29 May 2018

Happy Tax Freedom Day. Let’s hope it’s earlier next year


In a few months, tedious killjoys and fashionable non-conformists will complain about shops putting up their Christmas decorations too early. But there’s another day worth celebrating that comes later each year.

Every year, the Adam Smith Institute calculates Tax Freedom Day to illustrate the size of the annual tax burden. May 29th is first day of 2018 where the average Briton has finished paying off their taxes and starts working for themselves. This year is the latest it’s been since at least 1995.

It’s probably even later than it was in 1994, but we can’t say for certain because the ONS junked all pre-1995 net national income data in a recent revision. Our calculations suggested that last year was the latest it had been since the mid-80s. An alternative measure of the tax burden from the Institute of Fiscal Studies suggests it is the highest it’s been since 1986.

What’s changed? One reason the tax burden has grown is because tax bands have failed to keep pace with earnings growth. One analysis found that half a million people will pay the top rate of tax by 2021 if tax bands aren’t revised.

Tax Freedom Day focuses on the “average” worker. In reality, there is no average worker. The Treasury rightly points out that 1 per cent of taxpayers pay 28 per cent of the total tax take. This isn’t particularly healthy. We’re over-reliant on the volatile fortunes of the super-rich.

Even so, ordinary Brits probably pay more than they think. One virtue of Tax Freedom Day is that it counts all taxes, not just the ones you see on your payslip and your shopping bill.

Take Employers’ National Insurance. It might not appear on your payslip, but you’re poorer as a result. Multiple studies have found that when similar taxes are cut wages go up.

It’s the same story with Corporation Tax. While HRMC collects Corporate Tax payments from firms it is ultimately paid by workers, consumers and shareholders. When my predecessor Ben Southwood reviewed the empirical literature he found that, on average, workers bear more than half of the total tax take.

Politicians calling for even higher levels of government spending must recognise that by international standards we are already highly taxed. Tax Freedom Day comes more than a month earlier in the US and Australia.

At the last election, Jeremy Corbyn pledged to spend an extra £50bn a year and has made further commitments since. At the same time, the Conservatives were unable to cut the pensions’ triple lock, which costs an estimated £6bn a year. Even spending derided by economists across the political spectrum, such as the £3bn worth of farm subsidies under the Common Agricultural Policy, are set to continue to 2024. Without further cuts, increased funding pressures on the NHS and social care will leave us waiting until June to celebrate Tax Freedom Day.

In truth, all taxes aren’t equal. While almost all taxes act as a drag on economic activity, there are better and worse ways of raising revenue. For example, broad-based taxes on consumption tend to hit growth less than other taxes. Other taxes aren’t so benign. Take Stamp Duty Land Tax, a review by the Australian Government  found that it destroyed 75p of wealth for every £1 it raised.

Taxes on capital are particularly harmful. Nobel Prize-winning economist Robert Lucas estimates that eliminating all capital taxes (and replacing them with consumption taxes) would do more good than abolishing boom and bust altogether. Abolishing Corporation Tax and replacing it with a Cashflow Tax where capital expenses are fully deductible would boost investment and raise productivity. Similar reforms in the US led to a 17.5 per cent increase in investment, raised wages by 2.5 per cent and increased employment by 7.7 per cent.

Supply-side reforms can boost revenue. But we shouldn’t assume tax cuts will always pay for themselves. They may lower the sticker price, but we still need to constrain spending. After all, all spending must be paid for through taxes.

The good news is that the Government is bringing overall spending down. Cost of Government Day, which factors in borrowing as well as taxes, is nearly a month earlier than it was in 2010. In many ways, Cost of Government day is the true Tax Freedom Day because money borrowed will eventually need to be paid for through taxes.

All the signs point to Tax Freedom Day falling even later next year, but it’s not inevitable we will be waiting until June to start working for ourselves. If the Government is willing to make tough spending decisions, eliminate costly regulation and reform the tax code, we can make Tax Freedom Day come earlier next year. Just like Christmas.

Sam Dumitriu is the Head of Research at the Adam Smith Institute.