Taxation – focus on the UK Key issues to consider Reasons for taxation - what it’s for Principles of taxation – what taxes should look like Types of tax – direct/indirect etc looking at the UK Tax rates and tax revenues

Taxation - why Why do we tax? To pay for government spending: Goods and services provided by the state such as merit goods and public goods, capital spending and transfers As part of fiscal policy to manage the economy To correct market failure For example externalities – tax activities or goods with negative externalities (tobacco, alcohol, sugar?) To redistribute income Collect proportionately more tax from richer and wealthier Use some of the tax revenue to transfer to less well off

Principles of tax What makes a good tax (or a bad one)? Adam Smith came up with 4 principles (240 years ago) The cost of collection should be low relative to the yield of the tax No point introducing a tax which costs £500m to administer, yet only brings in tax of £500m The timing of collection and the amount to be paid should be clear and certain The means of payment and the timing of the payment should be convenient to the taxpayer Taxes should be levied according to the ability to pay of the individual taxpayer

Principles of tax These principles still apply, but we now consider 3 other factors which make a good tax: There should be no loss of efficiency, or even better the tax improves efficiency It should automatically adjust to changes in the price level (called indexing) - important when there is inflation The tax should be compatible with foreign tax systems, in the UK this means with the EU. This is not a universally acknowledged benefit Sometimes argued that a fair tax is also a hypothecated one, where the tax is linked to the benefit taxpayers receive – eg road tax should be spent on roads. In the past, national insurance was used to pay for pensions and the NHS

Types of tax Direct tax a tax taken directly from a person’s or business’ income or wealth Indirect tax a tax paid as a result of the purchase of goods or services Taxes are also progressive, proportional or regressive Progressive taxation as income rises, a larger % of income is paid in tax Proportional taxation the same % of income is paid in tax, no matter what the level of income Regressive taxation as income rises, a smaller % of income is paid in tax

Progressive, proportional and regressive ProgressiveProportionalRegressive IncomeTaxTax rateTaxTax rateTaxTax rate 5,00000%1,00020%2,50050% 10,0001,00010%2,00020%4,00040% 20,0004,00020%4,00020%6,00030% 40,00012,00030%8,00020%8,00020% 60,00024,00040%12,00020%10,00017%

Direct and indirect taxes Taxes 2014/15 Direct £b% totalIndirect£b% total Income tax % VAT % National Insurance % Fuel duties % Capital Gains Tax % Stamp duty % Inheritance tax % Spirits/beer/wine/cider duties % Corporation tax % Tobacco duties % Bank Levy % Air Passenger Duty % Customs Duties % Insurance Premium Tax % Total direct % Betting & Gaming % Total indirect % Other % Grand total What are the main direct and indirect taxes – which are most important

UK income taxes – progressive or regressive Look up UK tax rates How much tax does someone earning £25,000 pay? How about £35,000? Tax system is progressive: First £10,600 is tax free Next £31,785 is taxed at 20% (so up to £42,385 income) The tax rate is then 40% on taxable income over £31,785 until £150,000 Income above £150,000 is taxed at 45% Slight complication is that the tax-free personal allowance is withdrawn as income rises above £100,000 Taxable income Tax rate2014/152015/16 20%£0 - £31,865£0 - £31,785 40%£31,865 - £150,000£31,785 - £150,000 45%£150,000 + Tax-free allowance£10,000£10,600 Personal allowance reduced by £1 for every £2 earned above £100,000

UK income taxes are progressive The tax rate is the average tax rate So someone earning £10,000 pays no tax, but as soon as earnings are above £10,600 in a year, the marginal tax rate is 20%, ie earnings above £10,600 are taxed at 20% Someone earning £50,000 pays an average tax rate of 19%, but every extra pound in income is taxed at 40% Someone earning £150,000 pays 36% of this in tax, but every extra pound in income is taxed at 45% Someone earning £100,000 pays an average 30% but curiously every extra pound until £121,200 is taxed at 60%. Strange? IncomeTaxTax rate £10,000£00% £15,000£8806% £20,000£1,8809% £25,000£2,88012% £30,000£3,88013% £40,000£5,88015% £50,000£9,40319% £75,000£19,40326% £100,000£29,40329% £125,000£43,64335% £150,000£53,64336% £200,000£76,14338% £250,000£98,64339% £500,000£211,14342%

Indirect taxes Progressive, proportional or regressive? In principle they are regressive Spending does not rise proportionately with income – it rises at a slower rate This means as income rises, spending is lower as % of income Therefore since indirect taxes are based on spending, eg 20% (VAT), or a fixed amount per unit, this means tax is also lower as income rises Government recognises this and so many necessities do not attract tax (food, children’s clothes) But may be even more regressive, since for some goods taxed highly (tobacco and alcohol) spending may not change with income IncomeMPCSpendingVAT at 20% Tax as % income £0£5,000£833 £10, £13,000£2, % £15, £17,000£2, % £20, £21,000£3, % £25, £25,000£4, % £30, £28,750£4, % £40, £36,250£6, % £50, £43,750£7, % £75, £62,500£10, % £100, £81,250£13, % £125, £98,750£16, % £150, £116,250£19, % £200, £151,250£25, %

So, overall, regressive or progressive? Surprisingly, not clearly progressive (though it is progressive at the top end of the top quintile) Note, this does not mean we do not redistribute since: Gross income includes cash benefits The tax raised is also used for benefits in kind Once these are included, bottom quintile sees original (private) income rise from £5,521 to £15,504 including benefits, whilst the top quintile’s original income of £80,803 falls to £60,027 Overall, the ratio falls from 14.6 to 3.9 (top to bottom quintile)