Tax after coronavirus Contents

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5The major contributors to tax revenues

The importance of income tax, National Insurance and VAT to tax yield

89.The tax system raised over £740bn in 2019–20.97

Figure 7: Contributions to tax receipts in 2019-20

Source: Extracted from data in OBR, Economic and Fiscal Outlook November 202098

The three taxes which contributed most to this total were income tax, VAT and national insurance contributions. Together these three taxes raised £472.4bn, 63.7% of the total.99 They are therefore leading candidates for raising additional revenue to plug the widening gap between public spending and revenue identified in the OBR’s Fiscal Sustainability Report. Sir Edward Troup, a former First Permanent Secretary at HMRC, noted that “If you want big money, you have to go for the big taxes … Therefore, VAT, income tax and NICs will have to be in the mix.”100

90.HMRC provides an illustrative guide to the direct impact of tax changes on revenues, which shows that:

• a 1p increase in the basic rate of income tax would raise £5.5bn in 2022/23 (0.2% of GDP), and a 1p increase in the higher rate would raise £1.3bn in 2022/23 (0.1% of GDP);
• A 10% cut in the income tax personal allowance would raise £8.8bn in 2022/23 (0.4% of GDP);
• A 1% increase in Class 1 national insurance contributions would raise £4.3bn in 2022/23 (0.2% of GDP); and
• A 1p increase in the rate of VAT would raise £6.7bn in 2022–3 (0.3% of GDP).101

91.Paul Johnson, Director of the Institute for Fiscal Studies (IFS), told us that, given the proportion of tax revenues that come from national insurance, income tax and VAT, he would expect in the medium run at least some increases in those taxes simply because that is where a significant amount of income comes from.102

92.The Conservative Party manifesto at the 2019 election said: “We promise not to raise the rates of income tax, National Insurance or VAT.” The manifesto did not specifically address the thresholds for these taxes.103 The policy is widely referred to as the “triple tax lock”.104 In evidence given to the Liaison Committee in May 2020, responding to a question from the Chair of this Committee, the Prime Minister said: “We are going to meet all our manifesto commitments. Unless I specifically tell you otherwise”.105

93.The evidence submitted to this inquiry indicates that raising tax revenue quickly and at a large scale is likely to require higher contributions from one or more of income tax, national insurance and VAT, as they currently yield over two-thirds of the total tax take. Any increases in the rates of these taxes were ruled out in this Parliament by the Government’s “tax lock” manifesto commitment. It is clear to the Committee that the manifesto commitment of the Conservative Party will come under pressure under the current circumstances.

Income tax

94.Income tax is paid on all forms of income received by individuals, including wages and salaries, profits from trades or professions, pensions, interest, dividends and rents received. Income tax yield in 2019–20 was £193.6bn, of which £165.2bn was collected through the PAYE system.106

95.As income tax rates and thresholds on non-savings and non-dividend employment income (unlike national insurance contributions and VAT) have been devolved to Scotland, any change to rates of non-savings and non-dividend income tax would only directly affect England, Wales and Northern Ireland, although there would be an indirect effect on Scotland through block grant adjustments.107

96.Increases in income tax rates and changes to thresholds could make a significant contribution to yields. We heard evidence that increases in income tax would raise revenue with little economic damage. Paul Johnson told us:

If you were not politically constrained and you wanted to raise significant amounts of money quickly, you would probably want to simply raise the basic or the main rates of income tax by a few pence. That raises you a lot of money very quickly and easily. Certainly increasing the basic rate of 20% by 2% or 3% will not do any significant economic damage.108

97.Based on the evidence we heard and received, we conclude that income tax is more efficient than some other taxes and we do not see a pressing need for reform at this time. The Government’s manifesto commitment not to increase the rate of income tax does not preclude it from adjusting income tax thresholds. We note that the Government could raise revenue simply by freezing income tax thresholds, and that such a change would cause minimum economic distortion.

The standard rate of VAT

98.£133.8bn was raised from VAT in 2019–20.109 It would be open to the Government to amend the standard rate of VAT, which applies to most goods and services in the UK, and which currently stands at 20%. Structural changes to the VAT regime, going beyond a straight change to the standard rate, are discussed in Chapter 6 of this Report.

99.VAT has been one of the taxes used in the past when the fiscal position has required additional tax yield. Its present rate stems from two such rises: in 1991 it was increased to 17.5% from 15%, and (following a short period where it was again 15% between 1 December 2008 and 31 December 2009) it was further increased to 20% in 2010, following the financial crisis.110

100.Stuart Adam, senior research economist at IFS, summarised for us some of the advantages and disadvantages of increasing the standard rate of VAT:

Thinking [ … ] just about increasing the rate, rather than broadening the base, which is perhaps where I would be more inclined to look, it is not as progressive as increasing income tax, national insurance or most other taxes. Contrary to popular perception, it is not regressive, but it is much less progressive. It has an effect on discouraging consumption and therefore work, but it probably has less effect on that than income tax and national insurance does, and therefore somewhat less effect on growth.111

