Rich Will Avoid New Tax Hike In UK

by Robin Pilgrim, LawAndTax-News.com, London

22 April 2009

The government’s plans to raise income tax rates for people on incomes above GBP150,000 (USD218,526)are very unlikely to raise the revenue predicted without additional steps to tackle tax avoidance, according to a study by researchers at the Institute for Fiscal Studies (IFS).

The Treasury forecast in last November's Pre-Budget Report that it would raise GBP1.6bn (USD2.3bn) by introducing a new 45% income tax rate on incomes above GBP150,000 (USD218,526) from April 2011, and in today's budget Chancellor Alistair Darling raised the rate to 50%. The IFS noted that Shadow Chancellor George Osborne predicted in March this year that the increase would be "difficult to avoid."

However, even if the Treasury is correct in predicting in judging how people will respond to the rate increase, the study suggests that this reform would probably raise only around GBP550m (USD801m) once the loss of VAT and other indirect tax revenues is taken into account.

Based on this, the IFS predicts that the most the Treasury could expect to raise simply by increasing the marginal tax rate on incomes above GBP150,000 (USD218,526) would be around GBP900m (USD1.3bn) - and that would require an income tax rate of 54%.

In response to a Freedom of Information request submitted by the authors, the Treasury has revealed that its Pre-Budget Report calculations assume that the increase in the marginal tax rate on incomes above GBP150,000 (USD218,526) would normally reduce the taxable income of those affected by 3.4%, but that the reduction would be 2.9% when account is taken of its proposal to freeze the lifetime allowance for pension contributions.

However, research for the IFS's Mirrlees Review of the UK tax system suggests that these may be underestimates - although the uncertainty around all such calculations is enormous.

The IFS study goes on to point out that if people respond as they did to the last set of changes to the highest income tax rates in the late 1980s, then the new 45% band will actually reduce the government's revenue slightly, as the existing 40% income tax rate is one that would generate the most revenue.

The study also suggests a number of ways in which people can reduce their taxable income - including working less, contributing more to tax-free private pensions, or converting earnings into capital gains or corporate income that are taxed at lower rates. Higher tax rates might also lead to higher net migration, or earlier retirement.

Further to this, the Treasury also proposes to withdraw the income tax personal allowance in two stages from those with incomes over GBP100,000 (USD145,690) from April 2010. This reform creates two bands in which the marginal income tax rate is 60%. The authors of the IFS study argue that the Treasury's estimate that this too will raise GBP1.6bn (USD2.3bn) is more reasonable, but they argue that these spikes would complicate the income tax system significantly with little economic rationale.

As (according to the IFS) it is extremely unlikely that the Treasury will raise the GBP3.2bn (USD4.6bn) from its two proposals, the authors have considered alternative changes affecting the very rich that would raise equivalent amounts, assuming that the Treasury is correct in judging how the very wealthy will change their behaviour in response to the changes, but also allowing for the impact on direct taxes.

If the Treasury is correct in its assessment of people’s responses, then it could expect to raise GBP3bn (USD4.3bn) of the GBP3.2bn (USD4.6bn) by imposing a 60% tax rate on all incomes above GBP100,000 (USD145,690) rather than just in the two narrow bands above GBP100,000 (USD145,690) and GBP140,000 (USD204,017). But by imposing this high a rate on those with incomes above GBP150,000 (USD218,526) the Treasury would forego revenue unnecessarily.

Instead, it could expect to raise the full GBP3.2bn (USD4.6bn) by levying the revenue maximizing rate of 54% on incomes above GBP150,000 (USD218,526), with a 59% rate on incomes between GBP100,000 (USD145,690) and GBP150,000 (USD218,526).

Alternatively, it would though be possible to raise the full GBP3.2bn (USD4.6bn) by keeping the 60% bands and then applying a rate of 49% between GBP106,475 (USD155,152) and GBP140,000 (USD204,017) and above GBP146,475. These calculations underline the fact that it may well be impossible to raise any extra revenue from the roughly 1% of the population on the very highest incomes above GBP150,000 (USD218,526), simply by increasing the income tax rates applied to incomes above that level. In addition, the scope for raising money from those between GBP100,000 (USD145,690) and GBP150,000 (USD218,526) is limited.

The authors estimate that the Treasury could raise the GBP3.2bn (USD4.6bn) it is looking for by raising the current higher rate of income tax on incomes above GBP43,875 (USD69,939) (which is due to be paid by about 10% of adults in 2011–12) from 40% to 43%.

“Alistair Darling’s income tax increases for the rich will significantly complicate the tax system, and may well raise little revenue. A simpler and smaller increase in tax rates across a broader range of high-income taxpayers would raise the money the Treasury is looking for more efficiently, especially if combined with measures to make income tax harder to avoid,” concluded James Browne, senior research economist at the IFS.

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