Hollowing out the tax base

Reaction to the ONS announcement that 52 percent of households receive more in benefits than they pay in tax was predictable, though not quite as hysterical as it has been in previous years. Screen Shot 2014-07-01 at 08.25.16 This piece in the Daily Mail was quite balanced. A quote from Douglas Carswell, in an otherwise pretty measured Telegraph article, made me smile.

We have not lived within our means for a generation. The ever-expanding redistributive state is pressure down ever more heavily on a diminishing productive base. The financial crisis ought to have alerted the political elite that this model is just not sustainable. We have not made the fundamental changes to the architecture of the state that needs to be made.

So if an MP in the largest governing party isn’t a member of the political elite, who the hell is?

It was left to the Daily Express to wail about the “welfare bonanza” and quote Conservative MP Andrew Rosindell:

Previous governments focussed too much on handing out benefits. This government has been, and is right, to reduce the size of Britain’s welfare bill.

Really? When did it do that then?

As ever, though, once you dig into the figures, the picture becomes a little more complex. First off, the benefits referred to includes the value of benefits in kind such as subsidised education, transport and, of course, the NHS. All of us are beneficiaries of public services. The ONS reckons that the wealthiest 20 percent get more from the NHS than the poorest.


We can see the combined effects of these benefits in kind, together with cash transfers and taxation, on this ONS chart.

Screen Shot 2014-07-01 at 08.34.20

Much of the benefit poorer households get, then, is in the form of the benefits from public services we all enjoy, not of direct cash handouts. If you want to describe the whole lot as ‘welfare’ then we’re all on welfare.

The 52 percent figure also includes retired households. Once you take out retired people, the number of households receiving more in benefits than they pay in tax is around 38 percent.

Household benefits v tax

Source: ONS reference tables

That said, even the figure for non-retired households is a lot higher than it was in the 1970s. You would expect the percentage to go up during recessions, which it did, but there has also been a significant rise over the last three decades or so and a steady increase since 2000. This is consistent with what we know about the labour market. The number of working poor started to rise before the recession as did the number of self-employed people. Sometime around the middle of the decade, earnings began to fall, massively so for the self-employed.

Despite 3 percent growth over the last year, tax receipts have been disappointing. Wages are still stagnant and the increased amount of cash in the economy suggests that some of the self-employed are not declaring all their revenue.

The benefit dependency that government politicians talk about is increasingly an in-work benefit dependency. People may be coming off Job Seekers’ Allowance but they are going onto tax credits. Many of these workers also pay less tax now because thresholds have been raised. Taking the low paid out of tax and subsidising their pay is done for the best of reasons but it isn’t helping to increase the tax take or reduce the benefits bill. The result, as Frances said, is that the fiscal deficit is falling at a glacial pace.

This is all rather worrying, says the FT’s Chris Giles:

Tax revenues have consistently fallen short of expectations in this recovery – unlike public spending, which has been close to the chancellor’s targets set in the June 2010 ‘emergency’ Budget. For the 2013/14 financial year, this year’s Budget estimated public sector net revenues of £607.7bn, more than 8% (or £54bn) lower than the £661.9bn expected back in 2010.

Of course, most of this shortfall was caused by the economic weakness of 2011/12. Economic stagnation is a necessary, but not sufficient, explanation.

In 2010, the Office for Budget Responsibility expected the tax system to be able to collect 38.7% of national income in tax revenues. In fact, this year’s Budget documents show revenues accounting for only 37%. It means that 1.7% of gross domestic product – almost £30bn a year – has gone missing. That is a lot of money.

The trends are no better, even in the most recent year of rapid economic recovery. Taking real growth and inflation into account, the size of the economy grew 4.7% in 2013/14, but revenues rose only 3.5%. Normally, revenues grow faster than nominal GDP.

Weakness in revenue growth matters because if it continues, the shortfall will eventually be recovered through painful tax rate increases or further public spending cuts, meaning the grind of ever-harsher austerity will continue for longer.

The growing economy was supposed to have increased the tax take and reduced the welfare bill by a lot more. The longer it takes to do either, the more the government has to borrow.

