1 May 2015, 11:56am
economy:
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  • Representation without Taxation

    There’s an election in the offing in Blighty, as it’s been nearly five years since the last one. There’s much hue and cry, although to my eyes less separates the three main parties than there used to, much is about the details and less about the big picture. Some of the big picture stuff is changing, and it’s changing is some pretty rum ways.

    Many years ago, in the 1770s in the reign of good ‘ole King George there was a bunch of uppity upstarts in one of the colonies of the Empire that got all het up about paying tax without any say in how it got spent, and their rallying cry was no taxation without representation. They had a point, and the rest is the history of the United States of America, no longer a colony for over 200 years.

    Now one of the aims of becoming financially independent is of course to minimise taxes. One of the curious twists of fate in Britain is that it’s much easier to do that when you have money – you can influence how much tax you pay by using pensions and by controlling your income. As a wage slave I was always a PAYE employee, so the main option I used was using pensions, but the ways of controlling your income are much greater for the self-employed. In particular paying yourself in limited company dividends can be a lot more attractive that paying yourself in cash income.

    However, a more recent accelerating trend seems to be increasing the personal allowance, which lifts more and more people out of the tax system altogether. Of course they still pay consumption taxes like VAT; another curious twist of fate is that those chasing financial freedom probably pay less of this sort of tax simply because you probably buy less Consumer Stuff.

    From a personal point of view, that’s dandy. And yet I do wonder what will happen as this trend increases, and we have a larger and larger number of people represented in elections but who aren’t personally impacted by the grubby costs of all the jam today we would like. Some of this trend is simply the results of increasing inequality of income and wealth, of course – if the 1% own 99% of the wealth and most of the income then it isn’t surprising that most of the tax revenue comes from a smaller tax base. Although I don’t agree with all of his conclusions, I think the Torygraph’s Jeremy Warner makes an interesting case in his article about the tax and benefits system –

    it also makes the government dangerously reliant on those with increasingly less direct interest in what the money is actually spent on, the more so given the growing focus on pensions, health care and other welfare entitlements. The contributory principle in taxation has all but disappeared. By progressively raising the tax-free allowance, the Coalition has turbo-charged this process of disassociation between revenue providers and users.

    Obviously the Torygraph is there to bang the drum for Wealth, but his case is supported by Mona Chalabi’s brilliant Guardian article that shows that higher rate taxpayers contribute the vast majority of tax revenues, though they are only 15% of the taxpayers by number.

    Contrast this with the situation when the Ermine started work in 1982. Ignoring university infill summer jobs and suchlike, this was my first real job, a junior test engineer lining up electronic sensor heads. I was intrigued to find that after compensating for inflation it paid better than the average wage is now. However, the personal allowance in 1982/83 was shockingly low – £1565, so most of that salary was taxable, and the basic rate of income tax was 30% with an additional ~9% national insurance. The young Ermine paid nearly 40% tax/NI on a higher proportion of his salary at the beginning of this career than the 2006 higher-rate taxpaying Ermine.

    People in those days were much more involved in the costs side of the tax and spend equation than they are now – if the personal allowance goes up to £15,000, which of course I am all for, personally :), then a typical two-person household earning the average UK household income of £27,000 need not pay any tax at all if they both earn roughly half. The whole tax/spend/representation thing is very different to how it used to be. Perhaps the argument is that inequality has gone up and so this is inevitable.

    Inequality has risen since 1982

    Inequality has risen since 1982

    There’s some support for that argument in the change in GINI coefficient since 1982, unfortunately although the figures show inequality has increased I have no feel for how significant a shift from ~33% to ~37% actually is.

