Death, taxes, damned lies and statistics

By Charles Ansdell, Managing Partner

Americans are always fascinated by Britain’s choice to elect Clement Atlee over Winston Churchill at the end of WWII. How could Britain’s iconic war leader – voted the Greatest Ever Briton in 2002 by the eponymous TV series – be cast aside? But Clement Atlee was the man that Britain wanted to win the peace, recognising it required a very different focus to winning the war.

In much the same way, as our control of Covid-19 gradually comes under our control, so attention is now focussing to the post Covid world. While the focus is still rightly on controlling the virus and boosting the economy, there remains a brutal truth – we need to start planning to pay for the economic cost of Covid.

Setting the strategy

The pandemic has had a truly destructive impact on the economy.  The Office of Budget Responsibility’s July Fiscal Sustainability report projects UK public sector debt as exceeding 100% of GDP later this year, for the first time since the second world war.  GDP will not return to 2019 levels until late 2022.

It projects that public sector net borrowing will reach £322bn (16% of GDP), the highest peacetime level in over 300 years[1]. At the same time, we have an ageing population with increasing health and care needs and people in Britain want improved public services.

For the government there are strategies it can deploy to try and reduce the debt; it can grow out of the situation, with sufficient GDP growth allowing net tax receipts to exceed spending, thereby reducing the debt. While this is the most attractive option, if capacity has been permanently damaged by Covid 19 it may be hard to sustain the levels of growth required. In addition, disruptions from Brexit may impede growth in the short term. Finally, history is not on our side. The UK’s average real GDP per capita annual growth rate over the best part of 50 years has been 1.97% - hardly stellar and well behind the Eurozone and Asia[2].

It can try and inflate away the debt by allowing inflation to reduce the real value of debt. However, a return to 1970s style inflation would likely be destructive, especially with current high levels of household indebtedness.  This would further impact younger generations who are more likely to borrow and are already the worst hit economically by the crisis.

It could of course reduce spending – and the reduction of some parts of the public sector might sit well with current voters.  However – the big-ticket items - the NHS, pensions and welfare – may be off limits.  The NHS has just been hailed as heroic, pensioners are ardent voters and welfare payments in the form of furlough and universal credit may be a vital safety net if unemployment remains persistently high.

Taxing times

Which brings us to tax. It is becoming increasingly accepted that the government is going to have to increase tax.

There are broadly speaking three ways that a government can increase its tax revenue.  It can increase its tax base by increasing the base of assets/ people it taxes; it can increase the rates of tax payable; finally, it can increase compliance and reduce avoidance/ evasion.

The battle for who, how and where tax is levied is fast becoming a key political battleground.

Building revenue

When it comes to increasing the tax base, the government can either increase the taxable population or the number of assets taxed.  If unemployment remains high, it will struggle to increase the number of people paying tax.  Immigration is an option, but Covid-19 has reduced international mobility and encouraging further immigration just after Brexit might be politically challenging.

This has led to a proposed asset tax – or wealth tax.  Such a concept may prove an anathema for a traditional Conservative government but there is some significant appeal in this approach.  Total personal wealth in Britain was £10.6 trillion in 2016-2018[3].  Wealth is less evenly distributed than income.  The GINI coefficient for UK wealth is 63% as opposed to 32.5% for income[4] (a higher coefficient means greater inequality).  That jumps to 91% for financial wealth.  

This in turn explains the much-trailed discussions around Capital Gains Tax, a tax that is typically payable on financial wealth and second properties.

A property focussed asset tax would be another option though the Liberal Democrat’s previously mooted “Mansion Tax” was much derided.  Although property is the second biggest component of wealth after private pension tax, a value-based tax would disproportionately hit those in London and the South East and would be challenging to levy given the subjective nature of valuations.

Hang the rich

Despite this, the temptation would be great to put more of a tax burden on “those with the broadest shoulders”.  It would be politically popular. 

However, the rich have already been targeted.

In 2019-2020 the top 1% of earners earned 12.8% of the UK’s income and paid 29.2% of its income tax[5]. The top 10% of earners earn 34.2% of the UK’s income and paid 61% of its income tax.  In 1999/2000 the top 10% of earners earned marginally less (32.9%) and paid 50.3% of income tax.

By comparison the bottom 50% of earners paid 11.6% of income tax in 1999/2000 and 9.3% in 2019/2020.

