Reform UK tax to rebuild post-COVID 19 public finances

Rather than pointing the finger at individuals paying extremely low rates of tax, we need to ask politicians to change the structures that allow this.
- Andy Summers, Assistant Professor, LSE Law Department and International Inequalities Institute
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Around £11 billion a year could be raised from an Alternative Minimum Tax rate based on the total amount of income and capital gains that a person reports before applying any deductions or reliefs, according to new research which has gained unprecedented access to the tax records of the UK’s richest individuals.

The study, by LSE and the University of Warwick, analysed the anonymised personal tax returns of every UK resident who received more than £100,000 a year in income or capital gains and discovered that many are paying extremely low tax rates, lower even than people on modest incomes. This is due to the way the tax system is designed rather than avoidance or evasion.

One of the most striking findings is that those receiving £10 million effectively paid just a 21 per cent tax rate on average. This is driven by large variation in rates even amongst the very rich, with some paying close to the headline rate on earnings of 47 per cent and others paying just 11 per cent: lower than people earning £15,000.

With Covid-19 placing unprecedented demands on public spending, tax rises appear ‘inevitable’, the report says. It adds: “A key choice is between increasing taxes that affect almost everyone – VAT, National Insurance Contributions, the basic rate of Income Tax – versus targeting tax rises on the richest. But the rich, it is often pointed out, already pay a lot of tax: a frequently cited statistic is that the top 1 per cent pay nearly 30 per cent of all Income Tax. Is it fair, or even possible, to require that they pay more?”

The research, by Arun Advani of Warwick and Andy Summers of LSE, sheds new light on this question by revealing that even though the top one per cent pay a large amount of income tax, this is largely due to a substantial cohort of high-earning employees who pay close to the ‘headline’ rate, i.e. the top rate of 45 per cent Income Tax plus 2 per cent National Insurance Contributions that this group is typically assumed to pay on each pound received above £150,000.

Dr Advani and Dr Summers focused on people’s ‘effective’ average tax rates, i.e. the total tax they pay as a percentage of the total remuneration (taxable income and capital gains) that they receive. The difference between the headline rate and the effective rate is due to the much lower tax rates on dividends and capital gains, as well as deductions and reliefs. These are ways of structuring remuneration that largely benefit the richest, the report says.

It explains: “A substantial minority of the UK’s richest individuals – mainly investors and business owners – paid extremely low effective rates: much lower than others at the same level of remuneration, and lower even than people on modest earnings.” The authors emphasise that this is due to structural policy choices rather than bad behaviour from individual taxpayers.

The report says up to £20 billion a year could be raised from taxing all income and capital gains at the same rate as earnings. It proposes an Alternative Minimum Tax rate which would raise around £11 billion from those best able to afford it, without raising taxes on those who already pay the highest shares, and whilst minimising the scope for avoidance.

Key findings: 

  • The average person with more than £2 million in taxable income had an EATR (Effective Average Tax Rate) of only 40 per cent: for someone at £2 million this represented a tax saving of £140,000.
  • The average person with £10 million in taxable income and capital gains had an effective tax rate of just 21 per cent: less than the rate that would be paid by someone on median earnings of £30,000.
  • Effective tax rates vary considerably among the richest: one in four receiving above £100,000 paid the headline rate on earnings of up to 47 per cent, but one in ten people with total remuneration over £1 million paid just 11 per cent: a lower EATR than someone earning £15,000.
  • Low tax rates on dividends and gains almost exclusively benefit investors and business owners rather than employed or self-employed earners.
  • There is a lot of tax revenue at stake:up to £20 billion could be raised if all taxable income and gains were actually taxed at the existing headline rates applicable to earnings.
  • An Alternative Minimum Tax that required everyone earning more than £100,000 to pay at least a 35 per cent tax rate on their income and gains could raise around £11 billion. This is equivalent to 2p on the basic rate, or 5p on both the higher and additional rates.

The report, launched on Monday 15 June at an LSE public lecture, concludes: “In the coming years, the pressure to rebuild crucial public finances on a sustainable footing will inevitably require politicians to make tough choices about who should pay more tax…

“We have identified the maximum that could be raised from the UK’s richest individuals without increasing headline tax rates on earnings. Such a reform would have the merit of raising substantial revenue from those best able to afford it, without raising taxes on those who already pay the highest shares. When difficult decisions on tax look certain to be required one way or the other, this path seems a sensible way of ensuring that all those at the top are paying their fair share after the crisis.”

Dr Advani, Assistant Professor at the University of Warwick’s Economics Department and CAGE Research Centre, said: "In the current climate, there is – rightly – a debate about how to raise tax revenues, and about what proportion should be contributed by the rich.
“It is important to realise that raising money from the rich doesn't require increasing headline tax rates. Many of the richest pay far less than the top rate. An Alternative Minimum Tax of 35 per cent on remuneration above £100,000 would raise as much money as adding 2p to the basic rate, and be concentrated only on the rich who pay the least."

Dr Summers, Assistant Professor at LSE’s Law Department and International Inequalities Institute (III), said: “Rather than pointing the finger at individuals paying extremely low rates of tax, we need to ask politicians to change the structures that allow this to happen.
“Our findings are driven by two main policies: first, similar forms of remuneration are currently taxed at very different rates; and second, a raft of generous tax reliefs are made available without taking adequate steps to check their effectiveness. The government should look again at both of these policies to raise more revenue and make the tax system fairer.”

Read the report here: