Tuesday, 25 February 2014

"Simplify taxes now"

Allister Heath talks sense for a change:

It would be great if Ben Gummer, the Tory MP for Ipswich, gets his way. He wants national insurance contributions (NICS) to be renamed the earnings tax. This would be a far more accurate way of describing a little-understood levy...

To make matters worse, NICs are dishonestly divided into an “employees” bit (at 12 per cent and two per cent) and an “employers'” share (13.8 per cent on almost all pay). In reality, as most economists would agree, there is no difference: employees pay all of it.

The forces of supply and demand determine workers’ total cost; the fact that some of this is made up of wages and some non-wage costs makes no difference. If employers’ NICs were abolished, wages would eventually rise commensurately. So-called employers’ NICs are a stealth tax on workers.

The total tax bill on wages, salaries and bonuses, including income tax and all NICs, is shockingly steep. Earnings above £7,717 face 12.1 per cent; this increases to 22.7 per cent from £7,769; then to an astonishing 40.2 per cent from just £9,440.

The tax rate then spikes punitively to 57.8 per cent from £41,450; fortunately, that is merely a weird aberration and tax dips back to 49 per cent from £41,558, where it settles; eventually, it explodes to 66.6 per cent from £100,000 before falling back to 49 per cent from £118,880. Earnings above £150,000 face a cumulative tax rate of 53.4 per cent.

It’s time some clarity were injected into our hopelessly complex tax system.

It's just a shame that he didn't squeeze in a mention of the extra high marginal rates for many lower earners, i.e. benefits withdrawal, working tax credits withdrawal and student loan deductions.

And unfortunately he ignores VAT. He appears to have succumbed to the delusion that this is a tax on "consumption" not "production" and of course his beloved banking and residential construction sectors are either VAT exempt or zero-rated.

If you treat VAT more correctly as a tax on "value added", the bulk of which is wages, those marginal rates for people in the productive sector all go up by about ten percent*.

* assuming that an employee gets all the marginal extra income from a sale, the customer pays £100, 20/120 = £16.67 goes in VAT, 13.8/113.8 x £83.33 = £10.10 goes in Employer's NIC, leaving £73.23 gross wage; from which 32 per cent basic rate tax plus NIC is deducted = £49.80 net wages, a marginal tax rate of 50.2 per cent; not the 40.2 per cent he mentions.


The Stigler said...

He appears to have succumbed to the delusion that this is a tax on "consumption" not "production"


What the hell are we doing taxing something that by its own name ADDS VALUE?

I suspect it goes back to a certain protestant viewpoint. If you buy the apples, flour, fat and sugar and make an apple pie, you are doing The Right Thing. If you just buy one of Mr Kipling's then you are a feckless wastrel.

home baked apple pie does seem to taste better, but that's not the point

Mark Wadsworth said...

TS, fair point. The rate of VAT on raw ingredients and basic foodstuffs is usually lower in most EU member states. Because the farmers put in their usual special pleading, I suppose, there's no real reason for it.

Dinero said...

Would you agree that it is not a given that removing employer NIC would increase wages in every case. If an employer can fill a role with the person he wants at X pay with employer NIC on top then the employer would keep the difference if the NIC part was removed.

Bayard said...

"Because the farmers put in their usual special pleading, I suppose"

That, and levying VAT on food would tax even the best spin doctors to continue the "VAT is not a tax on necessities" lie.

Mark Wadsworth said...

B, aren't they always wailing that we throw away too much food? That "poor people" spend too much on junk food? All this "food miles" and "we import too much from abroad" stuff?

So put VAT on it, which the supermarkets would have to absorb anyway, and maybe we would buy slightly less food, which is a win-win allround.

Mark Wadsworth said...

D, in the short term and in some cases, yes, but broadly speaking, no.

The whole point is the overall marginal rates. If we genuinely don't trust employer's to hike wages in line with Er's NIC reductions, we could get the marginal rate on basic rate employees down to 20% (our medium term target) by keeping Ee's NIC at 12% and Er's NIC at 10% and exempting such income from income tax.

So out of £110 total cost to employer, the employee keeps £88 = 80%.

But following your logic, there'd be no point reducing income tax because evil employers would just cut wages by 20%.

Bayard said...

"B, aren't they always wailing that we throw away too much food?"

We throw away too much food because of the "Best before" date scam. People now beleive that food past its BB date immediately becomes poisonous and throw it away. (I mean, you get a BB date on honey FFS. Honey has been dug up by archaeologists which is thousands of years old and it is still perfectly OK). If food was more expensive they'd go on doing this.

Physiocrat said...

There is a view that the incidence of income tax and NICS is on the employer and functions as a payroll tax. On this view, these taxes add to labour costs and promote replacement of labour by capital, ie they are a distortion that causes unemployment.

Kj said...

I also wonder if there might be a different reaction to wages on different wage levels. All depending on bargaining power, relative elasticities all that, and union power I guess. Also what physiocrat says, in the long run, but that wages would be pushed upwards again to a natural equillibrium caused by the fall in wage costs.

Mark Wadsworth said...

Ph, to some extent possibly, but primarily the tax, taken in isolation, is borne by employees.

That's nto really the point, the point is the overall average marginal rate of 50%, that's the killer.

Kj, everybody has their own personal Laffer Curve, but even that isn't the point. The point is a) losing half your earnings and b) what the Laffer Curve implies but does not state - the deadweight costs.

Physiocrat said...

Look at it this way. People will work for the minimum they will accept. In practice this is set by benefit levels. Let us call this amount (W min). Now for the employee to end up with X, the employer incurs a cost of [1.7 x (W min)]. From this perspective, the incidence of income tax is on the employer, who must either absorb it or build it into his prices, and so pass it on to customers. That is not the end of the matter as it cuts into profits, and from that point, cuts into rental levels ie the landowner eventually picks up the tab.

Mark Wadsworth said...

Ph, yes, if we are just looking at the bottom end of the income scale, that is what would happen.


a) NIC doesn't kick in until you earn £7,000 a year or something, which softens it a bit.

b) The poverty trap is not just about a few quid NIC, it is about all the other means-tested stuff.

Remember that once you take benefit withdrawal into account, the overall average marginal tax rate is about 80% on incomes up to £15,000 (single adult no kids) or about £25,000 (parents).

c) So it is also means testing in the welfare system which entrenches unemployment and/or pushes up wages.

NIC only makes up a quarter of that overall withdrawal rate, income tax another quarter and various means tests the other half.

d) Once you are past that 80% threshold, NIC cuts into net wages, as your "W min" concept does not apply any more.

e) On closer inspection, VAT is worst of all taxes, NIC is only the second worst tax (unless you count means-testing as a tax, in which case means testing is second worst and NIC is third worst).