowance taper over a longer stretch of income, therefore reducing the top marginal rate.
    • A commitment to uprate the thresholds for the HICBC, personal allowance clawback and childcare subsidy in line with earnings growth.
    • A commitment that no steps will be taken to make the high marginal rates worse, or create new ones.
    • A new rule that Budgets will be accompanied by an OBS scoring of the highest income tax marginal rates before and after the budget.

    There’s a coherent political case for people on high incomes paying higher tax (whether we agree with it or not). There is no coherent case for people earning £60k, or £100k, to pay a higher marginal rate than someone earning £1m. It’s inequitable and economically damaging. Ms Reeves should call time on high marginal rates.

    Graphic by DALL-E 3: “A businesswoman climbing a set of stairs labeled with different tax percentages, with the middle step showing 100% and the others smaller %s, representing the different marginal tax rates. Widescreen. Cinematic.”

    Footnotes

    1. Everything interesting happens at the margin. For more on why that is, and some international context, there’s a fascinating paper by the Tax Foundation here. ↩︎

    2. Ignoring Scotland for the moment; we’ll get to the Scottish rates later. ↩︎

    3. That’s the headline rate – the actual rate is different… for which see further below. ↩︎

    4. Perhaps he is self-employed and chooses which clients/work he takes on. Perhaps he is employed, and can choose how much overtime to work, or whether to accept a promotion. Perhaps he is going back to work after time spent looking after young children. Many people have the ability to work additional hours if they wish. ↩︎

    5. Strictly that doesn’t exist – you’re paying basic rate tax plus Class 1 employee national insurance contributions. But realistically this amounts to 28% tax. I’m going to count income tax and national insurance as if they’re one tax throughout this article. ↩︎

    6. Strictly that doesn’t exist – she’s paying 40% higher rate tax plus 2% Class 1 employee national insurance contributions. Realistically this is 42% tax. ↩︎

    7. Note that the marginal rate will vary depending on how we calculate it, and the size of the “perturbation” we calculate the marginal rate over. Most textbooks define the marginal rate as the % tax on the next pound/dollar of income. Say that we looked at the tax Jane paid on £60,199 of income – that would be £14,726. A £1 pay rise takes her to £60,200, and tips her into the HICBC – she now pays £0.42 more higher rate tax, plus an additional HICBC charge of 1% of your child benefit – £30.94 (assuming you have three kids). So the marginal rate is 100 * (£31.63/£1) = 3,163%. This is not very meaningful, as nobody’s incentives are going to be affected by the consequence of a £1 pay rise. It also creates the silly result that the marginal rate on her next £1 pay rise will be 42%, because the HICBC won’t increase until she gets to £60,400. So it’s better to use a more realistic figure like £1,000. The practical consequence is that the 56.5% figure isn’t *the* correct answer, but it’s a sensible and useful one, and it’s important to check that weird marginal rates aren’t just an artifact of the chosen perturbation. Our charting code uses a £100 perturbation for convenience, but then “smooths” the HICBC formula so the marginal rate doesn’t leap up and down. ↩︎

    8. The £5,000 starting rate for savings tapers out, but slowly, and so it just somewhat increases the marginal rate – it’s also less relevant for most people. ↩︎

    9. The chart is for a single earner, but if they have a partner, the partner would also need to be earning at least £8,668 (the national minimum wage for 16 hours a week) ↩︎

    10. The 20,000% figure is a consequence of the code that produces the chart incrementing the gross salary by £100 in each step. It would be a mere 2,000% if we used the same £1,000 perturbation as above. Two million percent if we used the conventional £1 perturbation. Or two hundred million percent if we looked at the one penny increase. ↩︎

    11. Ignoring pensions, which create a marginal rate problem all of their own… ↩︎

    12. The code and underlying data are available here. ↩︎

    13. Note that the gap between the Scottish and UK marginal rates is much higher than the gap between statutory rates. The HICBC and personal allowance tapers have a bigger effect on higher rates, and so magnify the difference. ↩︎

    14. Particularly when the economy is running at very little spare capacity; it would be different if there was high unemployment/plenty of spare capacity, because the work that was turned away would (at least in theory, in the long term) be undertaken by others ↩︎

    15. Data from the HMRC percentile stats, uprated for post-2022 inflation. ↩︎

  • How to reform capital gains tax and cut income tax

    How to reform capital gains tax and cut income tax

    Capital gains tax (CGT) is currently both too high and too low. It taxes investors at too high a rate when they’ve put capital at risk, only to see it eroded by inflation. But it enables a very low rate of tax for people who haven’t put capital at risk, but are able to pay capital gains tax (rather than income tax) on what’s realistically employment income.

    We can fix both these problems by raising the rate but reforming CGT so investors pay a lower effective rate. That could be pure tax reform, or it could potentially raise up to £14bn. Or – my preference – it could be used to cut the rate of income tax and also raise around £6bn. This article explains how.

    This Government was elected on a platform of kickstarting economic growth. It has a large majority, and four or five years until the next election. It’s a rare chance for real pro-growth tax reform. That’s all the more necessary if we are going to see tax rises.

    We’ll be presenting a series of tax reform proposals over the coming weeks. This is the fourth – you can see the complete set here.

    This article is based heavily on a recent IFS paper by Stuart Adam, Arun Advani, Helen Miller and Andy Summers, and a Centax policy paper by Arun Advani, Andy Summers and Andrew Lonsdale.

    The proposals here are also consistent with those in the Mirrlees Review, the magisterial 2010 review of the UK tax system chaired by Nobel laureate James Mirrlees.

    The rate of CGT is too low

    Capital gains tax will raise about £15bn this year.

    The highest rate is usually 20%, but it’s 24% for residential property and 28% for the “carried interest” which private equity fund managers receive from their funds.

    That’s a lot less than income tax, where the highest rate is 45% (48% in Scotland). There’s an even greater gap with tax on employment earnings, where the 45%/48% top rate of income tax is on top of 2% employee national insurance and 13.8% employer national insurance.

    This creates two problems.

    First, many people think it’s intuitively unfair for a wealthy person making a large gain on their shares to pay less than half the tax rate of someone with normal employment income.

    Second, it creates a massive incentive to transform income into capital gains, to reduce your tax. For people who run a business in their own company, this can be as simple as: don’t take dividends out of the company, take loans from the company for now, and in the long term expect to sell the company and make a capital gain. There are many more complicated schemes.

    So we should raise CGT.

    The rate of CGT is too high

    Economic theory says that, if investors put capital at risk, we shouldn’t tax them on the “normal return” (i.e. the risk free return, broadly equivalent to bank rates). If we do, we discourage investment – the investor has done worse than if they’d put cash in the bank, but we’re taxing it anyway.

    We should instead only tax the “super normal return” (i.e. if an investor’s investment pays off).

    CGT does the opposite of this, because no allowance is given for inflation.

    Take an example where I make a less than normal return. Say I bought an asset for £1,000 in 2014, and I sell it for £1,250 today. On the face of it I’ve made a £250 gain. But inflation since 2014 accounts for £230 of that “gain” – I’ve really only made a gain of £20. So if I pay 20% capital gains tax on £250, that equates to an effective tax on my “real” gain of 250%.

    The longer an investor holds an asset, the greater these effects become. If the investment doesn’t pay off, I’ve made no money (in real terms), but pay tax anyway. I may decide I’m better off spending the money.

    Another bad feature of CGT is that I’m taxed on any gain, but if I make a loss then I can’t use that loss to reduce my general tax burden. HMRC takes a slice out of the upside (fair enough) but won’t share in the downside (unfair).

    All of this means that CGT in its present form discourages investment, particularly long term investment. It acts as a disincentive to people putting capital at risk, which is something we want to encourage.

    By contrast, take an example where I make a super-normal return. Say I buy an asset for £1,000 last week, and sell it for £2,000 today. The normal return is (almost) nothing, and I pay 20% CGT on my super-normal return.

    This is not how a tax system should work.

    So we should cut CGT.

    How to raise and lower CGT at the same time

    How do we cut CGT for people putting capital at risk, but raise it for others?

    Surprisingly that’s simple: we simply increase the rate, but create a new allowance for the “normal return” on the original investment.

    We used to have an allowance for inflation; this would work precisely the same way, but with a different rate. And in the internet age, applying an uplift to acquisition prices in peoples’ tax returns is trivially easy.

    Say we raise the rate to 40% and create a normal return allowance:

    • In the first example above, where my gain is swallowed by inflation, the normal return over 2014-2024 would be something like 40%. So we have to compare my acquisition cost uprated by the normal return (£1,000 x 1.40 = £1,400) with my sale price (£1,250). I’ve made a loss – no CGT to pay.
    • In the second example, the rate increases from 20% to 40% – a sensible result.

    So we have succeeded in cutting and raising CGT, at the same time.

    This is too complicated. Why not just raise the rate?

    If you take the current top rates to 45% then simple arithmetic suggests that would raise about £14bn per year. Why not?

    Because it would be a very bad mistake.

    It would greatly exacerbate the current effect of CGT to discourage long term investment.

    It also won’t raise anything like the £14bn figure. It could lose money

    Simple arithmetic often fails to sensibly estimate the yield of tax changes, because it doesn’t take into account “behavioural effects” – people doing things differently, in response to the tax change.

    The £14bn figure comes from an Office of Tax Simplification paper, which makes clear that the behavioural effects would be extreme:

    What are these behavioural effects? Some mixture of:

    • If you announce a CGT change in advance of it taking effect (which is what’s always happened in the past), then people sitting on large unrealised gains can sell their property before the rate changes. They “accelerate” their gain.
    • Once the change comes into effect, people who want to sell could take the view that the rate is bound to come down again soon, and “defer” their gain. This is particularly likely if there have been many recent changes in tax rates, or the Government is not expected to last many more years.
    • What if someone has a very large gain (e.g. an entrepreneur about to sell their company for billions of pounds), but can’t sell before the rate changes? They have another option. They can leave the UK for somewhere that doesn’t tax foreign gains (and many countries fit the bill here). Then sell and pay no tax.
    • There’s a very similar result if, instead of leaving the UK, a taxpayer dies. When the children (say) inherit the asset (which will often be exempt from inheritance tax), all the historic gain is wiped out. Any future sale by the children is taxed on the capital gain from the point they inherited. So an elderly investor facing a CGT bill has a powerful incentive to simply not sell their assets.

    This isn’t theory – we can see these effects with each of the many, many, changes to capital gains tax over the last 25 years. Massive taxpayer responses:

    CGT is particularly susceptible to these issues, because people control when they sell assets.

    There’s more evidence of that in a recent paper by Arun Advani, Andy Summers and others. People who’d received income into companies were liquidating them to make a capital gain. Then the Government announced that, from 6 April 2016, this structure would no longer work. That prompted a huge rush of people liquidating companies to beat the deadline:

    And this is why HMRC’s “ready reckoner“, showing the effect of changing tax rates, shows that an increase to the top rate of CGT will lose significant amounts of revenue. That was the problem with the Green Party’s general election proposal to raise the rate.

    The lesson is: any increase in capital gains needs to be made very carefully indeed.