101.However, the 20% VAT rate is not uniformly applied across products—some, such as food, newspapers and children’s clothes, are zero-rated or have a reduced rate. Stuart Adam argued that a VAT rate rise could exacerbate the problems these differentials cause. He told us:

One disadvantage of using it is that, because we have a lot of zero and reduced rates and exemptions, you will be increasing the bias between those things that are subject to VAT and those that are not. On the other hand, it does not have some of the disadvantages that other taxes have. It does not discourage saving. It does not encourage people to convert income into capital gains, to set up a business to avoid tax and all those kinds of things.112

102.Alan McLintock, Chair of the Indirect Taxes Committee at the Chartered Institute of Taxation, commented on international comparators:

“The median VAT rate in at least the European Union is 21%, with about half the member states being at 20%, 21% and 22%. At 20%, we are slightly below the median rate, so we think there is room to move up a little without being outside the pack. Germany is at 19%, so there would be a bit of a difference there. Moving our rate up and down is probably less open to challenge than dealing with the exemptions.”113

103.However, while increasing taxes is rarely popular, Charles Seaford, senior fellow at Demos, who has researched public opinions of tax rises,114 noted that increasing VAT may be particularly unpopular. He told us:

Raising VAT by a penny in the pound was the second most unpopular tax change that we polled out of 16. The most unpopular was a social care tax. It got a net positive rating of only 3%—that is to say the total of those who supported it minus the total of those who opposed it. It was still a net positive, but compared with changes to income tax it was much more unpopular. A proposal to raise income tax by 2p in the pound while raising the personal allowance by £1,000 to £13,500, which would mean that those earning less than £20,000 paid no more tax, got a net positive of 41%. There is far more appetite in the country for raising more money from income tax than from VAT.115

Rates and thresholds of national insurance contributions

104.Another way to raise revenue would be to change the rates and/or thresholds for national insurance contributions (NICs). It is estimated that in 2019–20 NICs raised £145bn, which is equivalent to 6.5% of GDP.116

105.We have not, however, looked in detail at this stage of the Report at the case for changes to national insurance contribution rates, because of the evidence which we have received on the increased distortions which would result. This is a structural problem which needs structural reform, and we address it in Chapter 6.

Overall recommendation on income tax, VAT and NICs

106.Careful consideration would need to be given to any potential increases in income tax, VAT and national insurance contributions, taking into account the degree to which any increases

• result in additional economic distortions,
• make taxes more or less progressive,
• assist or otherwise with the Government’s “levelling up” agenda, and
• impact on employment.

Increases in national insurance contributions may be especially difficult given the probable impact on jobs, at a time when increasing employment is likely to remain an economic priority.

Rate of corporation tax

107.After income tax, national insurance and VAT, corporation tax is the next largest source of revenue from taxation. It is not covered by the so-called “triple tax lock”. The Office for Budget Responsibility estimates that the corporation tax yield for 2019–20 was £48.0bn, equivalent to 2.1% of GDP.117 HMRC estimates that an increase in corporation tax by 1 percentage point would yield £2bn in 2021–22, £3bn in 2022–23, and £3.4bn in 2023–24.118

108.The rate of corporation tax is currently 19%, which is the lowest it has ever been in the UK and is one of the lowest in the G20. The average corporation tax rate for European OECD countries in 2020 was 21.9% and the world average in 2019 (measured for 176 jurisdictions) was 24.2%.119

109.Corporation tax rates in the UK have steadily fallen since the 1990s, and since 2010 they have reduced from 28% to 19%.120 The Government had intended to reduce the rate to 17%,121 but that was paused in 2018. Despite the overall decline in the corporation tax rate since 2010, the yield has risen from £36.5bn in 2009–10122 to £48bn in 2019–20.123

110.Chris Sanger, Global Government Leader at Ernst and Young and Chair of the Tax Professionals Forum, told us that

[ … ] the statutory corporate tax rate [ … ]is the shop window for a company looking at where to make investments. [ … ] We have seen a considerable reduction [ … ] That has had a big impact on making the UK an attractive place to invest into and to invest in for companies that are here today. “124

When asked about what the impacts of increasing the rate from 19% would be, Mr Sanger said

“In my view, anything that goes higher than the other lowest of the G20, the 20%, would send all the wrong signals about the direction for tax policy making in the UK if you want to encourage international investment.”125

111.On the other hand, John Cullinane, Tax Policy Director at the Chartered Institute of Taxation, said

“I do not think that multinational companies try to fine-tune shavings on the rates exactly like that. There is a lot of evidence that most of their investment planning is pre-tax in most cases, with specific exceptions, and then they look to make sure there is not a fundamental tax problem. Then, okay, they do their tax planning on the back of their commercial investments”.126

112.On the related question of whether increasing the corporation tax rate would raise money or whether Laffer curve127 effects would reduce the yield from an increase in rates, Tom Clougherty, Head of Tax at the Centre for Policy Studies, told us that

you probably can squeeze a bit more money out of the corporate sector with a slightly higher corporation tax rate before any sort of significant Laffer disincentive effects set in. I would question whether that would be the right thing to do, especially at a time like this when you really want to send a pro-business, pro-investment message as we come out of the pandemic.128

