Taxes and Subsidies: Incentives and Disincentives

Like it or not the world is driven by economic activity. Nothing happens unless people buy something, be that a product, service or employees. These economic activities vary in importance to those procuring and supplying them, with the balance point between supply and demand coming when the price for that product, service or employee is agreed between producer and purchaser. However governments have their own idea of how much of each product, service or employee should be procured and they attempt to control this via a number of mechanisms:

  • Banning that activity completely (e.g. selling of drugs that it determines only it should have the monopoly on);
  • Banning that activity as best it can (e.g. sex work);
  • Setting the price for that product, service or employee. This is very dangerous as it moves the economic equilibrium point and always has adverse and unintended consequences (e.g. national minimum wage, energy prices, train fares, etc.);
  • Taxing and subsidising.

When the state doesn’t want an activity to happen, but recognises it cannot successfully ban that activity, then it taxes it. Examples are the ‘sin’ taxes on tobacco and alcohol (the latter I’ve blogged about here). When it does want an activity to happen, but recognises it cannot do that itself, then it subsidises that activity. An example is agriculture.

However, although it is widely recognised that if you tax an activity then you create a disincentive to undertake that activity, the government then taxes anything that it sees happening in sufficient quantity for it to become a useful revenue stream if taxed. The unintended consequence of this is that less of that activity happens (or less of it happens legitimately). Similarly the government identifies activities that people cannot afford to do by themselves (usually due to their excessively high tax burden) and creates subsidies (called grants, tax credits, benefits, etc.) to assist those people.

So let’s take a look at what the government taxes, that is what it is (often unintentionally disincentivising):

  • Employment: Employer’s National Insurance is a tax on employing people, thereby creating disincentives for businesses to employ people until they really have to. Rates vary from 0% to 13.8%;
  • Work: Income Tax and Employee’s National Insurance are taxes on employees, making it costly to work (legitimately). Income Tax rates vary from 0% to 45% (recently reduced from 50%) and National Insurance rates vary from 0% to 12% – maximum of both is now 47% (45% Income Tax + 2% NIC);
  • Spending: VAT is a tax on spending. Spending is the way that we purchase items we need (or just want) which drives the economy and employs people in profitable activity. We are taxed on virtually everything we buy, except a small subset of items that the government deems as essential, such as some food, books and children’s clothing, but not gas, electricity, petrol, diesel, women’s sanitary protection products, incontinence pants, etc. (rates vary from 5% to 20%);
  • Insurance: Insurance Premium Tax is levied on all insurance premiums (6% or 20%);
  • Travel: Air Passenger Duty is levied on each segment that you fly from the UK (ranges from £13 to £188 per flight);
  • Profitable business: Corporation tax punishes the profitable business and creates incentives for companies to employee accounting schemes to minimise their corporation tax burden. Rates vary from 20% to 25%;
  • Earnings from a profitable business: Dividends are taxed with rates from 10% to 37.5%;
  • Digging oil out of the ground: Oil production companies are subject to several separate tax regimes to punish them for their ‘super-profits’. These taxes include Petroleum Revenue Tax (50% on value of oil extracted), Ring Fence Corporation Tax (disallows offsetting losses made elsewhere, unlike for all other companies) and the Supplementary Charge (75%);
  • Pensions: saving for your retirement is free of tax in certain closely-prescribed circumstances – step outside of those criteria and face tax rates from 20% to 55%;
  • Moving house: Stamp duty is levied on buying houses (!) with rates varying from 1% to 7%;
  • Death: Inheritance Tax is levied on dying. So if you haven’t managed to spend the lot before you expire then they take another swipe at whatever you’ve built up for your family (rate is 40%). Obviously government cannot disincentivise dying, but instead creates a market for exploiting loopholes that mainly the rich alone can afford to utilise.

Conversely (and often perversely) government creates schemes that subsidise many activities, again this may be unintentional:

  • Unemployment: I have written on this extensively elsewhere, but even Beveridge, the architect of the modern welfare state, warned against excessive or lengthy unemployment ‘benefits’;
  • Farming: the idiocy of the Common Agricultural Policy is well-documented by many already;
  • Under-performing or failing businesses: the history of nationalising or subsidising failing businesses, in the vain attempt to somehow turn them around by managing them with civil servants, has proven that this approach simply destroys more value than it creates;
  • Marriage: the latest moronic social engineering plan from the Conservatives. ‘Nuff said;
  • Children: while Child Benefit in itself probably isn’t enough to incentivise anyone to have children, the plethora of services provided to parents does create a system which taxes those who chose not to have children more and subsidises those who do have children. More social engineering.

As can be seen from the few examples above the UK has created a taxation system that creates some unfortunate economic incentives and disincentives. These all distort the market, whether they intend to or not. That we discourage employment and encourage unemployment alone should make us question the sanity of this system; and surely the continually high level of unemployment is evidence of this. Similarly taxing successful businesses and subsidising unsuccessful ones can only encourage the wrong behaviour (witness the legal use of tax avoidance to minimise corporation tax and the subsequent idiotic moral outrage at this natural consequence).