    How to avoid leaking tax

    There is a significant risk of tax leakage, as taxpayers think they’ll lose out and take steps to avoid the new higher rate. So any rise in CGT needs to be accompanied by a policy package:

    • There should be an “exit tax”, like many other countries already have, so that gains made in the UK are taxed in the UK. And, to be fair and coherent, we should stop taxing people who’ve moved to the UK on gains they made before they came to the UK (in the jargon, we should “rebase” their assets when they arrive here). I talked about exit taxes and entry rebasing in more detail here. But, in short, people would usually opt for the exit tax to be deferred to the point they actually sell the asset. Given the number of other countries that have exit taxes – the US, Australia, France, Germany – for us to create an exit tax shouldn’t put the UK at a competitive disadvantage.
    • Instead of death erasing historic capital gains, anyone inheriting an asset should also inherit its embedded capital gain. So, when they come to sell, they pay on the asset’s original capital gain as well as the capital gain during their own period of ownership. It is only fair that any inheritance tax is reduced to reflect this practical reduction in the value of the asset (so there is no double tax here).
    • Capital losses should be fully utilisable against other income/profits.
    • Abolish the existing Business Asset Disposal relief, whose initials tell you precisely what its reluctant creators thought of it..

    And there has to be an allowance for the normal return, otherwise the rise in tax will harm investment.

    The rate change, and the reforms, need to apply immediately after the Budget speech, so people can’t accelerate sales to keep the old rate.

    It would be a very serious mistake to increase CGT without these changes. Investment would suffer, and CGT revenues would likely fall. Winners from the new system would benefit; potential losers would avoid the tax.

    The authors of the recent Centax paper agree. Andy Summers said:

    “Our proposed package of reforms is about much more than just raising rates. In fact, there’s a big risk that if this is all the government does in the upcoming Budget, it will seriously backfire. There’s big money available, but only if the government is bold and takes on major reform.”

    Arun Advani is more blunt:

    “if they hike the rate without doing anything else that is a terrible idea. It would be easy to avoid and be bad for growth.“

    Winners and losers

    Tax reforms almost always have winners and loses.

    The clear winners are people who hold an asset which has risen in cash terms, but fallen in real terms (after inflation). Right now, they pay CGT when they sell. They’ll pay less tax. Better than that; they’ll get a loss they can use to shelter other income/profits.

    Also winners: people whose assets have risen in real terms, but beat the normal return by a sufficiently small amount that they benefit more from the normal return allowance than they lose from the rise in rates. They’ll pay less tax.

    So for many investors, large and small, and in shares and property, these reforms represent a tax cut.

    But people who significantly beat the normal return will pay more tax.

    We can quantify this. Say the new rate is 40% and the normal return is 5%. Anyone making an annualised return of less than 10% wins from the proposal; anyone making a return of more than 10% loses.

    You’d be forgiven for thinking that this is such a high break-even point that hardly anyone would be paying capital gains tax under our proposal. The surprising answer (from this Advani/Summers paper) is that nearly half of all capital gains are from shares in private companies where the annualised return was over 100%:

    The reason is simple: these are cases where someone starts a company with little or no capital of their own, works for it for many years, and then sells it at a large gain. This wasn’t a return on their financial capital; it was a return on their human capital – remuneration for their labour. But it’s currently taxed as a capital gain, at a lower rate than tax on normal income. It shouldn’t be.

    And private equity executives’ “carried interest” is also in this category. They pay next-to-nothing for interests in their funds which become incredibly valuable if the funds succeed. Currently taxed as a capital gain at a lower rate than income but, again, it shouldn’t be.

    People in these scenarios would pay significantly more tax than at present. If rates were equalised, it would potentially raise £14bn – and most of this new tax comes from these people.

    What does this do to incentives for entrepreneurs?

    I would say: very little. Very few people starting a company today think about what the CGT consequences would be when they sell it in say fifteen years time. If they did think about it, they’d sensibly conclude from history that CGT rates today are no guide to where they will be in fifteen years time.

    There is very little evidence that lower rates of CGT influence entrepreneurship/company start-up rates – our literature search found none. There is, however, evidence that few entrepreneurs consider CGT when they start up a new business – see this IPPR report.

    There is also detailed analysis in the Centax paper (starting on page 32), looking at studies of historic CGT changes in Canada and the US.

    But there would be very real and positive effects for investors who put capital at risk. There is good evidence that has a significant and positive effect on startups, because it makes it easier for them to access capital.

    What should the rate be?

    There are three approaches:

    One answer is to simply equalise rates to the appropriate income tax rate (45% for most assets; 39.35% for shares) whilst creating an investment allowance. The Advani/Summers paper plausibly estimates that would raise £14bn (and that’s a real £14bn, which fully accounts for behavioural effects).

    Another answer would be to raise the rate of CGT less than this. Enough to make the proposals break even, or further – but not to 45%. We’d improve incentives to invest, and reduce the incentive to avoid tax. Raise some lesser sum than £14bn.

    But that loses the wider benefits of equalising rates – an end to income-to-capital avoidance, and considerable simplification (given all the anti-avoidance rules that would become irrelevant).

    So, if the aim is (at least in part) tax reform rather than revenue-raising, a better idea is to equalise rates but reduce the rate of income tax. For example, cutting all income tax rates by 2% would cost about £14bn – so doing this, and raising CGT to that point would, therefore, be broadly neutral.

    Or we could cut all income tax rates by 1% and raise CGT to that point. This would raise around £6bn of additional tax: that would probably be my preference, given the fiscal constraints.

    So why not?

    There are political challenges here.

    The first is that a headline CGT rate of 45% would be the highest in the developed world:

    The effective rate would be much lower, because of the normal return allowance, but that may be too subtle a point to affect perceptions.

    The second is that the losers, entrepreneurs who start a company with nothing and make a very large gain, have a powerful political voice. I don’t see how these proposals would change their incentives – but I expect many entrepreneurs will disagree.

    The third is the risk that politicians see the large figures in the Advani/Summers paper, and think that a simple rise in CGT is the answer, without reform. That would be a disaster.

    The fourth is that the numbers are dependent on the Advani/Summers research. I’ve been through it in detail and am convinced; in fact it appears overly conservative in places. But I am not an economist. HM Treasury would need to undertake a very serious analysis before committing to this kind of reform.

    With these caveats, I’m strongly in favour of proceeding with reform. In the present environment, I’d cut income tax by 1%, raise CGT to the new income tax levels, and then book the c£6bn of proceeds as additional tax revenue.

    Many thanks to Arun Advani and Andy Summers.

    Photo by Austin Distel on Unsplash

    Footnotes

    1. Leaving aside for now the very high top marginal rates that can apply. ↩︎

    2. You can use a capital loss against a capital gain, but only a capital gain – not normal income. ↩︎

    3. NB this is only for UK residents; non-residents aren’t subject to UK capital gains tax, except on land and property. ↩︎

    4. Great care would need to be taken structuring the exit tax, so that people couldn’t escape it using double tax treaties. Treaties are supposed to stop people being taxed twice on the same income/gain, but are frequently used to stop people being taxed even once on an item of income/gain. ↩︎

    5. An interesting consequence is that anyone in this category who tried to “beat the Budget” by selling property ahead of it, to book a gain before the rate went up, will actually have lost money. ↩︎

    6. The formula to give the breakeven return for a new tax rate t and normal return n is: (n x t) / ( t – 20%). ↩︎

    7. It’s sometimes suggested that this is a special kind of labour, because an entrepreneur is taking a small salary in the hope of a large future payoff, but with a significant risk that payoff never comes. However, this situation is by means unique to entrepreneurs. There are many careers where people are gambling that their small initial income will be compensated for by a large payoff in later years, and therefore they accept the opportunity cost of failing to receive an income from a “normal” job. Think: actors, sportspeople – even some legal careers. ↩︎

    8. In particular, I think they underestimate the value of the US “buy, borrow, die” strategy because they assume that assets are subject to US estate tax. In practice, nobody of means pays US estate tax – it is even more full of loopholes than our inheritance tax. ↩︎

  • How to reform employer national insurance – don’t increase it, abolish it

    How to reform employer national insurance – don’t increase it, abolish it

    There’s 13.8% employer national insurance when someone’s employed, and nothing when they’re not. That’s unfair – but also creates a huge amount of uncertainty, litigation and tax avoidance.

    There are reports that Labour is considering increasing employer national insurance. We shouldn’t be talking about raising employer’s national insurance – we should be talking about abolition.

    This Government was elected on a platform of kickstarting economic growth. It has a large majority, and four or five years until the next election. It’s a rare chance for real pro-growth tax reform. That’s all the more necessary if we are going to see tax rises.

    We’ll be presenting a series of tax reform proposals over the coming weeks. This is the third – you can see the complete set here.

    Who pays employer NICs?

    The answer is, mostly, employees.

    Because, in the long run, the economic cost of employer national insurance is born by employees. The reasons why come down to “economic incidence” – it’s a concept many readers will be familiar with, but for those that aren’t, I’ll run through a short explanation.

    Who pays a tax? The obvious answer is: the person responsible for paying tax. This is the “legal incidence“. When I buy a bar of chocolate, the person legally paying the VAT is the shop. If Labour increase employer NICs, it’s the employer paying the tax.

    But who is *actually* paying the economic cost of the tax?

    If VAT goes up on all products, the shop pays more VAT. But everyone knows they’ll pass the cost on to me, buying the chocolate. The “economic incidence” is on me. (It’s different for VAT increases on individual products; they’re not always passed on.)

    If Starmer said “we’re increasing VAT. That’s a tax on business not on workers”, everyone would know that was nonsense. We all intuitively understand economic incidence and VAT. Employer NICs are less obvious.

    Conventional economic theory says the burden of all employer NICs and similar payroll taxes are shifted onto workers. In the long run, wages go up if NICs are cut (and/or more workers hired) and down if NICs are raised (with fewer workers hired). The evidence is extensive:

    • An extensive review by Stuart Adam (of the IFS) and others found that, in the long term, 2/3 of employer NIC increases/cuts were shifted onto workers’ wages. More in some cases.
    • This reflects a large body of work going back to the 70s.
    • A more recent IFS paper on a Hungarian payroll tax cut showed that high skill workers got a pay increase. Low skill workers didn’t; but more were hired. On that basis, an employer NIC increase would likely do the reverse.
    • A recent study in Singapore found that 76% of a payroll tax cut went to higher wages.
    • Another study from Brazil found that, outside of unionised sectors, there was a bigger effect on employment than wages. Cutting NICs increases employment; raising NICs reduces it. (Again that’s a conventional economic result: you tax something; you get less of it.)
    • A big US study for the Congressional Budget Office found that, even in the short term, up to 62% of a payroll tax increase would be passed to employees. The long term effect could be less if the tax was used to reduce Government debt (which seems unlikely).
    • There is some contrary evidence. A study of small businesses in Virginia found that payroll tax increases resulted in higher prices, not lower wages. This may be a special case, but it isn’t a compelling argument for a NIC increase.
    • And a study on Finland found that businesses bear the burden of Finnish payroll tax, resulting in lower employment of low-skilled workers and reduced investment. The result may reflect evasion rather than actual behaviour, but (if the results are “real”) then most policymakers wouldn’t see them as desirable.
    • It was likely on the basis of this evidence that the OBR advised the Government in 2021 that 80% of any rise in employer’s national insurance would be borne by workers.

    None of these results are comforting for anyone who thinks that increasing UK employer national insurance is a good idea. It’s one of the *worst* tax increases Ms Reeves could introduce.

    I listed 32 ways Labour could raise £22bn here. Some are good(ish). Some are bad. Almost all are better than increasing employer NICs. I’ll be very surprised if this is what Labour do.

    The wider point is that nobody should ever discuss a tax cut, or a tax increase, without first thinking about who will bear the economic incidence.

