HMRC’s case for reducing 50% rate
In his Budget speech, the Chancellor justified his decision to reduce the top rate of income tax from 50% to 45% based on findings from an HMRC study of how much the higher rate raised in its first year.
“HMRC find that an astonishing £16bn of income was deliberately shifted into the previous tax year – at a cost to the taxpayer of £1bn, something that the previous government’s figures made no allowance for,” the Chancellor said.
With Self Assessment receipts for 2010-11 £3.6bn below forecast, “The increase from 40p to 50p raised just a third of the £3bn we were told it would raise,” he continued.
“In other words, it raises at most a fraction of what we were told – and may raise nothing at all. So from April next year, the top rate of tax will be 45p. No Chancellor can justify a tax rate that damages our economy and raises next to nothing. It is as simple as that.”
The HMRC report The Exchequer effect of the 50 per cent additional rate of income tax is not quite so simple. While drawing on previous academic research into tax income elasticity (TIE) and Monte Carlo simulations to assess the economic impacts, the 60-page HMRC document leans heavily on assumptions angled to justify the Chancellor’s politically controversial decision.
While hedging its estimates with caveats, the report concluded, “The underlying yield from the additional rate is much lower than originally forecast (yielding around £1bn or less), and that it is quite possible that it could be negative”.
The HMRC report estimated that without the introduction of the 50% higher rate in 2010-11, total net incomes for those with incomes over £150,000 would have been around £107bn, in contrast with the actual figure of £87bn. Some £12.3bn of this difference was put down to forestalling, with the remaining £7.7bn attributed to other underlying behaviours.
The forestalling activity contributed to incomes for the same group in 2009-10 were £18bn higher than they otherwise would have been as a result of the additional rate, due to forestalling.
The assumptions that underpinned the HMRC research are drawn from a 2010 OECD 2010 report on tax policy reform and economic growth that concluded high top rates of income tax may be harmful for economic growth. According to this study, a reduction of 5 percentage points in the marginal income tax could raise the level of GDP per capita by around 1%.
“Other things equal, high tax rates in the UK make its tax system less competitive and make it a less attractive place to start, finance and grow a business,” the HMRC report concluded.
“The longer the additional rate remains in place the more people are likely to consider it a permanent feature of the UK tax system and the more damaging it would be for competitiveness. This suggests the negative impact on GDP may increase over time, and therefore the direct yield (and revenues from other tax bases) might fall over time toward or beyond zero.”
The HMRC report acknowledged that its source data is based on only one year’s tax take which makes “isolating the true underlying behavioural response to the additional rate challenging.” But AccountingWEB members and other critics questioned some of the report’s assumptions about the longer-term impact of taxpayers shifting income into previous tax years or leaving profits in their companies until it was more advantageous to take them out.
As Simon Sweetman pointed out in his Budget analysis, “The major avoidance device was to accelerate income into the previous year, which of course would not have worked in subsequent years. The argument that it failed to collect the expected tax is entirely mendacious.”
In a comment on pre-Budget estimates of the disappointing take for 2010-11 AccountingWEB member Andrew Diver argued that the 50% rate was always mooted as a temporary measure. “This in itself reduces collection as people could accelerate income or subsequently defer it for a period. But not indefinitely. Remove all doubt, embed it into the UK system at least for the term of this government. See how much it collects in year 2, 3 and 4. You cannot make a judgement on a single year’s figures and expect to make any practical conclusions from it.”
As we have seen in the subsequent controversy, the top rate is a political tool as much as a revenue generation exercise. “It isn't whether it collects 50% tax, but rather that people are aware that those who are most able to contribute when times are tough are,” commented Driver.
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