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UK Personal Taxation Assignment
Responsiveness of very rich for tax changes in UK
In recent time the responsiveness of the very rich for tax rate changes have become central issue for the public finance. After three decades of unthinkable political reforms in UK finally government have decided to levy the increased tax rates for the very rich people (Slemrod & Auerbach, 1997). The Very rich population is categorized as the people having their annual salary of more than £150,000. This category in UK is formed by just 1% of the overall population present in UK. The Intention of government behind raising the tax rates is to collect the £2.6 billion of tax revenue in order to increase their national revenue which will help government to reduce their public borrowing.[caption id="attachment_4204" align="aligncenter" width="780"]Showing tax rate to be followed in UK for year 2010[/caption]
The figure above shows the proposed marginal income tax by the government. As shown in figure the marginal tax rate for the very rich people i.e. income over £150,000 would be more than 40% of range hence the higher amount of taxes have to be paid by them (Carroll, 1995).
But this change in tax rates will affect the individuals having the high income range. But the government expectations of collecting high tax revenues may not be fulfilled as people will try to reduce their taxable income by various means (Randolph, 1994). This category of very rich people will try to explore working opportunities overseas and so will have access to various accountants as well which will help them to reduce their taxable income. Hence the government estimation of collecting £2.6 billion of increased tax revenue may not be fulfilled.
The Tax rate changes of previous time also have shown high responsiveness from the very rich whether it’s the tax rate increased or tax rate cut done in year 1970’s and 1980’s (Robert, 1997). The Shape of tax rate matters a lot for the society as a whole since it determines the incentive for individuals to slightly more pay hours.
The Tax rate reforms planned by the government are as per the following regulations:
- The Threshold amount for the payment of employee will increase to income tax personal allowances.
- The New tax rate introduced would be 45% over the income of £150,000 annually. The Combination of income tax and employee NI will give sum total of 46.5% while the employer NIC will make a total tax figure of 52.8% (Charles, 1997).
- The Basic income tax rate limit would be frozen hence rising the income tax rate to about 2.5% in total.
The Literature gives enough evidences of responsiveness shown by the rich people for the tax rate changes. At several times whenever government have changes the marginal tax rates then the very rich income people have reacted to it very sharply (Poterba, 1993). The Income levels of these people have shown sudden increased trends whenever the tax rates have been cut by the government while the income level have gone down in response to the tax rate increment. Whether it the situation before year 1980’s or after year 1980’s. In year 1978 when the marginal tax rate was 83% for the very high earner and it was slashed to about 40% in year 1980’s (Feldstein, 1995b). The Change in tax rate done by government impacted the very rich as their income level goes down during high tax rate while the income level goes up after tax rate cut announced by government.[caption id="attachment_4205" align="aligncenter" width="798"]Impact of tax rate changes on top 1% earners in UK[/caption]
As shown in the table above there are three lines showing 1% high income earner, their tax payment and their income share as well. As shown in the table the income share of the high earner comes down suddenly in year 1960 to 1970’s since the Marginal effective tax rate (METR) charged by the government was 83%. But as soon as government cut back the tax rates in year 1980’s then the income share of the high earner has risen sharply (Austan, 1999). And from year 1980’s this income share of the people is continuously rising at a faster pace. And after the year 1980’s the consumption tax pattern of the people has gown down as shown in the figure.
Though the increment of the income share for the 1% high earner in the country after 1980’s is faster than the other 4% people who are high earner in the country (Slemrod, 1998). A figure showing the consumption taxes and impact on income share for the rest of 4% people can be shown in as follows:[caption id="attachment_4206" align="aligncenter" width="835"]Showing change in income share and consumption tax for top 5% earners[/caption]
As shown in the figure that the income share get inflated for the 5% very rich people but this rise in income level was not as sharp as for the 1% very rich people (Liebman, 1997). Since the tax rate cut for the 5% very rich was not so big so their responsiveness was also less as compared to the 1% very rich people.
3.0 Responsiveness of very rich on tax rate change
3.1 Relation between taxable income and tax rate
The Responsiveness of the very rich was also very much for the tax rate cut. It was attributed to the taxable income elasticity. Taxable income elasticity is the change in taxable income of a person in response to the 1% change in tax rate. Using the information provided by BSS (Professor Emmanuel Saez of the University of California, Berkeley) on income level raised for the 1% very rich the taxable income elasticity was 0.46% (Heckman, 1993). It means that if the tax rate goes up from 50.5% from previous rate of 50% (which is 1% rise) then the taxable income of the 1% very rich people will fall by 0.46%.
As per the reforms introduced by government the current marginal tax rate would increase from 55.6 % to 59.3%. Hence the net of tax rate for the very rich will falls down from the 44.7% to a level of 40.4%. Hence the new tax rate policy the income of the very rich will decrease by 4.5% (Murnane et al, 1992). In other words we can say that an increment of 7.8% in marginal tax will give rise to 9.6 % decrease in net on tax and thus will overall leads to the 4.5% decrease in total 4.5% income.