    Maybe representation without taxation is just what you get as power shifts from labour to capital. I figure it’s going to lead to some strange places at times. It’s easy to make the case to no taxation without representation. I’m not so sure the other way round won’t have difficult birth pangs of its own…

    1 May 2015, 1:29pm
    by Neverland

    reply

    People bang on about income tax but its only about a third of government tax revenues. National Insurance is about a quarter of tax revenues and starts at £150 pw

    So most people in work are paying something, albeit not much

    The bigger question to my mind is the huge of public spending taken from a working population to non-working pensioners which is something the current government have only accelerated to buy votes

    Not only is this “representation without taxation” (as past contributions were lower and based on a pay-as-you go system) but its also completely unsustainable as the number of recipients of this generosity is constantly growing

    Obv pensioners don’t pay national insurance…

    1 May 2015, 2:03pm
    by grey gym sock

    reply

    well, the premiss is completely wrong: taking into account all taxes, it’s the poorest who pay the highest percentage of their income in tax.

    see e.g. http://www.taxresearch.org.uk/Blog/2013/07/11/the-inequality-of-the-uk-tax-system/ or http://www.equalitytrust.org.uk/sites/default/files/attachments/resources/Unfair%20and%20Unclear_0.pdf

    @Neverland those fellows at the IFS have done this work – it’s 25% tax, 17% NI (though that probably counts employers contribs, I have to say as an employee I only ever percieved the employees contribution as tax though of course the employer contribution no doubt reduced salaries and is a tax) and 17% VAT.

    Although half of UK benefit spending goes on state pensions the SP is one of the few benefits that does have a contributory component, unlike the other state benefits where the UK seems out of step with other European countries. So although it’s half the outgoings the cost is presumably less – the national insurance fund still seems to be in surplus by a big way

    1 May 2015, 3:19pm
    by Neverland

    reply

    @Ermine

    You forgot to add the proportion of the cost of the NHS and local authority social care for the elderly, which is disproportionate

    Many recipients never paid anything in for their state pensions, their contributions records were inherited from their husbands (which is not sexist to say as fewer women had jobs in past and women outlive men)

    National insurance fund in surplus…what tosh…the nation debt is £1.5tr and rising by about £100bn a year

    @greatgrey gym sock – can’t argue with that the impact on the poorest of the NI and indirect tax they do pay is greater as a percentage or their income, because their income as divisor gets smaller.

    However, for enabling government spending of any sort it is the total amount of money that matters, and it appears that the largest lump of the largest contributing sector (income tax @ 25%) is paid for by higher rate taxpayers.

    You hit a nerve with this.

    I do sometimes question the morality of arranging my finances so that I can avoid paying tax for at least the early part of my retirement. Someone else will be paying for the physio to fix my bad shoulder when I would be perfectly capable of continuing to make a contribution myself, and likewise, someone else will be forking up for me to download “Gardeners’ World” magazine gratis via my library subscription. (Ah, but that’s council tax isn’t it – so I will still be paying for that – if the library service actually survives into my retirement).

    The continual upping of the personal threshold is very expensive in lost revenue and doesn’t even unilaterally help the lowest paid. I don’t think that it’s a good idea that a significant percentage of people in society don’t pay any tax at all. Arranging taxation so that society is held together by the rich “donating” funds rather than everyone doing their part feels uncomfortably like taking a step away from the basic principles of democracy.

    @Cerridwen I think you have a clearer social fellow-feeling than I. Which is admirable, BTW. In the political compass I came out as slightly left-wing economically but very socially libertarian. Libertarianism is usually associated with right-wing views but I seem to be a wet there 😉

    I’m happy to take what I can get tax-wise now – to compensate for all the years I was royally screwed as a taxpayer to fund child benefit – including that of my colleagues. People who individually earn twice the UK average household income and more have no justification for suckling at the government teat for their lifestyle choices and I’m jolly glad Osborne iced that. So I’ll at least minimise tax to fund my lifestyle now 😉

    Neil Macdonald made a clearer exposition of some of the representational issues I was feeling uncomfortable with there. I do take Neverland’s point that there’s more than income tax to tax, but when it comes to how people think when voting it’s headline income tax (and thresholds) that make most of the running. It was quite amazing to discover that the young Ermine paid almost the same rate of tax but on more of his income in 1982 as the higher-rate taxpaying soon-to-be early retiree Ermine at the peak of his earning power 30 years later!