    Labour’s manifesto

    Labour’s manifesto said:

    “Labour will not increase taxes on working people, which is why we will not increase National Insurance, the basic, higher, or additional rates of Income Tax, or VAT.“

    On my reading, any increase in employer’s national insurances breaches the letter of the pledge, because employer’s national insurance is (obviously) national insurance. But it also breaks the spirit, because an increase in employer’s national insurance would, in practice, amount to a tax increase on working people, for the reasons noted above.

    The case for abolition

    There’s 13.8% employer national insurance when someone’s employed, and nothing when they’re not. That’s unfair – but also creates a huge amount of uncertainty, litigation and tax avoidance.

    All the many, many schemes to shift an employee into something that looks more like self-employment? They’re all about employer NICs. You can change definitions, and create new anti-avoidance rules; but if you’re going to have a massive tax difference between employment and self employment then avoidance and disputes are inevitable.

    The answer in principle is easy: end employer national insurance.

    Whilst we’re at it, we should abolish the apprenticeship levy. This was introduced in 2017 — a 0.5 per cent tax on employers’ wage bills. It sounds virtuous, but actually the connection to apprenticeships is almost non-existent. The name of the tax is just a marketing trick, when the reality is that it’s a tax on employing people, and (again) its effect is to depress wages. Keeping an entire tax on the books – and a fairly complicated one – just because the name is politically attractive is an insult.

    Why do employer NICs exist?

    Partly it’s because, just as employers contribute towards their employees private pensions, it was thought sensible that they contribute towards their state pensions (although national insurance doesn’t actually work like this).

    But, in recent times, it’s mostly because it’s been politically easier to raise employer labour taxes than employee labour taxes. The electorate, goes the theory, doesn’t see it the same way.

    And so we see very sizeable employer labour taxes in most developed countries (it’s the light blue bar):

    Denmark, New Zealand and Australia are the only developed countries which have (almost) no employer labour taxes. That doesn’t mean the overall level of personal tax is any different (and Denmark is a high tax country). It means that it’s clear to people how much tax they’re paying, and there’s a much lower incentive and ability to avoid tax by shifting income from wages to dividends, consultancy fees, etc.

    We should aim to join them.

    Why abolition is hard

    The problem is that employer contributions raise about £109bn and so can’t simply be abolished. The apprenticeship levy another £4 billion. We’d practically have to increase income tax commensurately. That would be a very large tax increase, given that income tax currently only raises £300bn.

    In the long term things should even out, given that the economic incidence of employer national insurance largely falls on employees (because it reduces pay packets). However in the short term it would represent a huge tax rise for employees, and a huge tax cut for employers. That’s unjustifiable and surely politically unthinkable.

    The question is: is there a clever way to bridge the gap? To, for example, oblige the NIC savings for employers to be paid to employees? It’s not clear to me that can be done, but the prize is so substantial that it’s worth very clever people spending time finding a solution. It might be tempting to pick on individual sectors (like professional partnerships), but that would be unprincipled and drive avoidance.

    Absent a brilliantly innovative solution, I have two suggestions:

    First – next time Government is thinking about cutting corporation tax, consider cutting employer national insurance instead.

    Second – don’t increase employer national insurance again.

    Footnotes

    1. On page 19. ↩︎

    2. Most of the current reports suggest Labour is considering a general increase in employer NICs. A different – but more rational – proposal would be to end the employer NIC exemption for pension contributions. That in principle could raise around £20bn. Again, in the long run the cost would be borne by employees. Like many pension changes, this would also have the disadvantage of (in practical terms) applying only to defined contribution pensions; the large (and mostly public sector) defined benefit pensions would be unaffected. That feels unjust. ↩︎

    3. One could imagine an obligatory 13.8% bonus that employers are required to pay to employees, tapering down over time (in the hope that tax incidence does its thing). Any real world solution would have to be considerably more sophisticated. ↩︎

  • How to reform stamp duty on shares. Abolish it.

    How to reform stamp duty on shares. Abolish it.

    The UK’s 0.5% tax on share transactions is the highest of any major economy. No other country with a major stock exchange has a comparable tax. Stamp duty holds back the FTSE and increases the cost of capital for businesses.

    So the reform is very simple: stamp duty on shares should be abolished. A second Boston tea party, but possibly in slow motion. The cost of abolition would plausibly be less than the tax generated from increased share trading and share prices, and the reduced cost of capital for businesses.

    This Government was elected on a platform of kickstarting economic growth. It has a large majority, and four or five years until the next election. It’s a rare chance for real pro-growth tax reform. That’s all the more necessary if we are going to see tax rises.

    We’ll be presenting a series of tax reform proposals over the coming weeks. This is the second – you can see the complete set here.

    Why do we still have stamp duty?

    Stamp duty was created in 1671. It made perfect sense. The State had limited power and resources, and collecting tax from people was hard. So some unknown genius had a brilliant idea: impose a tax on documents. No need to have an army of tax inspectors, because if you wanted a document to be used for any kind of official purpose, you’d have to pay to get it stamped. Beautiful simplicity – a tax that doesn’t need an enforcement agency.

    Stamp duty once applied to basically everything. Even tea – which helped spark the American Revolution. Over time, it’s shrunk and shrunk, and today old-fashioned stamp duty is of limited relevance, and we’re mostly talking about “stamp duty reserve tax“, which operates electronically, but still fundamentally works in the same way as the 1671 tax.

    So anyone who has bought UK shares will have paid 0.5 per cent stamp duty or stamp duty reserve tax.

    There aren’t many countries which have this kind of tax any more:

    • France, Italian and Spain have a “financial transaction tax” very similar to UK stamp duty, but the rate is lower (0.1% to 0.3%) and it only applies to the largest companies.
    • Belgium has a 0.35% tax on share transfers, but capped at €1,600.
    • The Finnish and Swiss stamp taxes only apply to domestic transactions and so are easily avoided and are of limited significance.
    • Ireland is the only country with a higher rate – 1% – but many observers believe that has significantly damaged its market (even though foreign investors can trade Irish shares free of stamp duty using ADRs).

    If we look at the countries with the biggest listed companies: the US, China, Germany, Hong Kong, Tokyo, India, Saudi and the UK, the only ones with a stamp duty/FTT is the UK (0.5%) and Hong Kong (0.2%).

    On the face of it, UK stamp duties on shares raise about £4 billion. However, revenues have been declining over time in real terms, reflecting the under-performance of the FTSE:

    Stamp duty may be one of the reasons for the underperformance of the London Stock Exchange – certainly many market participants believe that it is.

    What effect does stamp duty have?

    It depresses the share price of companies, particularly companies whose stocks are frequently traded.

    We can quantify this by looking at what happened in 1990, when the Government announced that stamp duty would be abolished. That abolition was put on ice, and this combination of almost-abolition and reprieve creates a nice natural experiment.

    Researchers from the IFS were able to quantify the effect in a 2004 paper, by comparing the relative changes in share price between frequently traded and less frequently traded shares. They concluded that frequently traded shares (broadly meaning larger companies) saw an uplift in share price of between 0.4% and 1.1%. To put that in context, 0.4% of the market cap of the FTSE 100 is £8bn; 1% is £22bn.

    Who pays stamp duty?

    As a legal matter, the answer is usually the broker buying shares for an investor – the broker or other financial intermediary bears the “legal incidence”.

    The broker, whose fee will be tiny fraction of 1%, will inevitably pass on the cost to the buying investor. So the investor, at first sight, bears the economic cost, the “economic incidence”.

    But the question of who really bears the cost is more messy than that.

    First, the structure of stamp duty means that the investor is sometimes exempt. Tax certainly applies if the investor is me, or a pension fund or unit trust. But if the investor is Goldman Sachs’ proprietary trading desk, or (in practice) a high frequency trading fund, the investor will be exempt. It’s not a tax on the City; it’s a tax on end-investors.

    Second, the fact that share transfers are subject to stamp duty means that the market value of shares is less than it otherwise would be. That means that some of the cost of stamp duty is borne by sellers. It also means that some of the cost is borne by the companies themselves – they receive less equity when they issue shares (due to the depressed share price). Stamp duty therefore increases the cost of equity capital.

    A distortive tax

    The ancient origins of stamp duty mean that it is taxed based on a simple legal definition (shares in UK companies) rather than on the economic substance of what is happening.

    That causes distortions:

    • If someone is thinking of establishing a company that will do business in several countries, and the UK is one possible location, stamp duty will (at the margins) mitigate against the choice of the UK.
    • Or if you’re establishing a UK company and want to avoid stamp duty anyway, an absolutely classic structure used by private equity and others is to hold a UK company beneath another company (maybe Jersey; maybe Luxembourg) and when you come to sell, sell the Jersey/Luxembourg company. This is very hard to stop.
    • Another problem is that stamp duty doesn’t usually apply to the transfer of debt. This means that stamp duty will, at the margins, increase the cost of raising funding through equity rather than debt.
    • The fact debt isn’t subject to stamp duty creates a handy loophole. If most of the value of a company is in debt (e.g. shareholder debt) it can be transferred free from stamp duty.
    • Public listed UK companies can’t play these games – they don’t usually have non-UK holding companies. And obviously public companies don’t have shareholder debt.

    This all creates a bias in favour of overseas companies vs UK companies, private companies vs public, and debt vs equity. None of these are desirable.

    These issues are discussed in this IFS paper from 2002. At the time the paper was written, stamp duty revenues were soaring. However, we note above, revenues have declined somewhat since then. The case for abolition is therefore stronger than it was in 2002.

    The cost of abolition – and the case for slow motion

    An IFS paper from 2002 used a simple model to find that increased tax revenue resulting from increased share trading and higher share prices would offset 70% of the cost of abolition. The figures in that paper are consistent with those in the IFS empirical study two years later. A more detailed analysis in a 2024 paper from the Centre for Policy Studies and Oxera found that increased tax revenue would be more than the cost of abolition.

    However it’s the indirect effects on economic growth which are more important. The Oxera paper estimates a permanent increase in GDP of between 0.2% and 0.7%.

    There is clearly significant uncertainty here, and an immediate abolition risks a loss of revenue. It would also produce a windfall for current investors (of the kind seen, temporarily, in 1990).

    It may therefore make sense to announce a tentative phase-out of stamp duty. For example, a reduction of 0.1% per year over five years, with an review after two years that would continue with the abolition only if there was no adverse revenue impact.

    That protects tax revenues during a difficult time; it also has the nice side effect of preventing today’s investors receiving all the windfall from abolition (given there would be genuine uncertainty if the reduction would proceed to complete abolition).

    Old-style stamp duty (which is principally relevant for unlisted shares) should simply be abolished overnight. That would put the UK position on par with France and Italy (where private company shares aren’t taxed), as well as eliminating what is currently a cumbersome tax which necessitates expensive UK tax advice on a swathe of transactions where it wouldn’t otherwise be necessary. Whilst we’re at it, we should eliminate bearer instrument duty (a tax on UK bearer shares and securities, which no longer exist (except in some technical cases where the duty doesn’t apply anyway).

    The politics

    The case for abolishing stamp duty is clear. No other major economy has a tax as high and as broad in scope as ours. It makes the UK a less attractive market/listing venue, and increases the cost of capital for British companies. And it’s not paid by City institutions — the burden falls on ordinary investors (and their ISAs and pension funds) and on businesses trying to raise capital.

