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UK Taxation System Overview: Structure, Economic Impact & Trends

Explore the historical, international, and economic aspects of the UK tax system. Learn about revenue levels, major taxes, and effects on income distribution and incentives. Gain insights into income tax, National Insurance, corporation tax, VAT, excise duties, environmental taxes, and local taxes.

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UK Taxation System Overview: Structure, Economic Impact & Trends

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  1. Taxation in the UK Stuart Adam

  2. Outline Overview of the UK tax system in historical, international and theoretical contexts: • Level and composition of revenues • Structure of the major taxes • Economic aspects of the overall tax (and benefit) system: • Effect on the income distribution • Effect on incentives to work • Effect on incentives to save and invest For more on 1 and 2: S. Adam & J. Browne, A survey of the UK tax system • www.ifs.org.uk/bns/bn09.pdf

  3. The tax burden in the UK Source: HM Treasury

  4. Tax to GDP ratiosTaxes and social security contributions Source: OECD

  5. Composition of revenuesCurrent receipts, 2006-07 Source: HM Treasury

  6. Composition of revenuesCurrent receipts Source: HM Treasury

  7. Composition of revenues 2003Taxes and social security contributions Source: OECD

  8. Income tax scheduleFor earned income, 2006 prices

  9. Changes to income tax rate structure • Big reduction in top rates (83/98%  40%) • the start of an international trend • Reduction in basic rate (33%  22%) • part of an international trend • Abolition and re-introduction of starting rate (now 10%) • international trend is to reduce number of rates • Large-scale fiscal drag • some increase in no. of taxpayers • massive increase in no. of higher-rate taxpayers

  10. The income tax burdenFor single worker at multiples of average full-time earnings Source: OECD

  11. Changes to treatment of families • Independent taxation introduced 1990 • part of an international trend away from family taxation • Abolition of additional tax allowances for married people and those with children • Tax credits bring support for children and low earners into the tax system • spread of means-testing revives joint assessment • major delivery problems with latest (2003) reforms

  12. National Insurance scheduleCombined employer and employee NICs, 2006 prices

  13. Changes to National Insurance More like income tax: • Abolition of ‘entry fee’ • Entry point aligned with tax allowance • End of cap on contributions • Extension to benefits in kind • Erosion of the contributory principle

  14. The burden of income tax + NICsFor single worker at multiples of average full-time earnings

  15. Main corporation tax rate

  16. Changes to corporation tax • Main rate cut (52%30%) • Small companies’ rate cut (40%19%) • ill-fated experiment with 0% starting rate • Reduced capital allowances • aim is to tax profit = revenue – expenses • expenses should include true economic depreciation • hard to measure so give fixed capital allowances instead • these deduct capital spending bit by bit over several years • R&D tax credit introduced 2000 • Rate cuts and base broadening is in line with international trends

  17. Taxation of corporations and shareholders 2005 Source: OECD

  18. The corporation tax burdenEffective average tax rates and capital allowances 2005 Source: Klemm (2005)

  19. VAT • Main rate 8%15% in 1979 and 17.5% in 1991 • part of international move towards uniform VAT • UK has lots of zero-rated items • but uses reduced rates less than other countries

  20. VAT rates and bases Source: OECD

  21. VAT • Is this narrow base a good idea? • Atkinson-Stiglitz: if leisure is weakly separable from all other goods, uniform VAT is optimal • May still be arguments for differential rates… • if not separable, tax complements with leisure more to offset usual distortion towards leisure • externality or merit good arguments • But widespread distributional defence is just wrong • progressive income tax is more efficient tool for redistribution

  22. Excise duties • Fuel, alcohol and tobacco • Rates increased, yet share of revenues declined (as in most other countries) • Rates fallen since 2000 • Fuel protests in 2000 • Serious concerns about smuggling

  23. Environmental taxes • Various new environmental taxes introduced: • Air passenger duty (1994) • Landfill tax (1996) • Climate change levy (2001) • Aggregates levy (2002) • London congestion charge (2003) • None of these raised more than £1bn in 2005 • compared with £24bn (+ VAT) from fuel duty • But revenues don’t tell the whole story

  24. Environmental tax revenue, 2006-07

  25. Property / local taxes • Council tax: • Replaced poll tax in 1993 (previously domestic rates) • Based on property values (banded, no revaluation) with discounts for 1-person households and low-income families • UK’s only local tax (councils set average rate only) • Business rates: • Proportion of estimated market rent (unbanded, revalued) with discounts for businesses with low rents • Centralised in 1990 • Lyons Inquiry report due on Wednesday

  26. Distributional effect of the tax and benefit systemExcluding most ‘business taxes’ Source: Authors’ calculations from ONS (2006)

  27. Effect of tax and benefit system on income inequality1998, personal taxes and benefits only Source: Immervol, Levy, Lietz, Mantovani, O’Donoghue, Sutherland and Verbist (2005)

  28. Effect of tax and benefit system on income inequalityExcluding most ‘business taxes’ Source: ONS (2002, 2006)

  29. Effect of tax and benefit changes on income inequalityPersonal direct taxes and benefits only, 1997-98 population Source: Clark and Leicester (2004)

  30. Work incentives among workersPersonal taxes and benefits only Source: Adam (2005)

  31. Work incentives among workers1998, personal taxes and benefits only Source: Immervol, Kleven, Kreiner and Saez (2005)

  32. Taxation of savings • Starting point not obvious • Tax all income (earnings and savings) equally? • Savers are rich so tax them more? • No… • Saving is just deferral of consumption • Atkinson-Stiglitz again: under various assumptions, should tax consumption today and consumption tomorrow the same • This implies no net tax on the normal return to saving • The assumptions are unrealistic, but it’s a useful benchmark

  33. How not to tax saving • Present value of lifetime earnings and expenditure are the same if all saving earns the normal return r • Ignoring bequests: a tricky issue! So three mechanisms: • Tax earnings, ignore savings completely: NICs • Tax expenditure, ignore income completely: VAT • Tax expenditure, calculated as: earnings – net contributions into saving accounts

  34. Income tax treatment of saving Default is to tax returns to saving (interest, dividends, capital gains) as well as earnings But… • ISAs: returns tax-exempt (wage tax treatment) • Housing & other durables: ditto • Pensions: expenditure tax treatment • contributions deducted from taxable income • returns within the fund untaxed • withdrawals (pension income) mostly taxed These account for most saving for most people

  35. Other taxes on saving • Savings cut entitlement to means-tested benefits • Other capital taxes • council tax, inheritance tax, stamp duties • Corporation tax • lots of savings are invested by companies • effective marginal tax rate (EMTR) depends on how far investment and returns can be deducted from taxable profits • this varies: • different types of investment (plant & machinery, buildings, R&D,…) • different methods of finance (debt, equity)

  36. Company-level EMTRs, 2005 Source: Klemm (2005)

  37. Conclusions • UK mostly in line with international trends • Rise in overall tax burden since 1979 • Income tax rates cut • Shift from excise duties to VAT • Corporation tax rates cut, base broadened • Shift from family to individual taxation • Whether reforms have increased inequality depends what you mean by a “reform”! • Labour’s reforms (relative to price-indexation) have been progressive but weakened work incentives • Distortions between different savings vehicles and forms of investment have been reduced

  38. Taxation in the UK Stuart Adam

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