Friday, 9 August 2013

Regressive Taxation explained


Regressive Taxation is a term that refers to any kind of taxation that affects the poor more than the rich. Taxation schemes are described as regressive if the apply a larger burden (in terms of available resources) on the poor, than the rich.

Put simply, a regressive tax is one that takes a larger chunk out of a poor persons income, than it does out of a rich one's.

Regressive Taxes are extremely common in the UK, I'll run through a number of examples before looking at another factor that increases the regressivity of the UK tax system; taxation asymmetry.

VAT

VAT is usually the most commonly cited example of regressive taxation. Research has consistently proved that the poor pay a higher share of their income in VAT than the rich. This is due to the Marginal Propensity to Consume (poor people spend a higher proportion of their income, rich people save a higher proportion).

A study by the Office for National Statistics in 2008/09 found that the poorest 20% of the population spend 8.7% of their income on VAT, whilst the wealthiest 20% spend only 4.0% of their income on VAT.
The evidence is absolutely clear that VAT is a regressive tax, however that doesn't stop right-wing VAT apologists lying about it. They often claim that VAT is not regressive because rich people spend more than poor people, therefore they pay more VAT, but this is a deliberately misleading argument. It doesn't matter that a wealthy individual actually pays more VAT in cash terms (because they buy expensive clothes and luxury items for example) because the VAT burden in relation to their overall income is still much lower than the relative VAT burden on a poor individual.

One of the key indicators that VAT is a regressive taxation is that it is highly favoured by the Conservative party. They have increased VAT on several occasions, including 1979, 1991 and most recently 2010, just a few weeks after categorically stating that they had no plans to raise VAT during the 2010 General Election campaign.

Fuel Tax
In western economies fuel tax is another regressive taxation because the working poor generally spend a higher percentage of their income on fuel than the rich. The individual that earns £1,000,000 a year is extremely unlikely to spend 50 times as much on fuel as the individual that earns £20,000 a year. Even if this hypothetical wealthy individual owns a fleet of luxury sports cars with large high fuel consumption engines, it is hard to imagine how they could spend so much time on this hobby that they spend 50 times as much on fuel as the £20,000 earner that commutes to work on a regular basis.

The reason I quantified the opening paragraph with "in western economies" is that in many poorer economies, where vehicle ownership is very rare amongst the poorest 20% (most African countries, parts of Latin America, large swathes of Asia), the regressive effect doesn't exist for them, since the poor majority rarely purchase gasoline or diesel. The regressivity still exists, but only between the wealthy minority and the remainder of the relatively small vehicle owning class
.

National Insurance
National Insurance is another example of a regressive taxation. The reason that National Insurance is regressive is that earnings above the National Insurance Upper Earnings Limit (UEL) of £41,150 per year (as of 2013) are subject to just 2% NI contributions on salaries and benefits in kind, whilst people earning between the Primary Threshold of £7,755 and the UEL of £41,150 must pay 5.85% on salaries and 12% on benefits in kind.

This massive disparity between the proportion of income paid in NI contributions by the majority of workers, and the significantly smaller amount paid by extremely high earners makes National Insurance another example of regressive taxation.

Here are some examples:

Percentage of basic salary paid in National Insurance:
£20,000 per year      =
3.58%
£50,000 per year      = 4.25%
£100,000 per year    = 3.12%
£1,000,000 per year = 2.11%
£2,000,000 per year = 2.06%

As you can see from the examples, the upper middle class actually pay marginally more as a percentage of their income in National Insurance than the working poor, however, the higher the earnings above the £41,150 upper threshold, the smaller the relative burden of National Insurance becomes.

Council Tax

Council Tax is yet another example of a regressive taxation because of the absurd and arbitrary way that Council Tax Bands have been calculated.

The way the bands work in England is that a Band H property (valued at £320,001 or more in 1991) pays three times the council tax of a Band A property (worth £40,000 or less in 1991). Because the nominal value of the property is at least 8 times as high between Band H and Band A, a tax differential of 3:1 is actually very small.

Since the upper limit is a value of £320,001, this means that a multi-million pound mansion might pay the same, or only very marginally more than a large family home. When considered as a proportion of the property value a typical Band H charge of £2,536 on a mansion valued at £2.6 million represents a minuscule  0.1% of the property valuation, whilst a house valued at £162,500 paying a typical Band G charge of £2,113 is shelling out 1.3% of the property valuation. An individual inhabiting a house that was only valued at £10,000 in 1991 facing a typical Band A charge of £845 is left shelling out 8.45% of the valuation of their property.

