24 March 2024

Weekly Briefing: Beware the cliff edge


There are a few things that are certain in life; trips to the loo, kicking the bucket and paying taxes. And in Britain, the last of those is particularly painful.

By now we’ve all heard on a number of occasions that the tax burden is at its highest level since Clement Attlee was Prime Minister. However, it’s not just how much tax is collected that’s the problem, but also how it’s collected.

Coming in at about 10m words and 21,000 pages, our tax code is around 12 times the length of the complete works of Shakespeare. But it’s decidedly less entertaining. From start to finish, it is stuffed with a cornucopia of unnecessary and distortive measures. The scale of the problem is so bad that it is impacting our international tax competitiveness, hampering our economic growth. In the Tax Foundation’s latest International Tax Competitiveness Rankings, Britain fell three places, landing at 30th place out of the 38 OECD countries surveyed. This puts us behind Canada, Japan, the United States and Germany.

While this debate usually focuses on the scale and complexity of our tax system, there’s one detail that often goes unnoticed.

Earlier this week, the Centre for Policy Studies and Tax Policy Associates hosted an event exploring the terrifyingly named phenomenon of tax ‘cliff edges’. A cliff edge occurs when someone experiences a sharp jump in their average tax rate and/or loses the benefits they were claiming at their previous level of taxation. As you can imagine, this is a pretty shocking thing to experience, essentially resulting in having the rug pulled out from underneath you.

But in addition to their cruel treatment of the unfortunate taxpayer, the existence of cliff edges in our tax system is a harmful economic distortion. They discourage aspiration by disincentivising people from earning more. What advantage is there is taking a promotion, picking up a few more hours, or in some cases working at all if the tax man will take 50, 70, or in some particular cases 90p of every additional £1 you earn? Why increase your workload if the state claws back the child benefit you were previously entitled to, leaving you worse off overall? Just as if you were approaching an actual cliff edge, your instincts would presumably deter you from hurtling towards it.

While there are other examples, such as the withdrawal of personal allowance for those earning upwards of £100,000 (meaning they jump up to paying a 60p marginal tax rate, with National Insurance on top), perhaps the most egregious case is in relation to childcare.

Dan Neidle, the founder of Tax Policy Associates, explained that the childcare subsidies recently expanded by Jeremy Hunt, which could be worth £20,000 to a couple in London, vanish when either parent hits that same £100,000 salary threshold. As the Institute for Fiscal Studies have calculated, this creates an absurd environment whereby a parent of two young children earning £134,000 will be worse off than someone on £99,000.

The IFS’ Stuart Adam, also on the panel, decried this tax trap, saying:

‘The thing that really looks maddest to me, I probably would actually say the childcare cliff edges at £100,000, because it is so big and the fact that you are worse off earning £130,000 plus than you would be earning £99,000 just seems absolutely insane.’

But the spectre of the cliff edge doesn’t just impact individuals and families: it also haunts businesses. Many small companies hold back their growth before they hit the VAT registration threshold of £85,000 for the 2023/24 tax year (or £90,000 from April). That companies are forced into a position where they may never realise their potential is shocking.

You may think the obvious solution is to increase the threshold. But this would just kick the problem into the long grass. As Neidle pointed out, the rational administrative move would be to dramatically lower the threshold as we have seen in a number of other countries, or to use existing revenue to slash the overall rate. But that would be hugely unpopular politically – and enmesh a load of smaller companies within the VAT system, which is often an administrative nightmare.

One of the depressing points of agreement on the panel was that these pinch points in the tax system are often the result of politics overriding economics. Perhaps it’s not surprising, then, that a striking number came into being during George Osborne’s Chancellorship. Until our politicians are honest with voters about the trade-offs of their policies and are prepared to face up to the tough decisions needed to fix our chronic problems, we’d better tread carefully, because cliff edges are here to stay.

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Joseph Dinnage is Deputy Editor of CapX.