    2 May 2015, 10:49am
    by Grumpy Old Paul

    reply

    Don’t forget that VAT was 7% in 1979 but raised to 15% by Howe and is now 20%.

    I suspect that Ermine, like me in the latter stages of my salary serfdom, paid a smaller proportion of his salary in income tax than most of his colleagues on a similar salary as a result of pension, AVC and share-saving scheme contributions!

    Surely, rather than increase the personal allowance to £12500 a year (or whatever next week’s political pathetic appeal to greed and stupidity amounts to), it would have been better to merge NI and income tax and then have progressive bands of tax at 10%, 20%, 30% up to 50% or whatever is deemed appropriate for people earning £10 million per year or more!
    I’ve heard mention several times this week of a Grand Coalition. This is something that I’ve been banging on about for years but I still doubt whether it will happen until the proverbial hits the fan. If a Grand Coalition is formed in such circumstance, reforms currently deemed electorally unacceptable then become feasible in the first budget under such a regime!

    I’d be interested in relative changes over the last 30 or so years in tax levied on Capital Gains, Inheritance, Corporation Tax, Interest and dividends.

    I wonder how much tax revenues are reduced by low interest rates and ISA allowances.

    I do struggle with the dilemma of exploiting quirks of the tax, benefit and pension regime whilst acknowledging that they are both unfair and, ultimately, unsustainable.

    Wot we need is that all bills show the price before VAT (and duties), then the tax, then the total. Then everyman would become aware how much indirect tax he was paying.

    Now someone will come along and tell me that the EU bans us showing the VAT explicitly. That’s easy: throw the rascals out.

    The election is certainly heating up, I saw old David Cameron getting ‘pumped up’ at a meeting with the Chartered Accountants.

    “In particular paying yourself in limited company dividends can be a lot more attractive that paying yourself in cash income.” – In my line of work we get a lot of contractors working for themselves, that do this. I’m sure there’s supposed to be a look-through type rule to stop people setting up like this and then effectively working as a permanent employee on more money and paying less tax. Not as far as I can see.

    Most people’s attitude to tax seems to be either 1) – they earn more than me so tax them more or 2) – I earn good money, I’ve worked hard so let me keep it. Jealousy or greed. That said I would rather pay less tax than more! 😉

    Mr Z

    BTW I picked up a copy of the black swan after your recommendation. Very much enjoying it so far

    2 May 2015, 4:45pm
    by grey gym sock

    reply

    there has been a big shift in taxation from capital to labour over the last 35 years. rises in VAT, council tax, and NI. cuts in income tax, especially the higher rates, and removal of the unearned income surcharge (which was a similar amount to NI, so it had the effect of making the total taxation of earned and investment income similar). and cuts in corporation tax, from over 40% to just 20% now, even for bigger companies.

    some big earners are able to minimize tax by working through a company; others can’t, because they have to work as employees. but anyone with big *capital* can work through companies, and pay lower tax rates than high-paid employees.

    the shift in power from labour to capital is partly a consequence of this change in tax policy (as well as being partly due to globalization and automation). it doesn’t have to be that this way. international “tax competition” is mostly a fiction; the UK taxes economic activity in the UK.

    there are differences in this election between the tax policies of the Conservatives and Labour, but they are very small compared to the historical shift in policy which has already taken place.

    to get a proper debate on tax policy, we need to start with spreading some information about who pays how much now. i’m sure there would be broad support for the principle that the percentage of your income you pay in tax should rise gradually as your income rises; that would be fair – it’s nothing to do with greed or envy. but ppl usually just think about income tax, which is why the Telegraph can make the incorrect assertion that the poorest don’t any pay tax.