To put these figures into perspective, it would take the country mansion dwelling family around 1,000 years of Band H Council Tax contributions to pay out the nominal property valuation of their dwelling. It would take the upper middle class professional with a large house in the leafy suburbs around 77 years of Band G contributions to pay off their nominal property value. And the poor occupier of the inner city slum dwelling would shell out the nominal valuation of their property in less than 12 years of Band A contributions.

Another factor to consider is that holiday homes and second homes are given a 50% council tax reduction, which means that someone with two Band H properties each nominally valued at over £1 million, would end up paying less in Council Tax for each of their two properties, than the owner of a Band G property with a nominal value of just over £160,000 pays for their single property.

Under the current Council Tax setup, it turns out that the more valuable the property, the lower the proportion of its value that must be paid in Council Tax, and the more properties an individual owns, the lower the burden of Council Tax becomes in relation to the value of the property portfolio.


Sin Taxes
Sin Taxes, which are sometimes called Pigovian Taxes (after Arthur Pigou, the English economist that developed the concept of economic externalities) are taxes which are applied on products like alcohol, cigarettes and coffee. Sin Taxes are amongst the most regressive forms of taxation because taxation on these "sinful products" does not account for ability to pay, meaning that the less well off pay a higher proportion of their income through these taxes.

According to research by The Tax Foundation in the US, the least wealthy 20% spend a 78% larger share of their income on alcohol taxes than people in the top 20%, and a staggering 583% larger share of their income on tobacco taxes.

In my view taxation on products with negative externalities (health costs, public disorder, domestic violence, pollution ...) should be taxed in order to cover the socio-economic costs, however, the way these taxes are currently applied results in the less well off bearing the greater proportional burden for their "sinful habits".


Bedroom Tax
[main article]
Before the pedants point out that "Bedroom Tax" isn't actually a tax in the strict sense of the word, it is still a government policy aimed at transferring the burden of austerity onto many of the poorest families and individuals in society. It is now absolutely clear that there is nowhere near enough smaller social housing available for everyone being hit by "Bedroom Tax" to relocate to, meaning that the vast majority are left with no choice but to cut their living standards in order to scrape together the money to pay "Bedroom Tax".

Taxation asymmetry

Aside from all of the regressive forms of taxation, there is another factor that plays a major role in widening the regressivity of the UK tax system. This factor is is lax tax enforcement, which causes taxation asymmetry.

To put it simply, it is much easier for the wealthy to reduce their tax burden through tax-dodging activities than it is for the ordinary person. The more permissive the tax system becomes in regards to tax-dodging, the lower the burden of taxation becomes on those wealthy enough to employ expensive tax lawyers to help them reduce their tax burden.


Taxation asymmetry means that wealthy bankers, celebrities and even Labour politicians can massively reduce their burden of taxation by using tax-loopholes or personal service companies, in order to avoid paying income tax and national insurance contributions on large chunks of their income. Some famous examples of wealthy people avoiding tax on their income include the Tory party donor George Robinson, the Topshop boss and Tory party "efficiency adviser Philip Green the so-called comedian Jimmy Carr and the former mayor of London Ken Livingstone.



The lax tax collection system in the UK allows many thousands of wealthy individuals to dodge paying their fair share of income tax, which is one of the very few UK taxes that isn't regressively applied. If the wealthy minority can just set up tax dodging schemes to avoid paying income tax on their fortunes, the progressive nature of the tax is invalidated, and a very unfair situation is created between the wealthy that do pay the expected amount of income tax on their earnings, and those that use tax-dodging schemes to avoid paying their share.

Taxation asymmetry is even more apparent in the business environment. The asymmetry between the tax burden on a Starbucks coffee shop franchise and a local independent shop without the means to divert profits offshore via convoluted transfer pricing schemes creates the situation where a Starbucks franchise pays virtually no corporation tax, whilst the local independent coffee shop is hit with the full tax load, means that the tax-dodging corporation has a massive unfair advantage.

  
Conclusion

The tax system in the UK is highly regressive and the policies of the Tory - Lib Dem coalition are making this situation worse. The Liberals hide their complicity in this behind the fig leaf of the rises in the lower threshold of income tax, but the small gains ordinary people have made from this have more than been wiped out by increases in other regressive forms of taxation and through the unprecidented scale of wage repression. For everything the Liberals have given with one hand, the Tories have taken away manyfold with the other.

It is hardly surprising that the dual strategy of making the taxation system even more regressive than it already was and the unprecidented scale of wage repression in the UK economy have coincided with the weakest period of economic recovery since records began. The creation of a consumerist economy majority populated by an over-taxed, under-paid and debt laden proletariat would be an utterly absurd venture from an economic perspective. However, given their policies of regressive taxation, wage repression and debt inflation it seems to be exactly what the Tory led government are working to achieve.

 



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