September 23, 2008 | posted by Michael Baxter in Taxation | comments (0) |

Here is a prediction for you. Whatever the rights and wrongs, it will be a big surprise if at some point during the next couple of years a new higher rate of income tax is not introduced. Don’t be shocked if capital gains tax goes up in tandem, either.

One thing is for sure, government finances are set to hit crisis. Gordon Brown’s golden rule and sustainable investment rule are in tatters. Government borrowing is set to surge. It can be funded in one of two ways. Either taxes go up, or inflation is allowed to set in.

The real worry though, is this. Right now, tax cuts are likely to be the most effective means of getting the UK through this economic downturn as painlessly as possible.

Yesterday, the Centre for Economics and Business Research (CEBR) warned that public sector borrowing could be about to double.

Recent data from the ONS revealed that five months into the financial year, and cumulative borrowing so far is £30bn, which is 70 per cent up on the same time last year.

Capital Economics said: “If current trends continue, public sector net borrowing (PSNB) could total £60bn this year, around 4 per cent of GDP and close to £20bn higher than Mr Darling predicted in his March Budget.”

Capital Economics calculates that the base rate of income tax would need to rise from 20p to 25p in order to plug that gap.

The CEBR reckons the current financial year will see debt hit £63.3bn, but then expects borrowing to top £90bn next year.

Capital Economics expects borrowing next year to reach £80bn and £100bn in 2010/11. It says total borrowing as a percentage of GDP will be 6.5 per cent in 20101/11. To put this in context, borrowing in 1976/76 reached 7 per cent of GDP, and in 1993/94 it was 7.8 per cent of GDP.

If the government is forced to adopt a Paulson style new deal, then clearly borrowing will rise even further.

The one ray of hope in all this is that the UK’s total public debt, or net debt, is still quite modest compared with most other G7 countries.

The snag, however, is that if the government were to raise the base income taxes, the consequences for the economy would be disastrous. Recession could turn to depression.

Remember this. The UK is suffering from a burgeoning pension crisis too. The UK savings ratio has been too low for years. This was not such a significant problem in the mid 1970s and 1990s.

Keynes said the solution to an economic recession created by debt, was to cut taxes paid by lower income earners.

So, consider the plot so far. Government borrowing means a massive black hole is set to appear. Not the kind of black hole that some scaremongers have warned could occur on the Swiss–French border, rather an economic black hole.

Unlike the CERN project, any black hole that appears will not evaporate in a fraction of a second. This economic black hole will need filling.

Now, consider this. The media is full of talk about fat cats, greed, and how it has been a culture of excessive bonuses that has fuelled the financial crisis. This conclusion may or may not be right, but whatever the reality, nothing will persuade the media, and the electorate, otherwise.

Until recently, it was argued that top management needed to receive pay rewards determined by the market-place, to ensure incentive. It was then argued that this would be good for the economy, as the management that the corporate world would then be able to attract would ensure business prospers. This would be good for us all.

This view is now being re-thought. All of a sudden, it seems popular opinion says it was excessive pay rewards that created the financial crisis.

It is difficult to say for sure what this will mean. It may mean the top rate of income tax will be increased to, say, 50 per cent. It may mean the introduction of a third income tax tier for people earning above, say – well, that is a tough one. It seems most of us think people who earn a lot more than us should pay more tax. So those who earn £50,000 a year may think people earning more than, say, £100,000 should pay more tax. Those earning £100,000 will no doubt think people earning more than £2000,000 should pay more tax. Those earning £200,000, but are lumbered with a massive mortgage and crippling public school fees, will no doubt think the threshold should be £400,000.

The snag is this. The number of people earning over £100,000 a year is quite small. If they were to pay more tax the resulting extra tax revenue would be quite modest.

Whatever the final threshold is, may be uncertain. But a higher income tax rate for higher paid workers now seems an odds-on cert.

August 28, 2008 | posted by Michael Baxter in Taxation | comments (0) |

If you want to know what really needs fixing in the UK it is this. According to data released by the Office of National Statistics this week, there are no less than 3.06 million working age households in which no one over the age of 16 is working.

Okay, this is better than last year – 0.2 percentage points or 15,000 better than 2007, but then again five years ago there were 43,000 less households falling into that category.

Drill down a little and the picture looks like this:

During the period April to June 2008 there were 19.36 million working age households in the UK. Of this number, 11.07 million saw all people over 16 working, 5.23 million contained both working and workless members, and 3.06 million had no people of working age actually working.

The proportion of children living in workless households was 15.4 per cent in the three months to June 2008, down 0.3 percentage points from the previous year and down 0.6 percentage points from five years earlier. This translates to 1.77 million children living in workless households.

Ultimately, the big challenge facing future government is to break the habit of not working. Presumably children brought up in workless households are less likely to work themselves.

Some will argue the solution is simple – cut benefits. But that could have very unpalatable results.

Instead, the government needs to increase the incentives to work. Too many people are caught in a poverty trap, in which they are barely better off if they work. Benefit calculations can also be highly complex, and some people on benefit are just not sure what would happen if they started to work, and are simply too afraid to rock the boat.

The government needs to introduce some kind of scheme in which the long term unemployed can still receive benefits for a period of time after they start work.

Ultimately, the solution to the current economic crisis surely lies with tax cuts – especially for lower paid workers – and maybe increasing personal allowances. It is true that government borrowing on an annual basis is too high but the UK’s total net debt as a percentage of GDP is still quite modest compared to other G7 members. The government needs to use this to its advantage, and spend money – which in the time of a recession is precisely what is required anyway, but to spend this money to fix the structural problems with the UK – and get workless households, working. This can be done via simple cuts in income tax, not through Gordon’s horrendously complex tweaking.