    The problem is that, on the surface, abolishing stamp duty looks like a giveaway to the wealthy. Any Tory doing it could expect to be (unfairly and inaccurately) carpeted by Labour for giving a handout to the rich.

    But, just as only President Nixon could go to China, perhaps only Labour can abolish stamp duty.

    Engraving of the Boston Tea Party by E. Newbury, 1789, photo by Cornischong

    Footnotes

    1. No official would accept an unstamped document, for fear of being thrown into jail. That principle is still there in the Stamp Act 1891, which remains in force. ↩︎

    2. Technically this was the Townshend Acts not the Stamp Act ↩︎

    3. Not really an FTT, which is a very different beast ↩︎

    4. The SEC charges a fee of currently $27.80 per million dollars per trade. But that very low level (0.00278%) means it can’t be sensibly compared with the taxes other countries charge. ↩︎

    5. I’m disregarding India’s very small stamp duty on listed shares, as it’s only 0.015%. ↩︎

    6. Data from ONS, chart by Tax Policy Associates. ↩︎

    7. The reason for abolition is curious: the Stock Exchange’s planned new software system for paperless trading, Taurus, couldn’t cope with stamp duty. Taurus failed for unrelated reasons, which meant that stamp duty won a reprieve. The eventual solution, CREST, incorporated a modern electronic version of stamp duty, SDRT. ↩︎

    8. The paper also looks at the impact of the rate reductions in 1984 and 1986, but the data is less good and so the results less reliable. ↩︎

    9. Or at least almost all of it ↩︎

    10. Because of various arrangements, of various degrees of dubiousness, that I should write about at a later date ↩︎

    11. This is inevitable given the way financial transactions work; attempting to tax financial intermediaries is doomed to fail – I explained why in this old piece for my former firm. ↩︎

    12. If you don’t believe that, imagine stamp duty was suddenly increased. Share prices would, logically, fall overnight. And see above for what happened to share prices when stamp duty was (almost) abolished. ↩︎

    13. It’s more complicated than this in theory – I went into this in detail here – but in practice “shares in UK companies” is a good approximation of the truth. ↩︎

    14. Why do sellers care about stamp duty? Because economically, on the sale of a private company, we can expect the cost to be shared between buyer and seller (with buyer paying the duty, and seller receiving a smaller price). ↩︎

    15. An anti-avoidance rule was introduced in 2016 to stop the then-common practice of avoiding stamp duty by cancelling and reissuing shares. However it’s not obvious how rules could stop “enveloping” companies without unwanted knock-on effects on normal commercial transactions… which is probably why none of the other countries with similar taxes have such rules. ↩︎

    16. Stock exchange rules and the requirements for a premium listing mean that UK listed companies in practice are usually UK incorporated. ↩︎

    17. The figures for the impact on share prices in the Oxera paper are derived theoretically and considerably higher than those in the 2004 IFS empirical study. That doesn’t mean they are wrong; the data analysis in the IFS paper was necessarily limited by its design, and relates to a period (1990) where trading volumes were significantly lower than the present day. ↩︎

    18. More details in this OTS paper and this paper from Sara Luder and the IFS Tax Law Review Committee. ↩︎

    19. i.e. cleared securities ↩︎

    20. I asked HMRC in a Freedom of Information Act application for the total revenue from bearer instrument duty; they didn’t know, but suspected there was none. I’ve spoken to senior Treasury officials aren’t weren’t even aware bearer instrument exists. ↩︎

  • How to reform corporation tax

    How to reform corporation tax

    This Government was elected on a platform of kickstarting economic growth. It has a large majority, and four or five years until the next election. It’s a rare chance for real pro-growth tax reform. That’s all the more necessary if we are going to see tax rises.

    We’ll be presenting a series of tax reform proposals over the coming weeks. This is the first: how to reform corporation tax.

    Most of the tax changes we hear about, in Budget speeches or newspaper columns, are driven by necessity or politics. But there’s more to tax policy than tax hikes or tax cuts, which garner headlines out of all proportion to their actual financial significance in the context of a £2.5 trillion economy. Much more important is tax reform – revenue-neutral changes that would drive economic growth.

    Tax reform can do that by lowering the marginal tax rate on work (for example, cutting employee national insurance) or investment (for example, more effective investment reliefs).

    But tax reform can also boost growth by reducing economic anti-growth distortions in the current tax system. There are all too many of those – for example, the way that stamp duty deters people from moving house in search of better opportunities elsewhere.

    Between now and the Budget we’ll be publishing a series of articles on tax reforms we believe are badly needed. This is the first: corporation tax. You can see the complete set here

    All of our proposals could be revenue-neutral, or raise or cut tax, depending on how they were implemented. But revenues aren’t the point: the idea is to make the tax system drive growth (or, at least, not hold it back).

    These pieces are very much summaries rather than full proposals – each proposal links to more detailed analysis elsewhere.

    The most complete guide to the wider issues around UK tax reform remains the Mirrlees Review – written in 2010, but still highly relevant today. It’s available for free here.

    The problem with UK corporation tax

    All taxes have two components: the rate, and the thing the rate is applied to – the base.

    It’s always obvious when the rate changes, but changes to the base can be much less obvious. So, for example, the rate of UK corporation tax fell precipitously from 1980 to 2017 – and lots of people noticed that. However, over the same period – and unnoticed by most non-specialists – the base expanded dramatically. The interaction between these two effects meant that the actual corporate tax paid (as a percent of GDP) was largely unchanged over this period:

    So the base is important.

    But the UK’s corporate tax base is uncompetitive.

    The UK’s corporate tax base is a mess, largely thanks to a mixture of historical accident and modern over-complication. If we reform the base, we could collect the same amount of tax, but reduce complication, create better incentives and make the UK more competitive – all of which would enhance growth.

    My personal experience is that the complexity, uncertainty and constant change of the UK tax base deters foreign investment. However we can obtain a more dispassionate take on how the UK looks from outside thanks to the corporate tax competitiveness work carried out by the Tax Foundation, a US tax think tank.

    The Tax Foundation ranks every OECD country’s tax competitiveness, looking separately at different taxes. Each country’s ranking (1 is the best) is of course significantly driven by tax rates – but not only by tax rates.

    Something interesting happens if we plot corporate tax rates against the Tax Foundation’s corporate tax ranking for each country. We see that the UK is much less competitive than other countries with similar rates of corporate tax. Indeed less competitive than Korea, Italy, Austria and Belgium, all traditionally thought of as high tax jurisdictions:

    It’s not just the rate – we see the same effect if we plot corporate tax revenues as a % of GDP against the Tax Foundation’s corporate tax ranking. Many countries raise as much or more revenue than the UK, but have more competitive systems.

    So, to put it crudely, corporation tax reform should aim to move the UK vertically downwards in these charts. We can’t be Singapore or Hong Kong, but we absolutely could be Finland or Sweden.

    We could collect the same amount of tax, but with a better and more competitive tax system.

    (Or raise corporation tax, or lower corporation tax, as per your preference – nothing in this article is about the overall revenue raised).

    The solution: radical simplification

    Much of the reason for the UK’s poor performance in the Tax Foundation study is complexity.

    An obvious measure of complexity is the sheer length of UK tax legislation. But to get a real sense of what it means in practice, one has to look at the actual steps a business has to go through to work out what its tax liability will be.

    I went through an example last year. I looked at a typical and fairly straightforward arrangement: a US parent company financing its UK subsidiary, and went through the main rules the subsidiary would have to go through to establish if its interest payments were tax deductible. There were nine, often overlapping, and involving thousands of pages of legislation and guidance.

    The worst of the nine was the UK “hybrid mismatch rules”, which aim to stop companies achieving a tax advantage by structuring an arrangement so it’s treated differently in two different countries. That principle is easy to state. The detail, on the other hand, is out of control – the guidance alone runs to 484 pages:

    All of this complexity carries a cost.

    Most obviously: companies spend time and money on tax accountants and tax lawyers. Without that, they wouldn’t be able to carry on in business. It’s facile to say we’d better off if the accountants and lawyers didn’t exist – we’d be worse off. But we would absolutely be better off if the need for tax lawyers and accountants was significantly reduced.

    There’s also a cost in lost investment. Tax complexity creates tax uncertainty (and many of the nine rules I went through in the article linked above are deeply uncertain in their application). There is good evidence that tax uncertainty hinders investment.

    I believe the complexity is mostly unnecessary. It has two main causes.

    • First, the complexity is a fossilised remnant of a 70-year arms race between HMRC and tax avoiders. But the war is over. The attitude of the courts, and modern anti-avoidance rules, means that classic tax avoidance is dead. It’s time to recognise this, and repeal the hundreds of pages of rules that are no longer needed. Whilst at the same time making clear that HMRC will pursue anyone trying to take advantage of “loopholes” created by the repeals.
    • Second, the historic common law approach to legislative drafting has reached its limit in modern internationally-coordinated tax rules. The result has been legislation and guidance of exquisite detail and painful length, which in practice fails to achieve the certainty that the common law approach always prized. We need to move towards principle-based drafting of complex rules.

    The Office of Tax Simplification produced dozens of reports, running to tens thousands of pages, which could have achieved really significant simplification. But it never received political support, and very few of its proposals were enacted. That was a bad mistake. The abolition of the OTS was a recognition of a political failure by successive Ministers, not a failure by the OTS.

    In the medium term, we need a kind of new OTS – but one that has heavyweight political support, and with a junior Minister attached, so that it is a body with real political weight.

    In the immediate term, Rachel Reeves should lock some current and retired policy people in a room, and not open the door until they’ve identified dozens of provisions that can be repealed. I don’t think this is a difficult task.

    A more ambitious solution: real full expensing

    There are lots of problems with the UK tax base. But perhaps the biggest one is the oldest: companies can claim a tax deduction for their ordinary expenses (“revenue”) but not for investments (“capital”). This distinction doesn’t follow economic or accounting concepts; it’s purely a tax invention.

    It’s clearly suboptimal that the tax system incentivises current expenditure over investment. So the rules create a special case where companies can claim relief (“capital allowances”) for a certain type of investment – “plant and machinery”.

    Capital allowances used to be claimed over time; now they’re usually claimed up-front, in “full expensing“. But again that’s only for “plant and machinery”.

    What’s plant and machinery? Inevitably, that’s not actually defined, although there are many rules excluding particular things (like buildings). There used to be an “industrial buildings allowance” which was very valuable to industry, but Gordon Brown abolished that in 2008 to fund a 2% cut in the rate. A more limited “structures and buildings allowance” was introduced in 2018.

    This complexity is a problem. It creates uncertainty, which makes it hard for companies to plan, and therefore reduces the incentivising effect of the reliefs. It also creates a curious incentive towards investing in the particular types of asset which qualify – and there’s no good reason for this. Investing in buildings, intellectual property and other intangible assets should be treated in the same way.

    The answer is simple: give up-front tax relief for all business expenditure. End the capital/income distinction. Real full expensing.

    If that’s the only reform that was made, it would be very expensive. It would also exacerbate the current distortion in favour of debt finance – you could claim tax relief twice for the same asset (once for the purchase of the asset, once for the financing cost).

    Real full expensing therefore has to come with the quid pro quo of ending the bias towards debt, by making interest non-deductible. There would need to be transitional measures or (preferably) a de minimis (as for the existing corporate interest restriction) to prevent disruption to small business.

    The aim should be to not change the overall level of tax on corporates, but to shift incentives decisively in favour of investment and away from financial engineering.