Then there’s this:

If you talk to Treasury officials about the missing tax revenues, you get one of two responses. In public, there are many explanations for weak revenue: more low-paid jobs have been created that are not so tax-rich because the government has increased the income tax personal allowance; housing transactions remain weak, leading to shortfalls in stamp duties; oil revenues have taken a hammering from the slump in North Sea production; and financial companies are still offsetting past losses against current profits, hampering the growth of corporate tax revenues.

In private, there is greater concern that the structure of the economy and the UK tax system no longer easily generate tax revenues.

The IFS said something similar in its Green Budget:

One way in which the current recovery has been different from previous recoveries is that in recent years there has been remarkably strong growth in employment given the relatively weak growth in the UK economy. This mix of relatively strong employment growth and weaker average earnings growth has implications for growth in tax revenues – particularly from income tax and NICs. The main determinant of growth in these revenues is the growth in total employment income in the UK economy, which is the product of employment and average earnings growth. However, because of the progressivity of these taxes – in particular of income tax – growth in average earnings creates a larger boost to tax receipts than equivalent growth in employment. This means that the distribution of total employment income, as well as its headline growth, matters for tax receipts.

So, in other words, a 1% increase in employment income that comes from a boost to average earnings would be expected to increase income tax and NICs receipts by about £1 billion more than a 1% increase in employment income that comes solely from an increase in employment.

Just increasing employment doesn’t help much. Average earnings growth is what boosts the tax take. Furthermore:

The increase in revenues over the next five years is forecast to come largely from income tax and capital taxes. The UK is increasingly reliant on a few very-high- income individuals for the former – for example, the top 1% of contributors (around 300,000 individuals) contributed 27.5% of income tax in 2011–12 – while capital tax receipts are particularly hard to forecast and are also disproportionately paid by a relatively small number of individuals.

HMRC data released in September 2013 estimated that the share of income tax contributions made by the top 1% of contributors (ranked by contribution size) would rise to 27.5% by 2011–12, compared with 21.3% in 1999–2000 and 11% in 1979.11 To put it another way, the income tax paid by 300,000 or so very high-income individuals accounts for 7.5% of all tax revenue. These individuals will of course also pay large amounts of VAT and, in all likelihood, pay a large fraction of total capital taxes.

Increases in average earnings boost the tax take but what we are seeing instead is rising incomes at the top and rising employment at the bottom. The hollowing out of the tax base reflects what is happening in the labour market.

Given that forecasts for increasing wages increases and falling benefit spend are also glacially slow, it’s difficult to forsee much improvement over the next few years.

Fig 3 - median earnings_jpg_400x265_upscale_q85

Source: Resolution Foundation

Screen Shot 2014-01-06 at 17.25.38

Source: Parliamentary briefing

On top of all this, the proportion of retired people is likely to increase too, putting additional pressure on the tax and benefits system. 

As the UK comes out of recession, it’s starting to look as though there are some structural weaknesses in our economy. We will probably see ‘More than half UK households receive more in benefits than they pay in tax’ headlines for some time yet. To blame all this on a welfare bonanza or the ever-expanding state is to miss the point though. It’s much more serious than that.

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11 Responses to Hollowing out the tax base

  1. Hollowed out indeed. If I catch your drift the govt policy of sucking up to the rich and depressing the wages of the poor and middle earners is biting them in the ass. If the only jobs are meanly paid and the wealthiest avoid taxation there is no-one left paying any taxes.

  2. its our fault for having benefits its our dault Maggie sold of industries its our fault that tata announce 400 jobs to go yes its our fault for breathing jeff3

  3. Jackart says:

    The self employed aren’t declaring all their income, and they’re probably being creative with costs too. That is the joy of self employment but you say it like it’s a bad thing. Chris Giles in the FT says 1.7% of GDP has “gone missing”. No it hasn’t. It’s been used more productively by people spending their money on themselves. “In 2010, the Office for Budget Responsibility expected the tax system to be able to collect 38.7% of national income in tax revenues. In fact, this year’s Budget documents show revenues accounting for only 37%” The tax-take falling to 37% of GDP is a good thing after Brown’s lunacy. You call it “the hollowing of the tax base” I call it a reduction in the tax burden, with most of that reduction being enjoyed by poor, working people. By contrast the burden is going up on the rich you like so much to sneer at.