Receipts from taxes aimed at wealthier cohorts – Capital Gains Tax, Stamp Duty and Inheritance Tax – have risen sharply over 20 years. While income tax receipts have risen 107% in 20 years, Capital Gains Tax has risen 370%, Property Stamp Duty 264% and Inheritance Tax 150%[6].

The temptation will be high to increase marginal tax rates. However, statistics from the Office of Budget Responsibility showed that the last time the highest marginal income tax rate was increased to 50% in April 2010 it did not generate anywhere near the projected income.  The highest earners deferred income or brought it forward to avoid paying the higher rate or used more tax planning instruments. Rather than raising a projected additional £2.6bn, it raised just £600m[7].

Fat Cats and Big Business

Which brings us to the elephant in the room.  Tax avoidance (and evasion).  The rich not paying their fair share.  Large corporates using complex tax schemes.

It’s a well-worn narrative which has considerable traction with the public.

In 2018-2019, the tax gap – the difference between what HMRC should in theory be paid and was in fact paid – was £31 billion, or 4.7% of tax liabilities[8]. This is the lowest that it has been since 2005-2006.

So, who were the culprits? The super-rich? FTSE 100 behemoths?

£22.4bn of the tax gap was attributable to companies. But it wasn’t the blue chips. £13.4bn came from smaller UK companies. By comparison, the tax gap of large companies was £5.2bn. For the wealthy it was £1.7bn.

Much of the gap was also purely on business taxes – VAT, corporation tax and excise duties made up £17.2bn.

In turn, most of the tax loss wasn’t complex evasion. The main causes were more mundane – “failure to take reasonable care”, “non-payment”, “errors” and “legal interpretation” were responsible for £17.6bn of the gap.

Undoubtedly there is a lot more to close the tax gap, but that alone won’t restore fiscal equilibrium.

Broadest shoulders

Although the wealthy are popular targets for tax, how does the UK compare with our neighbours when it comes to taxing an “average” person or company?

In the UK, the average tax wedge[9] (the total amount of income tax and social security contributions) at the average salary is 30.9%.  By comparison Spain is 39.5%, Sweden 42.7% , France 46.7%, Italy 48% and Germany 49.2%.  In other words, the average German worker on an average wage pays away an additional 18.3% from their wages in tax. 

It’s a similar story on corporation tax rates – at 19%, the UK’s corporation tax rate is amongst the lowest in Europe (only bettered by Ireland, Hungary and Lithuania).  By comparison Spain is 25%, Sweden 21.4%, France 32.0%, Italy 27.8% and Germany 29.9%.

Unsurprisingly, all these countries have a higher tax take as a proportion of GDP than the UK.

An all society approach

The reality is that, the “broadest shoulders” may not be enough to bear the increase in tax required for a post Covid world.  For a long time, there has been an embedded public view that the wealthy and big business are exploiting the system and must be taxed more.  As always, there are elements of truth to this view. Undoubtedly some corporations and individuals have behaved badly.

But it’s an easy, populist view which avoids difficult conversations and difficult decisions. After all, there are few large companies and few rich people. The vast majority of people and companies don’t fall into this definition.  The idea that these “few” can make up a fiscal shortfall is incredibly appealing.  Who, after all, would rather pay more tax when someone else could?

It’s a dangerous viewpoint that nurtures divisions and ignores collective responsibility.  No one doubts that those with the “broadest shoulders” should pay a higher proportion than those who can’t. However, this ignores an important reality.  All of us – including the man on the Clapham Omnibus and our small businesses – will have to pay more taxes to re-stabilise our public finances, to deliver excellent public services and to plough a successful course after Brexit. Just as the electorate accepted in 1945 that a new direction was required for winning the peace, so we must accept today that we will all have to play - and pay - our bit in post pandemic Britain.

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[1] Source: Office of Budget Responsibility, July 2020 Fiscal Sustainability Report

[2] Source: World Bank, Real annual GDP Growth rate per capita from 1960-2018

[3] Source: Office for National Statistics, Total Wealth in Great Britain (sixth round)

[4] Source: Office for National Statistics, Household Income Inequality UK (financial year ending 2019)

[5] Source: HMRC share of total income (before and after tax) and Income Tax for percentile groups 1999-2000 to 2020-2021

[6] Source: HMRC tax receipts and national insurance contributions for the UK

[7] Source: Office of Budget Responsibility, Effect of the additional rate of income tax on receipts, Oct 2014

[8] Source: HMRC Measuring Tax Gaps 2020 edition.

[9] Source: OECD.Stat.  Average personal income and social security contribution rates on gross labour income.