31 May 2015

Tax Freedom Day has arrived


Tax Freedom Day is upon us again. In 2015 the average person stops paying tax, and starts paying themselves, on 31st May. Every penny they earned from 1st January to 30th May, inclusive, went to the taxman.

Well, not quite. Firstly, and quite obviously, people pay tax throughout the year, not in one big block at the start. Secondly, lots of the total tax take comes from sources people don’t believe or know they themselves are actually paying. Thirdly, there is no average person; practically every single person in the country will actually stop paying tax either sooner or later than 31st May. Tax Freedom Day is not supposed to represent some actual experience for households — it is a regular, timely reminder of how large the state really is.

Tax is fairly simple: the government measures the total amount of money it takes in tax, and makes forecasts for how much it expects to take in future tax years. All the Adam Smith Institute does — like the bodies who work out Tax Freedom Day statistics in other countries — is to convert tax year to calendar year.

The less clear issue here is that total tax includes lots of taxes that households do not notice paying. For example: while national insurance contributions and income tax are right there on your pay slip, VAT isn’t always on your receipt. But at least every knows that VAT eventually comes out of consumer pockets.

Employer-side national insurance contributions seem to be paid by companies. It may be that they actually come out of wages; many have called them the ‘jobs tax’ since they make no difference to workers’ productivity, but they do affect how much the worker costs to the firm.

But even if they are not paid through lower wages, they cannot simply come from companies, since companies are legal constructs. They must come from companies’ owners (through lower returns) or companies’customers (through higher prices). Either way the tax must be paid, and paid by some households or others

Between HM Treasury, the Office for Budget Responsibility, and the Office for National Statistics, we get data on and predictions of total output in the UK economy. But output is not income. Output includes incomes produced in the UK that go to foreign owners—which are not used to bear the burden of UK taxes. And it excludes incomes to Brits from abroad. So we compare taxes to national income instead of national output.

What’s more, output does not account for depreciating capital — like machines going obsolete or buildings falling into disrepair. Since these need to be replaced or kept up to standard, we use net national income instead ofgross national income. You can’t use money to pay taxes and re-paint your shop.

So Tax Freedom Day does not measure when people stop paying income tax out of their income — it measures when households as a whole have lifted the entire tax burden based on their entire income.

What’s more, it understates the size the state can be expected to be over coming decades, since it ignores spending financed by debt. Government borrowing must eventually be paid off, meaning higher taxes than there otherwise might be. Cost of Government Day — when national income stops being spent by the government and starts being spent by households themselves — isn’t until 29th June. All this extra spending must eventually be paid for.

There is good evidence that a smaller state means a stronger economy, and there is some evidence that a smaller state might be a smarter one, that makes better, more focused decisions. Tax Freedom Day falls only one day later this year than last — we needn’t worry about the state expanding and we cannot celebrate it contracting — but we can think seriously about it’s overall size.

Ben Southwood is Head of Research at the Adam Smith Institute.