Wednesday, 16 September 2009

Centre for Social Justice Part 2: K-codes

Re: The welfare-reform proposals from the Conservative Party's Centre For Social Justice, I've printed off and skim-read the 370 page pdf, and although the background research is all spot on, the proposals are in fact complete bullshit.

From page 303, Chapter 18 'Implementation Proposals':

Key Recommendations

We recommend a three-phase approach to implementing benefits reform:
• Phase 1 would ensure that no individual benefit had a withdrawal rate over 55% - this could be implemented almost immediately.
• Phase 2 would coordinate the system of overlapping benefits to ensure the overall withdrawal rate did not exceed 55% - this might take up to 2 years.
• Phase 3 would integrate the new benefits with the PAYE system – this would likely take 3-4 years.


Re Phases 1 and 2: Their headline 'withdrawal rate' of 55% is completely misleading. Ignoring the 'income disregard' (yet more unnecessary complications!), the true marginal rate is about 69%. Under their proposals, if a someone on benefits earns £1 gross, his post-tax income is 69p then loses 55% of that 69p (another 38p) in benefit withdrawal, so overall he keeps 31p for every £1 gross that his employer pays him. If we factor in Employer's NIC, the overall 'wedge' is 72.5%.

Re Phase 3: I wouldn't put these people in charge of a government IT project (I wouldn't put anybody in charge of a government IT project, actually, as we shouldn't have any, but that's a different topic). Do these people not know how the PAYE system works and how easy it would be to incorporate a benefit withdrawal of 50%?
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Here's my crash course in the existing PAYE system:

a) Everybody understands the idea of a tax-free personal allowance of £6,475. If you earn more than £125 a week, your employer deducts PAYE (income tax and NIC) of 31p for every £1 you earn above £125 per week.

b) If you have 'benefits in kind', then your tax-free personal allowance is adjusted down. Let's assume your employer provides accommodation worth £6,000 on which the tax/NI bill would be £1,830 (£6,000 x 31%). In this case, your PAYE code is reduced to £475, so over the year you pay £1,830 more tax than somebody else on the same wage who doesn't get 'free' accommodation. This is a lot more convenient for all concerned than expecting the employee with free accommodation to stump up £1,830 in one go once the forms P11D are submitted.

c) It happens with some people that the total taxable amount of their benefits exceeds the level of the tax-free personal allowance of £6,475 (especially if they have an expensive company car and private fuel). Let's assume the taxable amount of the car benefit is £15,000, their PAYE code is then negative £8,525 (£6,475 minus £15,000), or what's known as a K-code (read up more on the HMRC website if you want).

d) Your payroll lady then adds the negative code to the cash salary and PAYE is then calculated as the lower of i) Whatever the tax would be on [K code plus cash salary] and ii) 50% of the cash salary (ignoring the K code).
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OK. Once you've grasped that, it must be obvious that we can easily adapt this to incorporate benefit withdrawal of 50% via the PAYE system. Let's assume our claimant gets 'Employment Support Allowance' of £70 per week and lives in a council flat, where the headline rent plus council tax is £90 per week, he would end up with a K-code of £20,364*

If he earns £10,000 a year, his notional taxable amount is £30,364. His payroll lady then deducts the lower of i) £30,364 x 31% = £9,413 or ii) £10,000 x 50% = £5,000, so deducts £5,000, that's a 50% overall tax/withdrawal rate, job done.

Maybe our claimant does really well for himself and starts earning £30,000. If he continues claiming ESA and living 'rent free' in a council house, his payroll lady then deducts the lower of i) £50,364 x 31% = £15,613 (ignoring the higher rate tax bit) and ii) £30,000 x 50% = £15,000, i.e. it makes little difference either way. His net income after deducting PAYE (which includes housing costs) and adding ESA is £18,640.

If our claimant then expects to continue earning at this level or above, he will stop claiming the ESA and instead of living 'rent free' will choose to stump up the £90 in cash every week for rent/council tax. His PAYE code reverts to £6,475 and he pays £7,293 tax every year (£30,000 - £6,475 = £23,525 x 31%), netting him £22,707, out of which he pays rent/council tax of £4,680 (£90 x 52 weeks), leaving him with £18,027.

In this case he'd be slightly worse off, but that is because I guesstimated the break even point at £30,000. But as you can see, the whole thing is nice and neat**, there's no poverty trap and no parallel system for means-testing.

Right. This took me the whole of my lunch hour to work out, I'm not sure what they are going to be doing for rest of the "3-4 years" that they expect the transitional period to last.

* Here's the maths: Weekly ESA plus notional Housing Benefit £160 x 52 = £8,320. Divide that by 31% = £26,838, deduct this from the tax-free personal allowance of £6,475 and you end up with a K-code of £20,364.

