Principles for tax policy - Mark Boleat

Summary

Jersey has seven long-established principles on tax policy. These principles are unarguable, but in practice debates on particular tax measures often focus on a single objective.

The analysis by Paul Johnson, Director of the Institute for Fiscal Studies, in his book Follow the Moneyis relevant to Jersey. He argues that one of the great failures of tax policymaking is that it happens in a series of silos and that not every tax should try to do everything - “as long as the tax and benefit system as a whole is progressive, not every tax needs to be”. He also makes the point that taxes on companies are borne by people.

In the UK the income of top fifth of households before taxes and benefits is 14 times larger than the poorest fifth; however, this is reduced to 4 times larger after taxes and benefits. In Jersey the tax and benefit system means that the top 10% of income earners have net income 4.1 times the bottom 10%, compared with 7.1 times before taxes and benefits.

In addition to complying with the seven principles, a better-quality debate on tax policy would be helped by a more detailed analysis of the overall effects of taxes and benefits; an analysis of the effectiveness of alternative ways of assisting low-income households; and tax proposals being accompanied by a statement of the objective, and an analysis of the expected impact on different groups and the cost of implementation, together with an analysis of alternative means of achieving the same objective.

Tax policy principles

Jersey’s has long-established principles on tax policy that have been agreed by the States Assembly.

1. Taxation must be necessary, justifiable and sustainable.

2. Taxes should be low, broad, simple and fair.

3. Everyone should make an appropriate contribution to the cost of providing services, while those on lowest incomes are protected.

4. Taxes must be internationally competitive.

5. Taxation should support economic, environmental and social policy.

6. Taxes should be easily implementable and administrable at a reasonable cost.

7. No one individual type of taxation will meet all these principles. But overall, the tax regime should represent a sustainable balance.

These principles are unarguable, but in practice debates on particular tax measures often focus on a single objective and do not take full account of wider issues as set out in the seven principles.

To take a few examples –

• Increasing stamp duty easily complies with principles 3 and 6 but is likely to fall foul of principles 2 and 5.
• Increasing the threshold at which income tax is paid complies with principle 6 but is contrary to principle 3 – as people on the lowest incomes do not pay income tax.
• Exemptions from or differential rates of GST meet principle 3 but are contrary to principles 2 and 6.

Paul Johnson’s analysis

An excellent book on taxation and benefits is Paul Johnson’s Follow the Money ( Abacus Books, 2023). Paul is Director of the Institute for Fiscal Studies. Both he and the Institute are widely respected for their high-quality objective analysis of tax issues presented in a way that is understandable to non-specialists. Jersey cannot afford its own IFS but it can draw liberally on its work and Paul’s work in particular.

The UK has a high standard VAT rate (20%) but with many exemptions and lower rates for particular items – which results in complexity. Paul’s book covers some of the complexities, in particular the fur skin flow chart, published by HMRC, to ‘help’ people work out what VAT they have to pay on items of clothing which contain some fur or animal skin. The flow chart has 12 questions, the final one of which is ‘Does the goat or kid originate from Mongolia, Yemen or Tibet?’ He then goes on to note that chocolate-covered biscuits are subject to VAT, and plain biscuits aren’t, which resulted in the Jaffa cake issue. It was eventually ruled that they are cakes (and therefore not subject to VAT as they are food) rather than chocolate biscuits, which are vatable.

Paul then puts these issues in context –

If you treat similar things differently for tax purposes – whether it be different foodstuffs, different clothes or different forms of income or employment – then you create complexity, inefficiency and unfairness. In the context of VAT, that leads most economists to a deeply unpopular conclusion. It should be charged at the full rate on everything we buy – food, books, children’s clothes, household gas and electricity. The lot.

Obviously, if you moved from where we are to that system you would make a whole lot of people a lot worse off. And because food and household fuel make up an especially large part of the spending of poorer people, you would have a particularly big impact on the poor. But in practice you could raise so much money you could easily more than compensate the poor on average by cutting other taxes and raising benefits. Don’t forget that while poorer people spend a larger fraction of their budgets on these currently zero-rated goods, it’s the rich who spend more in total. In cash terms, VAT zero rating is a bigger benefit to the rich than to the poor. Especially if they happen to like Jaffa Cakes.

The obvious objection is that you couldn’t compensate everyone who is poor. If there are people on low incomes spending especially large amounts of money on food or, more likely, heating, then some would be worse off than they are today. But we should ask ourselves why we might want to subsidise them at the expense of others on low incomes with different spending patterns and preferences? One person’s tax break is another person’s bigger tax bill, after all.

These comments seem relevant to the issue of the coverage of Jersey’s GST, which unlike VAT is broad, simple and low rather than narrow, complex and high.

Paul’s comments on corporation tax are equally instructive –

Of any taxes, corporation tax is one of the more popular. After all, it’s a tax on the profits that companies make, rather than on you or me. And we all love a tax which somebody else has to pay. ‘Don’t tax you, don’t tax me, tax that fellow behind the tree,’ as the saying goes. Even better if it’s a faceless corporation and not a person at all. To state what I hope is the bleedin’ obvious, it can’t be a corporation that pays tax in the end. In the end it has to be real people who pay tax. In the case of corporation tax, that could mean the people who own the company – the shareholders (including you and me if we have money invested in the stock market via our pensions, for example). It could mean customers – companies may raise prices to maintain profits. It could mean the owners of land and natural resources. Or it may mean the company’s employees, whose wages might end up lower than otherwise.

These comments are relevant to Jersey – particularly the key comment: “it can’t be a corporation that pays tax in the end. In the end it has to be real people who pay tax.” However, there is a qualification in that much business in Jersey is international in nature and in the case of some, but not all, companies the people who ultimately pay the tax are not resident in Jersey. It may be thought that the ideal is to levy a very high tax on the profits of companies where that tax would ultimately be borne by people outside Jersey – but in practice this would be very difficult to implement (Principle 6) and would also need to take account that businesses do not have to be located in Jersey and that Jersey’s tax rates need to internationally competitive (Principle 4).

Johnson’s conclusions on tax were summarised as follows -

We should aim for a progressive, neutral tax system. The word ‘system’ is important. One of the great failures of tax policymaking is that it happens in a series of silos. One tax is tweaked here, another is increased over there, with no regard for what the overall impact might be. We also shouldn’t look for every tax to do everything. As long as the tax and benefit system as a whole is progressive, not every tax needs to be, just as not every tax needs to promote a green agenda, so long as the system as a whole works to do that.

Then there’s neutrality – meaning treating similar things similarly. Lack of neutrality is where a lot of the problems we face come from. If you tax self-employment income differently from employment income, or capital gains differently from earnings, or biscuits differently from cakes, you are asking for trouble. You might as well put up a big sign saying PLEASE AVOID TAX HERE. Then enormous complexity is created because of all the efforts to reduce that avoidance. Most of these departures from neutrality are also just plain unfair, favouring one group over another.

As for being progressive, we will all have our own views as to how much more the rich should pay than the poor, but that the tax and benefit system should redistribute is surely not open to dispute. Again, not every tax needs to be progressive to achieve this – taxes on cigarettes are quite definitely not progressive. Poor people are more likely to smoke. But that doesn’t make them bad taxes. Within the tax system it’s income tax which does the heavy lifting on making sure it is progressive.

Measuring the impact of taxes and benefits

Each year HMRC publishes a report on the Effects of Taxes and Benefits on UK Household Income . The main points in the latest report published in July 2023, are –

• Median household income in the UK before taxes and benefits was £35,000 in the financial year ending (FYE) 2022, increasing to £38,100 after taxes and benefits.
• The richest fifth of people's average household income before taxes and benefits (£117,500) was 14 times larger than the poorest fifth (£8,200); however, this gap reduced to 4 times larger (£83,900 and £22,300, respectively) after taxes and benefits.
• Original income inequality (before taxes and benefits) increased by 1.6 percentage points to 50.2% between FYE 2021 and FYE 2022, while final income inequality (after taxes and benefits) increased by only 0.6 percentage points to 29.9%, highlighting the redistributive effect of taxes and benefits.
• Indirect taxes increased income inequality by 3.5 percentage points; the poorest fifth of people paid a greater proportion of equivalised disposable income on indirect taxes at 28.3%, compared with 9.0% for the richest fifth of people in FYE 2022.
• The proportion of people living in households receiving more in benefits than they paid in taxes decreased from 55.0% to 53.8% in FYE 2022.

These figures usefully make the point that while poorer people pay a higher proportion of income on indirect taxes than better off people, the overall effect of the tax and benefit system is to cause a significant redistribution of income such that the gap between the richest fifth and the poorest fifth fell from 14 times to four times.

Jersey does not produce exactly equivalent figures. The most relevant data is the - Jersey Household Income Distribution Report 2021/2022 . This is a very comprehensive study, showing in particular the impact of housing costs on different groups and in itself provides essential data which should help inform policy decisions. Unlike the UK analysis the Jersey data is for deciles (10% of an income group) rather than quintile (5% of an income group). The data is set out below –

The 90-10 ratio divides the income of the 90th percentile household by that of the 10th percentile. This ratio shows how many times greater the income of the 90th percentile household is relative to that of the 10th percentile household.

The 90-10 ratio was highest (7.1) at the pre-benefit income stage, reducing to 5.0 once household and individual benefits were included, indicating an improvement in income inequality through the benefits system. At the next stage of income analysis, after including tax, social security and pension contributions, the ratio reduces further to 4.1.

So the impact of the tax and benefit system means that the top 10% of households have net income 4.1 times the bottom 10%, compared with 7.1 times before taxes and benefits. This ratio has been unchanged since 2009/10. The report notes that after housing costs the ratio increases to 6.6, demonstrating the huge adverse impact that housing costs have had on lower income groups.

The Jersey Community Relations Trust has published Poverty in Jersey Report which discusses the impact of the tax and benefit system on income distribution.

A framework for the future

That the overall effect of Jersey’s tax and benefit system is progressive is beyond question – largely because the progressive impact of income tax and income support significantly outweighs the regressive impact of GST and duties on tobacco, alcohol and petrol.

The seven principles outlined at the beginning of this paper are appropriate – indeed it is impossible to argue against them. But there is no ranking and no quantification of them, nor would be possible to do so.

But a better-quality debate on tax policy would be helped by –

• A more detailed analysis of the overall effects of taxes and benefits.
• An analysis of the effectiveness of alternative ways of assisting low-income households, drawing on extensive UK and international analysis.
• Tax proposals to be accompanied by an analysis of the impact on different groups and include a clear statement of –

          o The purpose of the proposal (eg to reduce costs faced by low-income households).

          o The likely effect of the proposal.

          o The costs of implementing the proposal.

          o Alternative means of achieving the same objective.

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Sir Mark Boleat is Research Adviser to the Policy Centre Jersey. He has undertaken consultancy projects for the Government of Jersey on housing, consumer protection, immigration, financial resilience and Island identity and for clients in the UK and internationally on housing finance and the development of public policy. He has written several books and numerous papers on housing and housing finance in Jersey, the UK and globally.

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