    This is an area where plenty has been written – there’s an excellent piece from the IFS here.

    Photo © The Labour Party, Attribution-NonCommercial-NoDerivs (CC BY-NC-ND 2.0)

    Footnotes

    1. This is not a function of cherry-picking particular measures; however you cut it, the rate has dropped but revenues have not. ↩︎

    2. Data from the OECD tax revenue database. ↩︎

    3. Data again from the OECD tax revenue database. Note that Greece is excluded because there’s no 2022 data as yet. Norway is excluded because its large oil and gas revenues make it an outlier that turns the chart unreadable. ↩︎

    4. It’s often suggested our tax system could be as simple as Hong Kong’s, which runs to a few hundred pages. But it’s clearly unrealistic to expect the UK (where government spending amounts to 45% of GDP) to have a tax system that looks anything like Hong Kong or Singapore (15% of GDP). City states with a very high proportion of highly paid financial sector workers are not remotely comparable to large diverse economies like the UK. ↩︎

    5. Finland and Sweden are often viewed as high tax jurisdictions. From a personal tax perspective that is accurate. From a corporate tax perspective, the overall burden is similar to the UK; but the corporate tax systems are significantly simpler. ↩︎

    6. “Tax competition” is a bad word in some quarters. But, whatever you think about tax competition over rates, tax competition over complexity is a good thing. ↩︎

    7. Figuratively speaking. I am in not generally in favour of unlawfully detaining tax advisers. ↩︎

    8. And a distinction that’s often very unclear, being entirely a creation of common law and not legislation. Advisers spend significant time advising whether a particular transaction is capital or income, and often end up having to advise on both bases, just in case. ↩︎

    9. There is a good guide to the rules from PwC here. ↩︎

    10. i.e. expenditure satisfying the “wholly and exclusively” test. ↩︎

    11. The change would probably have to be prospective only in relation to losses. Many companies have huge amounts of historic capital losses which can’t be used against current (revenue) profits. There is no principled reason for this, and it should be changed going forwards. But enabling utilisation of historic losses would be very expensive; my belief (based on personal experience across the large business and financial institution sector) is that it would cost several billion pounds. ↩︎

    12. Excluding financial traders, such as banks, where interest income and expense is a fundamental part of the business. Taxing interest income but not giving a deduction for interest expense would end banks’ businesses overnight. Permitting a deduction for interest expense, but only against interest income, would result in distortive behaviour and avoidance. The Mirrlees Review discussed this problem in detail; I would duck it entirely by simply exempting financial traders. ↩︎

  • New evidence: the Post Office deliberately designed its compensation scheme to deter postmasters from applying

    New evidence: the Post Office deliberately designed its compensation scheme to deter postmasters from applying

    A document disclosed to the Post Office Inquiry, and published yesterday, shows that the Post Office considered requiring that postmasters pay a fee before applying for compensation. The intention was to deter applications. Realising this would be criticised, the Post Office instead designed a scheme which achieved the same effect through stringent (and unrealistic) eligibility criteria and documentation requirements.

    Our previous coverage of the Post Office scandal is here.

    The design of the scheme

    We have previously reported on the Post Office’s HSS compensation scheme, which was designed to compensate victims of the Post Office scandal who had not received a criminal conviction, and didn’t participate in the civil GLO claim against the Post Office.

    We’ve said that the HSS scheme appeared to be designed to deter applicants and minimise compensation payments. In particular:

    • The scheme application form was highly legal, with lengthy and complex forms to complete – but postmasters weren’t prompted to obtain legal advice, and received no help with legal fees.
    • The application form and documentation made it very difficult for postmasters to pursue any damages for loss of reputation, suggesting that such damages would only be available if the postmaster could prove financial loss (which is not legally correct).
    • The form and documentation didn’t even mention the possibility of punitive/exemplary damages, although the circumstances make such damages a real possibility.
    • Postmasters were required to provide “contemporaneous documentation“. In most cases they didn’t have any. In part because the events were more than ten years ago. In part because, when the Post Office suspended postmasters, it denied them all access to their records.

    These and other elements of the HSS scheme had the effect of minimising the compensation postmasters claimed. The Post Office paid for limited legal assistance for postmasters after it made them an offer; but by then it was too late. Everything was framed by a postmaster’s original application, and that was minimised by the design of the form and the surrounding documentation.

    The evidence of intent

    Many postmasters believed these elements of the HSS scheme were intentional. I agreed. But it was always possible that the Post Office was acting in good faith, with unrealistic hurdles a result of bureaucratic oversight rather than malice.

    We can now dismiss that possibility.

    The Post Office Inquiry yesterday published an email from Mark Underwood (Post Office compliance director) to Ben Foat (Post Office general counsel). The email was sent in January 2020 (at the point that the HSS scheme was being designed):

    It is fairly shocking there was a discussion about charging fees, and that this was only rejected because of how it would look. Underwood was instead suggesting a “very tight and clearly communicated set of eligibility criteria and requirements in terms of the documentation applicants have to provide”, to “achieve the same desired outcome” as fees.

    What was the “desired outcome”?

    At the Inquiry yesterday, Edward Henry KC (representing the postmasters) showed the email to Nick Read, Post Office CEO. Henry put to Read that the “desired outcome” was to restrict access to the scheme and deter applicants.

    Read replied: “possibly”.

    Henry went on to suggest that this was a “more subtle and insidious” way of making it difficult for postmasters to apply, and that this was by design.

    “You could certainly draw that conclusion”, said Read.

    I don’t see any other conclusion.

    Footnotes

    1. For which the Post Office was heavily criticised by Mr Justice Fraser – see paragraph 886 of the Common Issues 3 judgment. ↩︎

  • The Post Office – pushing postmasters to accept £75,000 compensation without legal advice

    The Post Office – pushing postmasters to accept £75,000 compensation without legal advice

    Postmasters previously offered derisory compensation by the Post Office are being given a new opportunity to claim under an independent appeals process. The Post Office has written to them offering the choice of appealing, or accepting a £75k flat payment. It’s one or the other – a difficult decision for which postmasters should receive detailed legal advice. But they’re being offered no help with legal costs, and few postmasters will be in a position to afford a lawyer. Many will take the path of least resistance and simply accept the £75k – which in some cases will be much less than they should receive.

    The Post Office scandal probably needs no introduction. But, in short, between 2000 and 2017, the Post Office falsely accused thousands of postmasters of theft. Some went to prison. Many had their assets seized and their reputations shredded. Marriages and livelihoods were destroyed, and at least 61 have now died, never receiving an apology or recompense. These prosecutions were on the basis of financial discrepancies reported by a computer accounting system called Horizon. The Post Office knew from the start that there were serious problems with the Horizon system, but covered it up, and proceeded with aggressive prosecutions based on unreliable data.

    Our previous Post Office scandal coverage can be found here.

    The HSS scheme

    The Post Office created a scheme to pay compensation to about 2,750 of the postmasters who hadn’t been prosecuted for theft, but had been required to repay “shortfalls” and (in most cases) lost their livelihoods. It was first called the “Historical Shortfall Scheme” and then renamed to the “Horizon Shortfall Scheme” – the HSS. But, by accident or design, the process for claiming compensation was complex and highly legal, and the Post Office didn’t offer postmasters any legal assistance in putting their claim together.

    So many postmasters ended up receiving derisory amounts – in one case as low as £15.75. And many received nothing at all.

    Campaigning postmasters like Christopher Head told the Post Office in 2023 that all the HSS settlements had to be reviewed. They were ignored, but kept pushing. Thanks to their efforts, and a subsequent recommendation from the independent Horizon Compensation Advisory Board, a new independent appeals process has been created by the Government for postmasters who feel their settlement was unfair.

    The catch

    Here’s the letter the Post Office is sending Postmasters who were eligible under the HSS scheme. There’s a catch:

    Postmasters have the option of receiving a fixed sum payment of £75,000, or can go through a full appeal assessment if they believe their losses are more than £75,000.

    Whether or not to accept the £75,000 is a difficult decision. A postmaster would need to carefully assess the losses they suffered, which requires detailed financial analysis, plus a legal assessment of appropriate level of damages for loss of reputation and stress. We believe that the legal costs for such an an exercise would be at least £10,000.

    How much is the Post Office offering to cover?

    Nothing:

    The Post Office will contribute towards postmasters’ legal fees during any actual appeal, but will make no contribution for legal advice on the critical decision of whether to appeal.

    Most postmasters are elderly and vulnerable; only a few will have the resources to properly investigate if they could recover more than £75,000.

    They’re being denied the chance to make a proper decision. There are cases where postmasters should be claiming hundreds of thousands of pounds – but without legal advice, we fear many will simply take the £75,000.

    It looks like, once more, the Post Office is choosing the path that minimises compensation.

    The Government should force the Post Office to do the right thing and cover postmasters’ legal costs, at this initial stage as well as during the actual appeal process.

    Footnotes

    1. I have previously written that this was between 2000 and 2013, but I have spoken to postmasters who faced false allegations of theft as late as 2017 ↩︎

    2. They were offered legal expenses for considering any subsequent offer the Post Office made to them. But that was too late – the whole process was framed by the initial application, and for that, postmasters received no legal assistance ↩︎

  • The £10bn R&D tax relief scandal: the evidence and the blame

    The £10bn R&D tax relief scandal: the evidence and the blame

    Recent events have highlighted R&D tax credit fraud. However we believe the scale of the problem is much higher than previously reported. We’ve a new analysis suggesting that the total cost of fraudulent and mistaken claims could be £10bn, or even higher. The mystery is how this went on for so long, when plenty of people were warning about it, and why it wasn’t until August 2023 that the rules were significantly tightened.

    The consequence is that we as taxpayers have lost a huge sum of money that could have been spent on public services or tax cuts. And many businesses have been misled into making large claims which they will now have to repay.

    The history

    The modern small business R&D tax relief was created in 2000, with the laudable aim of incentivising R&D investment. The scheme changed a few times over the following years. Then something dramatic happened to R&D tax claims by “small and medium-sized enterprises” (SMEs) in the 2010s.

    Here’s the number of claims:

    And here’s the value of the claims (i.e. the tax benefit to business, and the cost to us/HMRC):

    We’d expect to see a step change around 2014/15, as the rules became more generous at that point. And we see that, for both SMEs and large business. However SME claims just keep growing, and growing – and that can’t be explained by changes in the rules.

    HMRC’s analysis of 2020/21 claims (published in July 2023) found that half of all claims were incorrect in at least some respect. One quarter of claims were fully disallowed. Another 10% were fraudulent (5% by value). For SMEs, HMRC estimated that 25.8% of all claims by value were wrong or fraudulent. For large companies, 4.6%.

    This is a very high rate of error and fraud. For comparison, across the tax system as a whole, the fraud rate is around 1% and the error rate around 3%.

    HMRC’s accounts for 2022/23 and 2023/24 included estimates of the total cost of R&D fraud and errors from 2020/21 to 2023/24. That’s been widely reported as suggesting a total of £4.1bn of wrong and fraudulent claims. However, HMRC only started to systematically analyse R&D claims from tax year 2020/21 – and so the £4.1bn figures does not include fraud and error prior to 2020/21.

    Our analysis

    We’ve made a very cautious estimate of the total fraud and error from 2013/14 by assuming (prudently) that there was no fraud/error in that year, and that the level of fraud/error then ramped up linearly until it reached the 25.8%/4.6% level in 2020/21.

    That results in total fraud/error losses looking like this:

    The total over this period is then £7bn.