    I’ve just discovered your website as I’ve made a decision to retire early in 2 years, when I reach the age of 58. I will be funding this from savings until I reach age 60, when my pension kicks in. I’ve been brought up with a strong Protestant Work Ethic and whilst the prospect of early retirement is liberating, I’m struggling with the ‘guilt’ of using hard won financial resources to leave early – financially it is not a sensible decision, but is a great one when I think of my lifestyle changes, and how badly I need them. I was particularly interested in your reflections about how you experienced living off savings and the issues you faced. These resonate with me, and it has been helpful to read about someone who has done what I am looking to do, and is a bit further down that road. Thank you!

    @Grumpy – I used the IFS http://www.ifs.org.uk/tools_and_resources/fiscal_facts

    there’s corporation tax back to ’71 here

    http://www.figurewizard.com/list-uk-corporation-tax-rates.html

    and this helped me too a while back

    http://www.icaew.com/en/library/subject-gateways/tax/tax-rates

    @dearieme I’m sure Tesco bills show the pre/post VAT amounts, and most receipts for road fuel, so I don’t think it’s that the man from EU sez no…

    @Mr Z – yep, IR35 is not the contractor’s friend if they work for one firm like an employee 😉

    @great grey gym sock – the trouble with tax is it’s used both to fund government, for which it has to tax the largest flows of money, but it’s also often used to discourage bads – sin taxes etc. One of the benefits the FI community have relative to typical consumers is we often are seeking to reduce consumption flows, which both reduces consumption taxes but then also gives us the flexibility to defer income, reducing income flow taxation. While it’s a minority sport, we may as well play the system IMO 😉

    Interesting point of the shift fof power from labout to capital as aresult of policy shifts. Or should that be the other way round – the somewhat illiterate Owen Jones makes this point at length in his book The Establishment: And how they get away with it makes a reasonable case that the establishment co-opted the political system even after one takes some of the student politics out of his narrative!

    @Tony glad some of that story helped – although the adjustment will be easier or not for different temperaments, even for someone as conventionally-minded as I was it was tractable 🙂 You sound like a fellow who may want to consider the value of a short SIPP to leverage your savings if you are looking to bridge a two year gap…

    Interesting article.

    For what it’s worth I’d start with a zero personal allowance. It should be a given that everyone (who works) pays something – however small – to the state. There are too many people for whom everything is paid for by “someone else”.

    Clearly other taxes and benefits would have to change so neither the state, nor the people (as a whole), actually lost out. But it would enforce the principle that everyone pays something, and is seen to be doing so.

    I would also generally disagree that the proportion you pay in income tax should go up (materially) the more you earn. That the top 1% of workers pay 30% of income tax is scandalous (and potentially unsustainable).

    Merge NI and IT, scrap the PA, bring in a flat rate of income tax, revamp benefits (more to those who can’t, less to those who won’t; no benefits for lifestyle choices, etc).

    The state should have a very good reason for taking hard-earned cash from citizens. Some of the reasons, currently, are not very good at all…

    There’s a sound economic case for a consumption based tax replacing income tax (income-saving=taxable consumption). That’s basically what the FI community does through the use of pensions.

    Pensions is an interesting one. I don’t see the state pension as sustainable.

    If I were in charge I would phase it out over the next 50 years, having it replaced by workplace pensions (for workers) and a minimum income guarantee (for the rest).

    I’m assuming workplace pensions will be modified so that the 8% contribution (from 2018) would be increased in time to c25%. That would then give workers a pension related to their salaries – essentially a career average final salary scheme. But funded, adequate and not flat-rate. I realise that this increases the cost to businesses of employing people, but can’t have everything.

    The minimum income guarantee would have to be set sufficiently low to encourage working for a living. And there would still need to be benefits for those that can’t provide for themselves (rather than those that decide it’s acceptable – and financially possible – to opt out of work). Benefits relating to lifestyle choices would be cut to the bone.

    Devil would be in the detail, and the transition phase. But we can’t keep going on as we are now – you wouldn’t run a business like this…

    @Richard – although I’ve never been one of them other than as a low end HRT taxpayer, I was also made uncomfortable by the implications of that Guardian infographic with who pays most in income tax. He who pays the piper usually gets to call the tune somewhere.
    There is, of course, always the conundrum of telling those who won’t from those who can’t. I’ve never understood why it became politically incorrect to try and tell the deserving from the undeserving poor, apart from the whole postmodern relativism thing.