    The fact remains that, as I wrote in 2009, the recovery will be to the sound of fired public sector prodnoses crying on their way to the job-centre. A million state jobs have gone. Good riddance. Most state spending is toxic to the economy. The coalition is getting out of the way, and releasing the state choke-hold.

    This is precisely what you people told us wouldn’t happen. State “investment” was vital to the recovery. The recovery was “too fragile” to start cuts. Yet you’ll never admit it. Austerity worked. As a direct result of the lower tax-burden, and fewer clip-board wielding apparatchiks, the UK has the fastest recovery in the developed world.

  4. John says:

    As a retired state pensioner, I could adopt the attitiude that as long as my pension gets paid I should not be concerned about what is going on. However, even pensions may have to be cut in the future if these trends continue. Also, I have younger relatives who will obviously be affected by these trends, particularly those on lower levels of income.
    Ultimately, what is needed is to identify emerging industries which offer the prospect of paying reasonable levels of wages to workers in those industries, and to promote those industries in this country. One example is the mass vehicle manufacturing industry, where well paid jobs for relatively modest skill levels are still possible.
    It is all very well promoting high-tech industries but they too follow the trend of a few highly rich individuals and a vast lowly paid workers model.
    This is of very little use if state expenditures – including pensions – are to be met in the future.
    The self-employed pocketing cash and not declaring it for taxation – what’s new about that?
    Presumably, our wise coalition government realised this when they promoted self-employment?

  5. David says:

    Exactly , Jackart and John , couldn’t have put it better myself . I am also the recipient of a state pension and often wonder how long it can go on for . Strongly recommend our more liberal minded friends to go and live in the command based economy that is China for , say , five years .

  6. David says:

    Sneer ? You do Rick you really do . I feel Jackart was merely offering another view and a comment on the cherry picked ‘data’ so often shown . Your facetious remark “what the hell has China got to do with it” is surely obvious . But just for you ….my tongue in cheek suggestion is an allusion to that economy accruing BEFORE spending . That’s the ability of a command economy . Not entirely comfortable for its peoples but at least a sustainable situation and such a far cry from successive generations of politicians bribing various groups constituents (even if some don’t want it) we are so familiar with .

    • John says:

      National governments do not always need to accrue before spending.
      If the British government had waited until it had accrued sufficient finance to conduct the Second World War, we would all be speaking German now.
      The same is true of much valued national institutions like the NHS.
      Sometimes, it is necessary to have the political will power to commit to a course of action in the expectation that future funding flows will finance it.
      What this and all other governments need is a strategy to ensure that Britain will generate sufficient revenue flows to ensure future spending commitments can be met.
      By shifting the tax burden on to those who can least afford it, this present government is showing itself to be economically illiterate. Let’s hope the next lot can do a better job!!

  7. David says:

    Fair comment John although the first example doesn’t really hold up to too much examination , the second certainly does . But my comment is that as a broad generalisation governments need to be far more certain of accruals before spending commitments (electoral bribes) , as we are now finding post Brown . I frequently fear for the future of our demand model economy despite being a grateful recipient of its bounty . However , I really can’t agree about the shift of the tax burden despite my being in some bar charts disadvantaged section .
    The next lot ? Same as the present lot . We’ve painted ourselves into the ‘no choices’ corner fiscally ! Hopefully they won’t be reemploying any of those public employees or going on too much of a spendfest for big infrastructure projects ….nice as they’d be .

    • John says:

      Sometimes, of course, politicians set off on a course of action without having any real idea as to what the eventual cost will be. It is at least arguable that if they had had the slightest idea as to the financial, material, culltural and human cost it would eventually end up at, British politicians may well have given the idea of going to war in 1914 a whole lot more thought than they did.
      Grey reportedly did make a remark about the lights going out all across Europe but even he had no real idea as to what he and his ministerial colleagues were letting the British Empire in for.

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