    But what if the level of fraud/error in 2020/21 had always been there in the past, it’s just that the number and value of claims were smaller? If we apply the 2020/21 figures to earlier years we get this:

    And total losses of £10bn.

    It could be worse still. A large proportion of the “new” claims after 2014/15 could be bad, with HMRC’s estimate for 2020/21 having undercounted them.

    The evidence for undercounting

    There are two reasons to believe that HMRC may have been undercounting fraud and mistake.

    The first is anecdotal. A large number of unqualified and unregulated businesses have carried on for years, making a good living from R&D tax relief claims. In the last few years their claims have been systematically challenged by HMRC; they weren’t before that. This implies that, historically, dubious claims were missed.

    The second reason lies in the HMRC analysis for 2020/21, which includes a table showing fraud and mistake by sector:

    It’s important to note that some of these sectors saw many more claims than others:

    Looking just at the more significant sectors, the R&D tax reliefs specialists we spoke to were surprised that 58% of the claims in wholesale/retail trade were found by HMRC to be compliant. It would be unusual for a wholesaler or retailer to have any qualifying R&D expenditure. Similarly, the 60% figure for construction looks very high.

    Three possibilities:

    • We’re wrong, and there really has been a significant amount of qualifying R&D expenditure in wholesale/retail and construction.
    • HMRC has misclassified businesses.
    • HMRC has missed a significant amount of non-compliance, whether it be from fraud or mistake.

    We fear that the anecdotes and the data lead to a conclusion that the true cost to the UK is more than the £7-10bn estimated above. The soaring number of claims from 2015/16 did not reflect more people making claims of much the same quality as before. It reflected many new unqualified firms setting up as R&D tax advisers and making claims of significantly poorer quality than previous claims. The majority of these new claims – which by 2020/21 represented half of all claims by value – may have been non-compliant.

    We shared these estimates with HMRC and they didn’t provide any specific comment, but said:

    “Our recent published estimates are data driven and use a significantly improved methodology. Clearly, the level of non-compliance we have seen is unacceptable and taxpayers rightly expect us to scrutinise claims. That is why we have increased compliance activity. We do that thoroughly and fairly, and the overwhelming majority of valid claims are paid on time.“

    The scandal

    Tax professionals have been of aware of incompetent and fraudulent R&D tax relief claims for years. HMRC must have been aware of the claims too. And HMRC and HM Treasury must have noticed the spiralling number of claims from small business, the increasing number of unregulated firms in the market, and the suspicious sectors for which claims were being made.

    So why wasn’t anything done? There was a fraud prosecution for a one-off entirely fake R&D transaction, but there appears to have been little action on what became widespread fraud and error.

    Philip Hammond, Chancellor between 2016 and 2019, told The Times that the Treasury and HMRC were well aware of the problem:

    “We were certainly on it. It was top of the HMRC agenda issue with me. This is probably the single biggest area in percentage terms of fraud and error in the tax system at the moment.”

    However nothing much seems to have happened until 2022. It was then that The Times reported that people were treating R&D tax credits as “free money” and making clearly non-compliant claims for, most notoriously, vegan menus. HMRC then conducted its detailed analysis of claims for 2020/21, but it was a year more (August 2023) before more stringent procedures were introduced to discourage frivolous/fraudulent claims.

    Why?

    We don’t know. But we believe it’s a scandal. We as taxpayers have lost up to £10bn, little of which is likely to be recovered. Many small businesses that made more recent claims will find them challenged by HMRC, and will find themselves out of pocket (with the fees they paid their R&D advisers hard to recover).

    It’s been described as the “next PPI scandal” given the number of businesses affected and the large liabilities they have. However, at least with the PPI scandal, the banks ended up compensating the people they’d sold useless insurance. In the case of the R&D tax scandal, most of the small businesses affected won’t receive compensation from anyone. Likely almost all of that £7-10bn is lost to the Exchequer for good. Much of that went as a chaotic and uncontrolled subsidy to small businesses. Some 20-30% of it went as fees to questionable and even fraudulent advisers.

    There is now an equally depressing coda: businesses undertaking real R&D projects have had their claims delayed, putting some startups in financial jeopardy.

    Who will be held accountable for this?

    Thanks to Paul Rosser and T, O and A for their R&D tax credits expertise.

    Footnotes

    1. All data from official statistics available here. ↩︎

    2. There were further small changes, but too marginal to drive changes of this magnitude. ↩︎

    3. See section 5.1.5 starting on page 256. ↩︎

    4. See section 4.1.5 starting on page 241. ↩︎

    5. A business’ “sector” is determined here by a company’s Standard Industrial Classification (SIC) code, and this coding is often subjective or inaccurate. For example, Tax Policy Associates Ltd is a “tax consultancy”. It’s also unclear how HMRC allocated businesses which listed multiple different SIC codes. ↩︎

    Photo by 50Fish on StockSnap

  • Map of MPs’ donors and interests

    Map of MPs’ donors and interests

    Which MP is the highest earner? Who receives the highest donations? Who takes the most foreign trips? We’ve just launched an interactive map that lets you explore all this and more.

    Apologies – this is currently down… the map needs to be updated. We hope to get to this soon.

    There’s an important political debate about what gifts an MP should accept, and what outside roles are appropriate. We’ll leave that to others. However, we do think it’s important for MPs’ gifts, donations, earnings and other financial affairs to be publicly visible.

    So we’ve launched an interactive map. You can use it directly below, or click here for a full screen version.

    How to use it

    Hopefully the map is reasonably intuitive, but this is a quick guide:

    • Change the “shading” box on the left to shade the map to show donations (i.e. gifts made for political campaigning), gifts (i.e. personal gifts), earnings, foreign trips, shareholdings, etc
    • Then you can zoom in and click on individual constituencies to see all the data for individual MPs, all cross-linked from every source we could pull data off.
    • When looking at foreign trips, you can click the “world map” button to see the countries MPs have visited.
    • Or enter text in the “category” box to e.g. see all trade union funding.
    • Or enter text in the “donor” box to see all donations/gifts from particular individuals/companies. Note that you may need to zoom in to see the shading for smaller constituencies (particularly London).

    Limitations

    All donations, employment, paid trips, and other benefits are reported by MPs, and Parliament publishes a register of them. We used Parliament’s fantastic API (together with the Companies House API) to create this interactive map.

    The data is often not very good – there are many errors, particularly around company and individuals’ names. We tried to fix and match them as well as we could. But the errors suggest that there is no checking of data by Parliamentary authorities – we’ll be writing more about this soon.

    Please do leave comments below, either with suggestions for improving the map, or if you find anything interesting. Or drop us a line (using the About/Contact menu option at the top of this page).

    Other sources

    There are other similar projects:

    Please let us know if we’ve missed any.

    Many thanks to the brilliant M, who wrote the code that powers the map. He’s done something amazing, for no pay or reward of any kind, and doesn’t even want to be credited.

    The map is © M and Tax Policy Associates Ltd (as his agent), and licensed under the Creative Commons BY-SA 4.0 licence. That means you can freely refer to it, copy it, and use it however you wish, provided you credit M and Tax Policy Associates Ltd.

    Footnotes

    1. To answer a question that’s often raised – there are usually no tax implications from gifts, which is why we haven’t commented on the recent controversies. Gifts from an employer are taxable. Gifts made by someone who dies within seven years can be subject to inheritance tax. Gifts to trusts and companies can sometimes have an immediate inheritance tax charge. But gifts (meaning gratuitous payments which are not in exchange for something valuable) made to individuals by someone who isn’t an employer aren’t subject to income tax. The exception, as someone pointed out in the comments, is where the gift is related to the employment and coming from someone who has received services, like a tip (the authority for that is Calvert v Wainwright) – there will be evidentiary challenges proving that any gift to an MP is for services rendered (and indeed likely more serious adverse consequences for the parties than tax). The foregoing reflects the conventional view, but some very knowledgeable people have suggested in the comments below that there may be in some cases a question as to whether it is correct. This may be something we look into further, but (having made extensive enquiries) the practical answer seems to be that nobody – HMRC or advisers – can recall a politician being taxed on a gift they receive. ↩︎

    2. It is sometimes suggested we should change the law so MPs are taxed on gifts – we don’t see the case for that. There is a rational case that gifts should be banned, and a rational case that gifts should be permitted. Permitting them, but subjecting them to a uniquely punitive tax regime, doesn’t seem justified. ↩︎

  • How to end offshore secrecy – a new proposal

    How to end offshore secrecy – a new proposal

    Offshore secrecy is a problem. Tax avoidance, tax evasion, sanctions evasion, drug cartels, corruption, questionable government contracts – all have been enabled by offshore companies whose ownership and accounts are hidden from public view.

    We believe everyone would benefit if all companies, everywhere in the world, had to publish basic information: their shareholders, directors, beneficial owners and accounts. But previous attempts to persuade or force this result have stalled.

    We’re presenting an alternative. Companies across the world would be invited to publish their basic corporate information on Companies House. Companies that don’t would be subject to a 10% “transparency levy” on all payments received from the UK, and barred from public sector procurement contracts. Companies from countries with fully open corporate registers would be entirely exempt.

    The UK could introduce the transparency levy unilaterally. We’d anticipate it would then be implemented by many other countries – OECD members and developing countries alike. We’d see a new wave of corporate transparency. All it takes is for the UK to take the first step.

    The case for open company registers

    Journalists frequently find their investigations stymied by offshore secrecy. We might trace a dubious business to Belize, or to Arkansas, but it’s then impossible to find out who owns it, who runs it, or what its business actually involves.

    This is an obvious problem for journalists investigating malpractice and corruption; it’s also a problem for banks deciding whether or not to open a bank account for a company owned by an offshore entity.

    On the face of it, law enforcement and tax authorities don’t need open registers. The Financial Action Task Force and the OECD have made considerable progress in ensuring that, in theory, law enforcement has full access to company information (including the identity of companies’ beneficial owners). But in practice it’s often hard to obtain cross-border access; formal requests have to be made, the process can be slow, and bad actors can use legal proceedings to slow things down further (giving them the time to move their assets elsewhere).

    Worse still, many countries still don’t require key information to be filed at all. The US, Bermuda and Belize, for example, don’t require companies to file accounts. If the local authorities don’t have the information, it’s impossible for foreign authorities to obtain it, short of complex local litigation.

    So offshore secrecy doesn’t just block investigations by journalists and financial institutions; in practice it’s a significant impediment for investigations by public authorities. That’s why there’s a strong public interest in open corporate registers.

    The current problem

    Anyone can go onto the UK’s Companies House and find all the filings made by any company. This includes its shareholders, directors, accounts, and the identity of its true human owners (the “persons with significant control”, or “beneficial owners”). This is all searchable, for free, by any member of the public.

    This is not typical. This interactive chart shows how open each country’s corporate registry is. All thanks to data from opencorporates.com, and you can click on a country to go to the individual assessment:

    Many countries have public registers which show companies’ directors, shareholders and accounts. But important jurisdictions like the US and Dubai don’t, and tax havens almost never do (Gibraltar is an unusual exception).

    The UK has one of the more open company registries in the world (the best, in our view, is Estonia, where the company registry search is both comprehensive and user-friendly).

    Fewer countries still have open registers of beneficial owners – the individuals who really run a company (sometimes hidden by layers of ownership, trusts and other arrangements). The EU introduced mandatory public beneficial ownership registers in 2020, but an unfortunate decision of the CJEU blocked this, resulting in a significant reversal of the progress that had been made. Under the new anti-money laundering directive, the registers will be open, but only to people with a “legitimate interest” in money laundering. So, for example, it may not be possible to search the French register when investigating tax avoidance.