    @mucgoo – I’d never thought of it like that, however, your thesis is supported by the fact that those adopting Fi do tend to try and minimise spending as a way ot marshalling their resources (in this case flinging current earnings towards teir future selves). And indeed a lot of tax planning is rate-managing income and drawdown.

    Thank you for your comments. I must confess that I had not considered a SIPP. Am I right in thinking that I could invest say £15000 pa in two tax years and automatically get 20% tax relief on this? I assume there would be restrictions on what and when I could take out. I would need to take out the full amount spread equally over the two years before my pension kicks in. Would I be limited to 25% tax free followed by a monthly pension?
    I need to do some more research on this.

    @Tony you need to qualify how much you earned (there is carry-forward available) and how much you have already contributed to pensions, which is part of your annual allowance – there’s a calculator there to factor in carry-forward if applicable. You also need to bear in mind the lifetime allowance (link 4 on that page). You may invest annually £3600 or the entirety of your annual gross earnings, whichever is greater. You can get 20% tax relief on it – since you are over 55 you can go into drawdown, first taking 25% of your putative £30k cash as a tax-free lump sum (£7.5k) and then take the personal allowance (~11k) this tax year and next, assuming you have no other taxable income.

    You don’t have to take the cash monthly, this is between you and your chosen SIPP provider. I personally would probably take it annualy to minimise costs. As you will probably be using cash, check fees carefully. FWIW I used Hargreaves Lansdown – they’re dear for investments but not bad for cash. You get tax relief at your marginal rate. On your £30k gross that’s £7.5k saved (it only costs you £22.5k) so it’s at least worth running the numbers for you!

    Hello Tony

    You’d pay £12,000 into your SIPP this year and you’d get £3,000 (being 20% of the £15k gross amount) basic rate tax relief paid directly into your SIPP by HMRC.

    If you do the same the following year you now have – ignoring investment growth/decline and fees/charges – £30,000 in your SIPP for (after tax) payments of £24,000.

    This takes you to 58 and you retire. You now use this fund to keep you going for two years until you can draw your other pensions.

    As you’re over 55 you can withdraw from your SIPP – 25% of the pot is tax free and the rest is taxed as income.

    You might take half the pot each year, of which 25% will be tax free. Thus you get £3,750 tax free and £11,250 which is taxable. Assuming you have no other income then the personal allowance will near-as-makes-little-difference mean that there’s no tax to pay on the taxable element.

    Over the two years you will essentially have got your £30k back tax-free. Thus you’re £6k up compared with keeping the cash in the bank (or, for that matter, in an ISA). That would pay for a very nice holiday to celebrate your retirement – funds courtesy of HMRC’s largesse, method courtesy of Ermine’s blog.

    (I suppose I’d better the give you the caveats! This assumes you’re a basic rate tax payer (you’d get more tax relief paid back to you if you’re a higher rate tax payer). You also need to have earnings of £15,000 in each year you contribute. You are capped at paying in £40,000 (inc basic rate tax relief) per annum, but you can bring forward unutilised allowances from the last three years if you have sufficient earnings in the year you make the pension contribution, and were a member of a pension scheme in those earlier years. You can continue to pay into a pension once you’re drawing from it, but the £40k limit becomes £10k. You can pay in up to £2,880 (before tax relief, = £3,600 gross) even if you have no earnings, but if you wish to pay in more you must have earnings to support it. And, of course, nothing said here constitutes financial advice!)

    @Richard is absolutely right – hat tip for a much clearer description and better arithmetic. I screwed up computing 20% of 30k as £7.5k, that happens to be the size of the 25% tax-free lump sum which is not the same as the saving in tax 😉

    Still worth getting out of bed for IMO!

    Thank you Ermine and Richard. I will certainly look into this.

     

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