** The only thing left to tidy up is the transfer of the 'rent' element of the PAYE from one government department (HM Revenue & Customs) back to the local authority in whose council house he lives, but that can't be rocket science.

17 comments:

Witterings from Witney said...

MW, you really are a 'star' - wish I had your brain-power!

The Stigler said...

The more complicated you make the rules, the more complex the software gets, and changing it becomes an exponential problem that every change has to be analysed and tested against existing software.

I think it would still make sense to have a computer system, but you could make it a great deal simpler than it is right now.

Letters From A Tory said...

My head hurts....

Mark Wadsworth said...

WFW, ta.

OC, employer's payroll software won't need to be amended. The DWP just tells HMRC how much benefits everybody is getting (matched up to NI number) and HMRC issues revised PAYE codes (i.e. K-codes) accordingly.

LFAT, take it from me, that is how the existing PAYE system works (glossing over the separate nil-rate bands for tax and Employee's NIC). Nobody's head needs to hurt and it would make life simpler and better for all concerned.

The terrifying thing is that after all these years of researching and 370 pages, the CSJ haven't sussed this out for themselves.

JuliaM said...

Yes, that's a terrifying amount of maths.. ;)

"The more complicated you make the rules, the more complex the software gets..."

And the easier it becomes to cheat and manipulate the system, I presume?

Mark Wadsworth said...

JM, "And the easier it becomes to cheat and manipulate the system, I presume?"

Correctamundo. But being fair to the CSJ, they did propose replacing 51 separate benefits with 2 separate benefits, and I can't fault them on that (1 single benefit would be better, but hey).

ScotsToryB said...

As a NeoliberalisticToryFashiticNerdicProle I think I understand exactly where you are coming from.

We, Mark, will have to take time to learn that what you have studied.

Do not get that upset-we are learning-and will continue to do so.

I have no doubt that eventually we will all understand what you say, so keep on saying it.

As I once said to Professor X 'I know I will eventually get this; so keep on trying, man(or somesuchlike).

STB.

ScotsToryB said...

Kristus, that sounds so pretentious. I was just sayin' that you know your subject and I among others are still learning...

STB.

James Higham said...

Let's assume your employer provides accommodation worth £6,000 ...

But is this a likely scenario and would it be different in London and up north?

bayard said...

"Do these people not know how the PAYE system works and how easy it would be to incorporate a benefit withdrawal of 50%?"

Perhaps they approached a civil servant from the gov't department in charge of PAYE, he told them it was a very complicated procedure, that would take a long time and many extra staff to implement and they beleived him.

sobers said...

Wow! I am seriously impressed. Why has this never been done before? It seems so obvious. It allows the claimant to decide when to stop claiming benefit and doesn't mean that if you lose your job you then have to start back claiming anew. Utterly brilliant, and simple. Therefore hasn't a hope in hell's chance of ever being implemented.

silicone breast implants said...

Its really a big amount. My head hurts...

Matthew said...

I don't follow one bit:

The man who gets £15k in perks has a K-code of £8,525 (in other words if I follow it correctly a negative personal allowance of the same amount).

But the man who gets £8k in benefits has a K-code of £20,364.

Why so much larger? In other words I don't get the bit where you divide £8,320 by 31%, rather than multiplying it. Are the state benefits seen as negative tax or something?

Matthew said...

And while you're answering, why is there this whichever is lower of '31% of (K code plus cash salary) or half cash salary'?

Doesn't that mean that if you have very high non-cash benefits you do better than having the same amount in salary?

Mark Wadsworth said...

Matthew: "Are the state benefits seen as negative tax or something?"

Yes of course. If person A has taxable benefits-in-kind from his employment, of £8,000, the State wants to collect £2,480 tax thereon, so they reduce his personal allowance by £8,000 to collect £2,480 extra tax.

If person B has taxpayer-funded benefits of £8,000 (i.e. negative tax), the State wants to claw back £8,000, i.e. collect extra £8,000 tax, so they reduce his personal allowance by £25,806 and try and collect £25,806 x 31% = £8,000 extra tax.

"why is there this whichever is lower of '31% of (K code plus cash salary) or half cash salary'?:"

Because there just is, those are the existing rules.

"Doesn't that mean that if you have very high non-cash benefits you do better than having the same amount in salary?"

On a month-to-month basis, yes, but you then owe a correspondingly larger amount underpaid at the year end (which HMRC will chase the employee for, not the employer).

marksany said...

Blimey, Obo's driven some traffic your way. I hope they get hooked, like I already am.

As welfare reform minister, I'd like to say you got this almost right.

I need to see a graph; into the TBT for me. I may be gone some time...

Mark Wadsworth said...

MA, thanks.

I didn't say that this is exactly how I'd do it - I was explaining how I would achieve what IDS said he wanted to achieve and that IDS was lying to us
a) When he heralded this as a 55% marginal withdrawal rate, and
b) When he said that this would be administratively difficult to implement.