    There are around 35 countries with open beneficial ownership registers:

    There are other countries, like the US, where there is a register, but it’s only accessible by local law enforcement.

    The problem is that bad actors will gravitate towards countries that don’t have open registers. There is widespread agreement that this needs to change. The question is: how?

    The current solution

    International efforts to persuade tax havens to open up their corporate registers have largely been unsuccessful.

    The UK has taken direct steps to require the Crown Dependencies (e.g. Jersey) and Overseas Territories (e.g. Cayman Islands) to have open beneficial ownership registers, overriding their local legislatures. This continues to meet resistance.

    The moral case for requiring tax havens to have open beneficial ownership registers was seriously damaged when the CJEU blocked open registers across the EU on the basis they conflicted with beneficial owners’ right to privacy. If Cyprus and Malta don’t have open registers, why should Jersey? And why the focus on so-called “tax havens” (typically small islands) when the richest country in the world has some of the least transparent company laws in the world?

    There are also obvious practical problems with forcing the CDs/OTs to adopt open beneficial ownership registers. Those with most to fear from transparency will move elsewhere. Increasingly that means Dubai, which has essentially zero corporate transparency. There is also a valid fear on the part of the Crown Dependencies/Overseas Territories that legitimate clients who wish privacy would also relocate to Dubai and elsewhere, putting them at a competitive disadvantage. And sometimes countries resist for darker reasons.

    In any event, the project is limited in scope. There are no current plans to require “tax havens” (or indeed anyone) to publish other corporate information, in particular accounts.

    We need something that is simultaneously more democratic (which doesn’t involve overriding self-governing territories), more ambitious (not just beneficial ownership) and fairer (not just “tax havens”).

    An alternative model – FATCA

    In the 2000s, following a series of bank secrecy scandals, the US Government resolved to require banks across the world to report their US accountholders to the IRS.

    The US of course had no way to require this as a matter of law. So it did something much smarter.

    Under what became known as “FATCA“, the US asked financial institutions worldwide to agree to report their US accountholders to the IRS. Financial institutions could freely choose whether to sign up to FATCA. But if a financial institution chose not to, it would be subject to a 30% withholding tax on all its US income. So, in reality, financial institutions had no choice at all – they almost all ended up becoming compliant with FATCA.

    This was highly controversial, but a brilliant innovation. The original idea was conceived by the Congressional Black Caucus, who saw it as both a more effective and fairer strategy than the previous approach of targeting small island tax havens for economic sanctions, and letting larger states off the hook. FATCA treated all countries equally.

    OECD members eventually responded by creating a multilateral version of FATCA – the Common Reporting Standard. Thanks to CRS, over €12 trillion of accounts are automatically reported between countries every year. If a UK resident opens a bank account almost anywhere in the world, it will be automatically reported to HMRC. That is all thanks to FATCA, and the revolution in cross-border reporting that it created.

    Our proposal is inspired by FATCA – we believe the UK should use a unilateral measure to incentivise businesses and countries to move towards transparency.

    The proposal – the transparency levy

    The following paragraphs summarise our proposal.

    This is very much a “proof of concept”, and not a fully-worked-out technical proposal, but we’ve included some of the legal detail in footnotes.

    Disclosed entities

    The key concept is a “disclosed entity” – an entity that publishes “transparency disclosure” about itself. That means it lists its shareholders, directors and beneficial owners, and publishes annual accounts.

    As a policy matter, we want every company, partnership, trust or other entity that has any dealings with the UK to be a “disclosed entity”. An entity that isn’t, is an “undisclosed entity“.

    Where an entity is incorporated in a country (like Denmark, Estonia or the UK) which already has a free public register including “transparency disclosure” – then that company would be a “disclosed entity” automatically. It wouldn’t have to do anything. HMRC would publish a list of all such countries (“disclosing jurisdictions“). Listed companies would also become “disclosed entities” automatically, given they don’t have beneficial owners in the usual sense, and already publish detailed accounts.

    At the start, many countries in the world wouldn’t be “disclosing jurisdictions”, because they don’t have open company registries publishing transparency disclosure. A company in such a country could still opt to be a “disclosed entity” by filing its own transparency disclosure with Companies House in the UK. Companies House already registers plenty of foreign companies – little would be required in terms of systems/IT changes.

    So every company, trust and partnership in the world could become a “disclosed entity”. Why would it do this? Because of the transparency levy and the procurement rule.

    The transparency levy

    Anyone in the UK making a payment to an “undisclosed entity” would have to withhold a 10% “transparency levy“.

    So, for example, if a UK company was making a £100 interest payment to a BVI company which hadn’t registered with Companies House and become a “disclosed entity”, the UK company would deduct £10 for the transparency levy and the BVI company would only receive £90. The transparency levy would be paid to HMRC.

    Payments to “disclosed entities” would not be subject to the transparency levy. It would be simple for UK payers to check if they were paying an entity which was disclosed.

    The transparency levy could simply apply to all payments, regardless of their nature, but it would be simplest – at least at first – to apply it to the narrower category of payments that are traditionally subject to withholding tax. That means UK source rent, interest, dividends, royalties and annual payments. By limiting the levy to financial payments, there’s no impact, for example, on a small business supplying goods or services to the UK.

    The transparency levy therefore creates a powerful economic incentive for foreign entities to become “disclosed entities”, either by registering their own details with Companies House, or to pushing their government to upgrade their public register so the country becomes a “disclosing jurisdiction”.

    Who applies the levy?

    Where a bank or other intermediary is making a payment, they would be subject to an obligation to withhold the transparency levy (as they are at present for UK interest withholding tax). In other cases, the payer would withhold the levy.

    The transparency levy would largely be self-policing, because all the risk of failing to apply would fall on the UK payer, but the cost of the levy falls on the recipient. UK payers are therefore incentivised to err on the side of caution and apply the levy even when the technical position is unclear.

    UK individuals and companies would list, in their tax returns, the foreign entities they’d made payments to, and whether they were disclosed entities or undisclosed entities.

    The procurement rule

    The “procurement rule” is simple – no supplier would be able to enter into a contract with UK central or local government (procurement, real estate or anything else) unless it is a “disclosed entity”.

    What about avoidance and evasion?

    There are two obvious approaches bad actors would take to avoid/evade these rules:

    • First, by simply filing false information (as is currently endemic with Companies House reporting).
    • Second, by registering one offshore entity, but having it secretly make payments “behind the scenes” to another undisclosed offshore entity. In tax terminology, the first entity is a “conduit“.

    How to deter and prevent such behaviour?

    There would have to be active enforcement by HMRC, to prevent the new register duplicating the existing problems with Companies House. But HMRC has the considerable advantage that (unlike Companies House) it has enforcement powers and expertise.

    HMRC would have to be given additional powers. For example:

    • If HMRC has reasonable grounds for believing that a “disclosed entity” has filed false information, or is acting as a conduit for an undisclosed entity, it would require the entity to remedy the situation. If the entity doesn’t, it would be put on a “bad list” of non-compliant entities. Payments to an entity found to be non-compliant would become subject to the transparency levy, with an additional charge to make up for the period in which it was wrongly claiming to be compliant.
    • UK companies would be liable for avoidance by offshore “conduit” companies if they are in the same group.
    • Making a false declaration would be a criminal offence for a company’s directors; dishonestly failing to withhold the levy would be a criminal offence for the payer’s directors (in the same way as for any tax). However, in most cases it would be the transparency levy mechanics which would incentivise compliance, not the (usually remote) prospect of criminal prosecution.

    Would it be legal for the UK to introduce the transparency levy?

    We don’t believe there are legal impediments that would prevent the introduction of the transparency levy:

    • The levy would not be subject to (or contravene) the UK’s tax treaties, because the treaties only cover certain designated taxes, and the transparency levy is different from all of them.
    • The levy should be compatible with the UK’s WTO obligations, as it is being introduced to help counter tax avoidance, tax evasion, sanctions evasion, money laundering and corruption.
    • If adopted by EU Member States, the levy should be consistent with EU law, because it applies equally to all payments, depending on the objective status of the recipient, and is not discriminatory. So there should be no breach of the free movement of capital or the freedom of establishment.
    • There should be no GDPR violation; in most EU countries, director and shareholder information is already published. Beneficial ownership information often isn’t, and in those countries we anticipate companies may need to obtain the consent of their beneficial owners before registering and becoming “disclosed entities”. There is an obvious economic incentive on beneficial owners to give this consent.

    There have been a number of recent legal challenges to transparency initiatives – but a UK transparency levy would be introduced by primary legislation, and so wouldn’t be subject to legal challenge.

    Implementation

    It’s anticipated that relatively few payments would end up being subject to the levy, because most affected businesses would simply become disclosed entities. However the total amount of in-scope payments is so vast – likely in the trillions of pounds – that the transparency levy would still likely raise a large sum, particularly in the early years.

    The funding raised from the transparency levy would be used to finance the additional work for Companies House and HMRC, and to help the Crown Dependencies and Overseas Territories build capacity for their own open registers (if that’s what they wish to do).

    Implementation would be phased, with (for example) entities able to register as disclosed entities through the course of 2026, and the transparency levy and procurement rule both starting to apply from 2027. The scope of the levy could potentially expand over time, from dividends, interest, royalties and rent in 2027, to include fees and sale proceeds from 2028, and all payments from 2029. But it is possible that, as was the case with FATCA, global adoption would render an expansion of the rules unnecessary.

    Wouldn’t the levy stop people from doing business with the UK?

    The transparency levy copies the brilliant innovation at the heart of FATCA – the creation of a powerful incentive for foreign companies to voluntarily comply with a rule. There is, however, one very important difference: FATCA was complicated and expensive for financial institutions – they had to create entirely new systems to operationalise the reporting of all their US accounts, costing many billions of dollars. By contrast, it would take most companies less than an hour to register with Companies House, submit their corporate information, and update it once per year. The transparency levy should be no impediment to legitimate business.

    And the basic concept here is nothing new. Businesses that operate cross-border are used to the idea that, if they want to escape withholding taxes, they have to register, or complete a form.

    Won’t the UK come under significant pressure from other countries not to introduce the levy?

    This is a complex question, and dependent on unpredictable geopolitical events (e.g. the outcome of the upcoming US Presidential election). A Kamala Harris administration might well welcome a global transparency initiative that requires no US legislation. And there is strong support for corporate transparency across the world, particularly in the European Union, South/Latin America and Africa.

    The lesson from FATCA is that, when one country announces its intention to introduce a measure of this kind, the first reaction is complaints that it amounts to extraterritorial legislation. The second reaction is that other countries see the benefit and adopt similar measures.

    The UK could be pushing at an open door.

    Multilateral implementation

    Whilst the UK could implement the transparency levy unilaterally, the ideal outcome is that other countries would adopt it, either creating their own registration system, or taking advantage of the UK’s own implementation and simply cross-referencing Companies House.

    The UK should therefore advocate for international adoption of a transparency levy at the UN and OECD, and in bilateral discussions with other countries.

    The more countries that implement the levy, the greater the moral and practical pressure for widespread adoption of open registers. And the easier/cheaper it becomes for other countries to implement the levy, because they can “piggy-back” on existing implementations.