These estimated figures are according to the taxable income elasticity developed during year 1980’s. The Economic Scenario at that time was little different from the current economic scenario. As the top rate of the income was falling promoting people to earn more while there was also high inequality in income ranges for the people (MaCurdy, 1992). Hence the taxable income elasticity of 0.46% may be too high and the estimation of income decrease may not give a right picture of the situation. Also the estimation of taxable income elasticity done in 1980’s was based on the small sample and if the methodology was correct too then also it will give the sampling error.
3.2 Impact of tax rate change on worker demand/supply
The Investigation of the marginal tax rate and hours worked have shown a different economic scenario. In this view it has been revealed that the tax rate cuts would lead to the increase in the labour supply (Parcell, 1996). This labour supply increment will be attributed to the factor that the lower rates would be provided and hence the revenue loss would be there for the labour. The literature has shown that the demand for labour in case of women is less affected due to the rate changes.
The Effect of tax rate change on the demand /supply for the labour has been shown by the Laffer curve (John, 1986). The Laffer curve not only explain the impact of tax rate change on total hour worked but also shows the impact of tax rate change on taxable income.
As shown in the figure the Laffer curve explains the impact of the tax rate change on the taxable income of the very rich people. At x-axis the tax rate have been shown which are for the incomes over £150,000 while at the y-axis shows the change in income tax and NI revenues (Randolph, 1995). There are two estimations have been shows one from the government elasticity perspective while other from the elasticity which was define in the 1980’s.
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4.0 Estimation of revenue effect
The Current tax rate reform proposed by the UK government has shown the planning for collecting the additional £2.6 billion tax revenue from the tax rate change. But after taking various behavioral responses from the very rich it has been estimated that the government would be able to collect the £0.9 billion additional tax revenue which is considerably lower than the tax revenue planned by the government (Rosen, 1992).
4.1 Higher tax rate leads to lower spending
One of the main reason while low tax rate collection estimation can be the lower spending done by the very rich in response to the higher tax rate. Since if the people are changing their income in response to the tax rate then they will reduce their spending as well. Less spending from the people will give rise to the lower consumption tax collection for the government (Weiner, 1997). As per estimation if the very rich will reduce their spending in co-ordination with the tax rate change and reduced income level change, then the impact on revenue collection would be as follow according to Laffer curve.
As shown in the figure the tax paid by the very rich changes with the tax rate change due to the reduction in their spending. The Estimation has been shown from the government taxable income elasticity as well from the elasticity developed in 1980’s which much higher (Wolfson, 1992). The Consumption tax paid by the very rich would raise as per the government estimations but according to the elasticity developed in 1980’s which is 0.46% the consumption taxes paid by the very rich will decrease in response to the new proposed tax rate change.
Hence according to the taxable income elasticity of 1980’s which 0.46% is, it has been estimated that the net loss in terms of consumption taxes for the government will lead to a total tax revenue collection of £0.9 billion which is £1.5 billion less as per government estimations (Slemrod, 1994b). Hence the government is collecting the maximum revenue at the current tax rate and if the government changes the current tax rate then the tax collection would be impacted considerably.
The Behaviour of the very rich in response to the current tax rate may be very different as expected by the government. The following points may depict some of the action taken by them:
- The Response of high income people would be different to not only income tax paid but also to the various other taxes paid by them. This additional tax paid by them includes the consumption tax levied on the various consumptions done by the people (Toder, 1995). Value added tax is such one kind of tax. Hence the VAT tax collected by the government may go down considerably in response to the increment in tax rate.
- The Number of different people above £150,000 would also not be estimates correctly.
4.2 Tax planning
The Higher tax rate levied by government on very rich will force them to plan their tax payment in such a way the government will suffer the considerable revenue losses. The Measure for considerable tax planning would be taken by the very rich and these measures will enhance their interest to invest overseas. The Overseas investment done by the very rich will help them to evade them to pay the excessive taxes on their earnings (Parcell, 1996). Hence the current home investment done by the very rich will convert into overseas investment which will again be a loss for the government.
Other measure taken by the very rich for the excessive tax planning will include the conversion of the income into capital gain. If the very rich convert their income into the capital gains from any mean then they will have to pay considerably very less amount of taxes (Huang, 1991). The Tax rate paid on the income is 40% while at the same time the tax rate applicable on the capital gain is just 18% hence the tax paid would be considerably lower.
The Other method of tax planning done by the very rich in order to save the taxes would be to increase the pension contribution into their income. Since the pension contribution in the income will allowed them to pay fewer amounts of taxes for them.
- Auerbach, A. and J. Slemrod (1997), AThe Economic Effects of the Tax Reform Act of 1986", Journal of Economic Literature, 35(2), pp. 589-632.
- Auten, G. and R. Carroll (1995), ABehavior of the Affluent and the 1986 Tax Reform Act,@ in Proceedings of the 87th Annual Conference on Taxation of the National Tax Association, Columbus, Ohio: pp.7-12.
- Burman, L. and W. Randolph (1994), AMeasuring Permanent Responses to Capital-Gains Tax Changes in Panel Data,@ American Economic Review, 84(4), pp. 794-809
- Carroll, Robert (1997), ATaxes and Household Behavior: New Evidence from the 1993 Tax Act@ Mimeo, Office of Tax Analysis, U.S. Department of the Treasury.