113.We were given an opposing view from Alex Cobham, Chief Executive of the Tax Justice Network:

The UK rate is inappropriately low in the international context. As Chris has said, it is well below most major economies, which means we are losing revenues because multinationals are coming here for the market size anyway. It is also far above the effective rates in profit-shifting hubs like the Netherlands or Ireland, so we are not competing with them, even if we wanted to compete in the dirty game of profit shifting. You would be looking at something like the Biden-Harris proposals, raising the rate to something in the order of 28%, which would bring in, depending on the size of the behavioural effects, perhaps £20 billion to £25 billion.129

114.Another consideration which must be taken into account regarding changes to the corporation tax rate is the effect it has on decisions by small businesses to incorporate. We asked witnesses about how the corporation tax rate affects the attractiveness of using limited company structures rather than employment which is taxed under PAYE (see Chapter 6 below). Chris Sanger told us that:

“One or two percentage points is not going to overcome the lack of paying national insurance that comes as a benefit of paying out dividends through a personal service company. You would need to go up quite a few percentage points to address that. Arguably, it may be better to look at the employment/self-employment divide that I know you have considered before, because that would then be taken into account into the IR35 calculation. On the question of raising it for small businesses, if you were going to go down that route, you would really have to distinguish between the avoidance you are trying to deal with rather than penalising smaller businesses because of the third-person problem.”130

115.Recent press reports have suggested that the Government is considering increasing the corporation tax rate.131 We note that the policy of the Biden administration in the US is to increase corporation tax rates.132

116.The UK has a lower corporation tax rate than other major economies, and we believe that a moderate increase in rate could raise revenue without damaging growth, especially if balanced with fiscally appropriate measures to help business, such as enhanced loss relief and capital allowances. However, it is clear that a very significant increase in the rate would be counterproductive.

Tax relief on pension contributions

117.Pension tax relief is the second most costly tax relief and is estimated to have cost £20.4bn in 2018–19.133 Reducing the cost of this income tax relief could make a significant contribution to public finances.

118.Pension tax relief for employees enables them to benefit at their highest rate of income tax for pension contributions both for deductions from salary and for contributions paid by the employer on their behalf. The size of any relief is limited by a lifetime allowance, which limits the value of payouts from pension schemes by providing for a tax charge when the allowance is exceeded, and an annual allowance which limits the total amount of employee and employer combined contributions in any one year.134 When pensions are paid on retirement, any lump sum provided by the pension scheme is free of income tax, and the annual pension is subject to income tax but not national insurance contributions.135

119.At the July 2015 Budget,136 the Government announced a consultation on pension tax relief which raised the possibility of reducing the amount of tax relief for employee pension payments.137 It also suggested moving to a system which is “taxed-exempt-exempt”,138 in which pension contributions would be made out of taxed income, but then the income accruing from such savings within the fund, and the pension income derived from it, would be tax-free. However, the Chancellor announced no fundamental change to the tax treatment of pension contributions in the 2016 Budget Statement.

120.Changes made to restrict pension tax relief have caused problems.139 For example they have had an impact on doctors and consultants, as the limits to, and tapering of, the annual allowance and the lifetime allowance caught many higher-paid public sector workers.140 Some NHS consultants ended up with effective marginal tax rates of over 100% on any additional earnings, meaning that working extra hours would actually make them worse off. The Government sought to address these problems at Budget 2020.141

121.There was a range of views in evidence on pension tax relief: some were supportive142 while others called for it to be restricted.143 The Chartered Institute of Taxation was cautiously positive about the idea of reform:

These are politically and economically sensitive matters in which it will be difficult to achieve consensus and in which technical issues of various disciplines interact with political choices. People have expectations developed over many years and it is clearly undesirable to ‘chop and change’ too often. However comprehensive, public, consultative review seems overdue …

And it went on to say:

This does seem worth revisiting in current circumstances. It may also offer a way of addressing the absolute tax breaks inherent in the current system, without needing to ‘attack‘ one or more of them on an isolated basis. No doubt there were good reasons for the thumbs-down given to the earlier consultation but since then we have had the COVID crisis and the partial retreat in the 2020 Budget from the piecemeal complex measures taken over the last 12 years to reduce the weighting of benefits in the system toward the higher paid.

122.A previous Treasury Committee also considered this relief, and recommended that:

There is widespread acknowledgement that tax relief is not an effective or well-targeted way of incentivising saving into pensions. Ultimately, the Government may want to return to the question of whether there should be fundamental reform. However, the existing state of affairs could be improved through further, incremental changes. In particular, the Government should give serious consideration to replacing the lifetime allowance with a lower annual allowance, introducing a flat rate of relief, and promoting understanding of tax relief as a bonus or additional contribution.144

123.Given the regressive nature of the benefits accruing to individuals from the current arrangements on pension tax relief, especially those in the top earnings decile, the Chancellor should urgently reform the entire approach to pension tax relief.