May 21, 2008 | posted by Michael Baxter in Taxation | comments (0) |

Eighteen million families will be worse off by an average of more than £150 a year from tax and benefit changes over the next two years, unless the Government finds the money to extend last week’s one-off income tax cut and to continue topping up the winter fuel allowance, said the Institute of Fiscal Studies (IFS) this morning.

IFS said that recent changes to personal allowances announced earlier this month, and the tax giveaway announced in the recent Budget, will tally £5.5bn.

Of this, around £2.6 billion is being financed through increases in other taxes (including green taxes, capital gains tax, business rates on empty properties and anti-avoidance measures), and around £2.9 billion by increased borrowing.

In fact, if it is maintained, the May 13 mini-Budget was the biggest Budget or pre-Budget giveaway since 2001, when the outlook for the public finances appeared much stronger.

Some 21.3 million families will be better off this year than they would  have been without the personal tax and benefit changes announced in Budget 2007, and subsequently. But 0.9 million families will still be worse off than they would have been in the absence of these changes.

In fact, 6 million individuals will still pay more income tax this year as a result of the abolition of the 10 per cent tax band, despite the increase in the personal allowance. But most of these 6 million individuals either live with a spouse or partner who gains more than they lose, or are fully compensated by increased benefits and tax credits.

The 0.9 million families who are still worse off overall this year as a result of the reforms in Budget 2007, and subsequently, include: 500,000 childless single adults under 25 (almost all living in a household with other adults); 140,000 childless couples both aged 25 to 55; and 115,000 childless single adults aged 25 to 55.

Apparently, the losing families have an average income after taxes and benefits of £11,800. More than two-thirds are in the poorest third of the  population. These families lose around £83 a year on average, with the  poorer among them losing a larger proportion of their income than the richer ones.

But here is the rub; unless the government maintains the recently announced tax giveaway in future years, then by 2010/11 some 18 million families would be worse off in 2010/11 than in 2008/09.

Chancellor Alistair Darling said in the House of Commons on 13 May that, “Our aim is to continue the same level of support for those on lower incomes,” which suggests that he will try to ensure that at least as many of this group are compensated in future as are being compensated this year by the increase in the personal allowance. Retaining the higher personal allowance would require the Government to find around an extra £2.7 billion a year, while keeping the winter fuel payment at its winter 2008 level would require another £575 million a year.

The IFS then rattled off the Government’s options:  increasing personal allowances even further, for example, but as a result benefiting the better paid too.   Or it could extend eligibility for Working Tax Credit to those aged 21 or over and working at least 16 hours a week.  Another option would be to taper away personal allowances to those on higher incomes.  The IFS list of alternatives goes on and on.

But of course the Government could have done something else back in 2007 when the then chancellor revealed his last budget.   You will recall back then he lowered the 22 pence tax rate to 20 pence, but abolished the 10 pence rate.  Instead, he could have simply left the 22p rate unchanged, removed the 10p rate, but upped personal allowances. 

That would have been nice and simple, and transparent also.  But maybe that was the problem, the last thing Gordon Brown wanted was for his tax changes to be transparent – much better to earn some good headlines with a sleight of hand, a bit of mystery dust, and a good deal of wool flung over our eyes.

May 14, 2008 | posted by Michael Baxter in Taxation | comments (0) |

Gordon Brown and Alistair Darling need to remember to kiss more.  No, not that type of kiss, this one:  Keep It Simple, Stupid.

Yesterday, Alistair Darling did get the kiss in.  By upping personal allowances by £600, and by reducing the threshold for paying 40 per cent tax, in one foul swoop he solved the problem.  Well, not entirely solved, some will still be worse off, but at least it’s getting better.

It really is simple to explain. 

Last year, most of us enjoyed a personal allowance of £5,225. Our next £2,230 of earnings were taxed at 10p, then we were paying 22p tax for the next £32,369.  Then, in his last budget, GB set our personal allowance for this year at £5,435, removed the 10p band, but lowered the 22p rate to 20p.    So, obviously, someone who was not previously earning a sufficient amount to fall into the 22p tax bracket, but was then set to pay tax at 2op, was going to be worse off.

Now, Mr Darling has upped the personal allowance by £600. Previously, anyone earning up to around £18,500 was going to be worse off, although at that level of income the loss would have been tiny. Now you would need to be on an income of between just under £7,000 and £10,000 to be worse off.

How much better or worse off are we after removal of the 10p rate, but dropping the 22p rate to 20p? See the table below for income 2008/09 before the change and 2008/09 after the change.

The good news, most tax payers who are not in the 40 per cent bracket will be £120 better off.  The money will be paid in one £60 instalment in September, and then in monthly £10 instalments.

Of course this represents a big change of mind from the chancellor, and there is a queue of politicians and media waiting to put the boot in.

But they may have overlooked a key point.

In many ways yesterday’s announcement was not dissimilar from the tax credits being handed out in the US – the main difference being scale.  In the US many individuals will be receiving $600, couples $1,200.

Tax credits are what the UK needs now.   They should be far more effective than cuts in interest rates.  As regular readers of this column will know, rate cuts when borrowing has been too high were once described by Keynes as “pushing on string.”

The snag, though, is the size of these cuts.  A £60 one-off rebate is better than a kick in the pants, but it is hardly worth kissing the air over.   That’s what happens when governments spend too much during the good times.

But the real issue is this.  Why didn’t Gordon Brown up personal allowances in the first place? As we said last month, he could have upped personal allowances by around £1,000, but left the 22p rate alone, rather than reducing it to 20p.  That way, hardly anyone would have been worse off, and the cost to the chancellor would have been small.

Presumably that would have been too easy.