    Why it works

    The transparency levy is a radical new way of solving an old problem:

    • It’s a path to worldwide corporate transparency that doesn’t require countries to act against their own immediate interest. We wouldn’t be begging Dubai to comply; we’d be giving Dubai companies a strong incentive to comply, if they want to continue to do business with the UK.
    • We’d be creating an incentive for countries to create their own open corporate registers, to save their businesses the bother of individually registering with the UK’s Companies House.
    • The transparency levy treats all countries equally – it doesn’t attack politically vulnerable small islands whilst ignoring the widespread secrecy problem in the US and EU.
    • The transparency levy uses a well established pre-existing concept. Many countries impose withholding taxes on outbound payments unless procedural formalities are completed. The purpose and details of the transparency levy are different, but the basic idea is nothing new.
    • The procurement rule avoids subjective judgment about tax avoidance, but ensures there won’t be a repeat of valuable contracts being awarded to businesses whose ultimate ownership is highly opaque.
    • The disclosure, levy and procurement regime is reasonably straightforward for the UK to implement, building on an existing Companies House system and existing withholding tax mechanics.
    • Once the UK has implemented, it becomes easy for others, particularly developing countries, to follow. They wouldn’t need to build any kind of complex registration/compliance system, just enact a transparency levy into their own local law, and cross-refer to the register kept by the UK Companies House.

    We welcome comments, criticisms and suggestions.

    Many thanks to all the tax lawyers, trade lawyers, regulatory lawyers and transparency campaigners who contributed to this proposal.

    Image generated with Flux AI: “A secure safe containing secret financial documents”

    Footnotes

    1. In practice the most important barrier to money laundering and other financial crime is the banks, and their anti-money laundering (AML) and “know your client” (KYC) teams. They, of course, have no special investigatory powers. Open registers would help them do their job more effectively, and that would benefit all of us. ↩︎

    2. It is unfortunate that UK company law uses the PSC concept; it would have been better to align with the well-understood “beneficial ownership” concept. This paper won’t go into the differences between the two ↩︎

    3. Companies House has many problems, largely caused by a failure to check data and enforce the rules (which may be about to get better). We would also be cautious about assuming that the UK is worse than others, as opposed to just having more companies, and more widely publicised problems). ↩︎

    4. Note that some sources, like openownership.org, conflate closed registers (open only to local law enforcement) with open registers). ↩︎

    5. Data from openownership.org; code to display map by Tax Policy Associates Ltd, and available on our GitHub here. ↩︎

    6. The US has a particular issue here, because it taxes US citizens no matter where they live. That “citizenship based taxation” is in our view unfair – more on that here – but that doesn’t change our view of the effectiveness of FATCA. The US couldn’t in practice enforce citizenship-based tax against some of its expats before FATCA – FATCA meant that it could. So most of the complaints about FATCA, are in fact complaints about citizenship-based taxation. ↩︎

    7. The Wikipedia article on FATCA is a pretty good summary of how things stood 10 years ago, but unfortunately is now mostly rather out of date ↩︎

    8. A “withholding tax” is a requirement on a person making a payment to deduct from that payment an amount representing tax that is really the liability of the recipient. Withholding taxes are widely used in circumstances where it is easier for a tax authority to collect tax from the payer than the recipient. The case people are most familiar with is their own employment income, where in most countries the employer withholds the tax. But it is also very common for tax authorities to require tax to be withheld from cross-border payments, where the tax authority has little ability to tax a foreign recipient. ↩︎

    9. This is a very simplified history. Data protection and bank secrecy laws meant that most banks feared they wouldn’t be able to voluntarily provide account information to the IRS. So they pushed their governments to enter into agreements with the US under which (e.g.) the French government would require its local financial institutions to make reports to the IRS (solving the data privacy problem) and in return the US would deem all French financial institutions to be compliant. This would never have happened if it wasn’t for the original promise/threat of a withholding tax. ↩︎

    10. CRS was entirely consensual, with no withholding obligation to prod people into compliance. But, once a country had accepted the principle of FATCA, it was very hard for it to refuse to sign up to CRS. Large countries acted out of self-interest. Small countries fell into line. ↩︎

    11. Discussion can be impeded by the fact that “transparency” can, in a tax context, mean that an entity is not subject to tax itself, but whose shareholders, partners or members are taxed as if they were carrying on the business. The entity is then “tax transparent” or “fiscally transparent”. If, alternatively, it is taxed like a normal company, it is referred to as being “opaque”. When we use the words “transparent” and “opaque” in this proposal, we are using the more colloquial meaning of whether the company’s details are publicly disclosed ↩︎

    12. Thought would need to be given as to what standard is required for the accounts. The current standard for small UK companies – which is about to change – feels insufficient given that it doesn’t include the P&L. ↩︎

    13. Whether or not strictly a legal entity under its local law. So, for example, unincorporated associations would also be included – past regulations that have omitted unincorporated associations have created loopholes. ↩︎

    14. It would have to be a little different for trusts and partnerships, which traditionally don’t register with company registries at all. Practically, a separate “disclosed trust/partnership” concept would probably be required. As of today, it’s possible that no country in the world would be a “disclosing jurisdiction” for trusts and partnerships – the UK certainly wouldn’t be. So all trusts and partnerships receiving payments, including UK trusts and partnerships, would have to register with Companies House. This is a feature, not a bug. ↩︎

    15. At least those listed on major markets ↩︎

    16. i.e. because Companies House already registers foreign companies with a UK branch, and foreign companies that own UK land. ↩︎

    17. The levy of course wouldn’t have to be 10%. A levy that was too small (say 1%) could be regarded by some bad actors as an acceptable price for secrecy, and so fail to achieve change. 5% might be sufficient. 20% might be too high. But it is also advantageous to raise some funds in the short term to fund implementation in the UK and abroad. This would need careful thought. ↩︎

    18. Indeed much simpler than it is to apply current UK withholding tax rules, which are notoriously awkward. ↩︎

    19. The quoted Eurobond for listed bonds needs some thought. It’s not workable to e.g. require Marks & Spencers plc to identify individual bondholders, because it won’t be able to (there is a nice explanation here as to why that is). However simply excluding listed bonds creates a loophole. There would have to be an anti-avoidance rule so that, for example, the transparency levy applies to listed bonds issued between connected parties. ↩︎

    20. Listed shares would also need thought; again, they should be generally excluded subject to an anti-avoidance rule ↩︎

    21. And if expanded to all payments, thought would need to be given as to how to avoid creating a barrier for small businesses, particularly those in developing countries. ↩︎

    22. And to ensure this, any contractual term that purported to prevent the levy being withheld, or make the cost of it sit with the payer (a “gross-up” or indemnity) would be void. That’s fair given that it’s entirely within a foreign company’s control whether to comply and become a “disclosed entity”. Such a rule is not unprecedented – the UK has had a rule for over a hundred years that any attempt to make one party indemnify another party’s stamp duty is void. Other countries (e.g. Switzerland) have statutory rules that prevent any attempt to make the payer contractually liable for the cost of a withholding tax caused by the recipient’s status. ↩︎

    23. There would need to be a refund mechanism, so that if the transparency levy is wrongly applied (e.g. the payer thought the recipient was an undisclosed entity when they were in fact a disclosed entity), the recipient can reclaim it. However, there should be no way for an undisclosed entity to be subject to the levy, become a disclosed entity, and then reclaim historic levies it had been subject to. That would enable people to play games with timing of disclosure. The transparency levy is not a tax, and standard refund mechanisms are not appropriate. ↩︎

    24. The fact a payment was made to an undisclosed entity should be of interest to HMRC, and other regulatory and enforcement authorities, given that (after the rules had bedded in) all legitimate parties would be expected to become disclosed entities. Consideration could also be given to publishing the number/amount of transparency levy payments each company makes. ↩︎

    25. This goes further than the new requirement that contracting parties must declare their beneficial ownership. ↩︎

    26. That mirrors the approach taken under FATCA, where (for example) a UK financial institution is automatically deemed to be compliant with FATCA, but in the event of “significant non-compliance”, they lose that status. ↩︎

    27. There is a similar mechanic in the UK’s existing interest withholding tax rules; if a foreign company claims relief from withholding under a tax treaty, but wasn’t actually eligible, then HMRC can direct the UK payer to make “catch-up” withholdings so that the full amount of historic tax is collected. ↩︎

    28. See e.g. Article 2 of the UK/France treaty. The question is whether the transparency levy is “identical or substantially similar to” income tax. It isn’t. The levy isn’t related to profit in any way (there are no permitted deductions), and wouldn’t be creditable against any UK tax liability the foreign entity might have). Note that the question isn’t whether the levy is similar to “withholding tax”, because there is strictly no such tax. Withholding tax is simply a particular collection mechanism for income tax, and it’s income tax which is designated in tax treaties. The transparency levy is nothing like income tax. ↩︎

    29. See the WTO Appellate Body decision in the Argentina v Panama case, where the Appellate Body held that countries could restrict trade with tax havens for “prudential” reasons or to comply with national laws, as long as they did so in a consistent and non-arbitrary manner. ↩︎

    30. There would need to be some form of “anti-conduit” rule, where a UK person making a payment to a disclosed entity which it knows will be on-paid to an undisclosed entity has to apply the levy. ↩︎

    31. Some delay is advisable to minimise “teething problems” with the new rules, as well as to give financial institutions time to build withholding and reporting systems. Delay may also increase the likelihood of international adoption – these processes tend to move slowly at first. ↩︎

    32. FATCA was initially planned to extend to a much wider and more complex class of payments, encompassing gross sale proceeds and non-US source payments – but this ended up being deferred indefinitely because the standard withholding approach proved a sufficient incentive for widespread adoption. If that didn’t happen, and the UK remained the only country with a transparency levy, then it might be necessary to expand the scope of payments impacted by the levy to prevent avoidance by shifting one form of payment into another. ↩︎

    33. An approach that would be particularly attractive for countries without the capacity or budget to implement their own systems. ↩︎

    34. i.e. because if many countries created their own registration systems then that could be quite burdensome for companies – i.e. because they’d have to make numerous separate registrations. The solution is for their home jurisdiction to create its own open register, so all local companies automatically become “disclosed entities”. ↩︎

    35. That’s a stronger incentive if many countries adopt, all with their own company registry. The burden of registering with many registries would push businesses to lobby countries to create open registries and become “disclosing jurisdictions. ↩︎

    36. It would in many ways be preferable to create a new international register, of the kind suggested by some campaigners. Implementing such a register in the short term is likely to be difficult from both a political and a systems perspective. In the long term it’s conceivable that the transparency levy would begin a process that ends with such a register. However the important benefit of the transparency levy is that implementation isn’t dependent on international agreement or building complex new IT systems. ↩︎

  • The state of play of open corporate data

    The state of play of open corporate data

    Our proposal to end offshore secrecy, and move the world towards open registers, is here. But right now, the world looks like this:

    The interactive chart above shows how open each country’s corporate registry is. All thanks to data from opencorporates.com, and you can click on a country to go to the individual assessment. Full screen version here.

    Or we can focus on beneficial ownership registers, and look at whether each country has a register, and whether it’s “open” (available to everyone), or “closed” (available only to law enforcement) and whether they’re open or closed. You can click through to go to each country’s register’s website:

    Full screen version here. Beneficial ownership register data from openownership.org.

    All code by Tax Policy Associates Ltd, and available on our GitHub here. Many thanks to opencorporates.com and openownership.org.

    Photo by CHUTTERSNAP on Unsplash