While we let government distort the market in the way it thinks benefits its electorate* then the economy will never operate freely, employing all, feeding all, benefiting all. We will forever be slaves to these idiots, few of which have ever run a successful business.

*note use of word ‘electorate’ – the fools who vote them into power – not citizens, the poor schmucks who pay for them and their ideas.

On The Stupidity Of Bureaucracy

I recently tried to pay my company’s quarterly VAT bill to Her Majesty’s Revenue and Customs (HMRC). As I used the compulsory method and logged onto the ‘Government Gateway’ website I discovered that I couldn’t submit a VAT return. In a panic I called the HMRC office that deals with our returns (only 16 minutes negotiating their phone system and on hold before I spoke to a human). There I discovered yet another travesty of bureaucracy.

Some background:

We moved our company offices in March last year. I asked our accountant, who is registered with HMRC as our ‘tax agent’, to change our VAT registration address, but they weren’t allowed to. Although this was stupid I have now discovered that the actual process verges on ridiculous.

As time progressed I continued paying the quarterly VAT via the Government Gateway website without any issues. However, earlier this year I tried to change the VAT registered address online. To do this you have to register separately for the ‘Change Business Address’ service on Government Gateway, even though I’m already registered to pay VAT and PAYE.

When you register for any new Government Gateway service they send you an authorisation key in the post. So guess where that went? Yes … to the old address!

This would have probably been ok but for another bureaucratic organisation: Royal Mail. They cannot setup a redirect on a shared office, as ours was previously, and so this post was never delivered but instead returned to Government Gateway; subsequent VAT post must have been sent back to HMRC too.

So despite the fact that I’ve been paying the VAT as expected on each quarterly date they registered us as a ‘lost business’. This is despite:

  • our address being online on our website
  • our address being correct at Companies House
  • our address being correct at HMRC to pay PAYE
  • them having my mobile telephone contact details

Finally in their completely inadequate ‘tracing’ process they sent me an ‘update contact details’ form to my home address. This lay unopened, like all my HMRC post, for a couple of months.

When I did discover it I completed the form and sent it off, receiving a new VAT registration certificate at our new address last month. However, because we were registered as a lost address we were switched to six-monthly returns, so a VAT payment is not due this quarter (after all the panic). When I explained that I have £90,000 to pay the nice chap on the phone said “well you’ll have to wait” – so that’s about £250 interest we’ll make! Also there are also no penalties as we’ve been paying VAT to date and it’s HMRC who changed our status.

Just how stupid is this system?

  1. You need to change your business address?
  2. No, you can’t do this online even though everything else is without registering for the ‘change address’ service
  3. When you register we’ll send you the key you need to your old address

The chap at HMRC was surprised that I hadn’t registered for this important service already: how often does he think businesses move? This was our first address move in nine years! And who would honestly expect that changing address for VAT would be so difficult? Weirdly HMRC allows you to change the business address for paying PAYE and other taxes online without this convoluted mechanism: the same government department!!!

Now the astute among you will know that HMRC was formed in 2005 by the merger of HM Customs and Excise (who dealt with VAT, customs and excise taxes) and Inland Revenue (who dealt with company and personal taxes). This merger was sold to parliament as a method of making 12,500 job savings by then Chancellor of the Exchequer, Gordon Brown. Obviously little actual integration has occurred in the intervening eight years, even though all payments and returns are made through the Government Gateway.

This is yet another demonstration of the stupidity of bureaucracy, especially in government.

By the way, I’m not suggesting that this process is ‘accidentally’ used as a tax avoidance mechanism!

Lies, Damned Lies and Dodgy Statistics – The Guardian’s approach to financial reporting

Introduction

Before we begin let me make a few statements:

  1. Firstly, I love the Guardian. Its style, commentators and quality of journalism are nearly unsurpassed in the UK’s daily newsprint media. Only the FT is better in my opinion;
  2. Secondly, I cannot abide the misuse of statistics or data, whether unintentional, through ignorance, or intentionally through malice;
  3. Lastly, I have no time for the Conservative Party[1], nor any political party, and am always dubious of political donations, whether from company or union.

The article

On Tuesday the fifth of June, 2012 The Guardian published a piece on page 7 about Lycamobile and their donation to the Conservative party. This was written by Rajeev Syal and Solomon Hughes.

In it they referred to the donations of “more than £300,000 over the last nine months”. I cannot and do not disagree with this data, as I have no independent way to verify it; the data is purported to come from the electoral commission. However the first line of the article stated that the company “has paid no corporation tax for three years”. It then later in the article states that the company “did not pay any tax between 2008 and 2010, despite generating a turnover of between £47m and £88m”. Before I start any analysis just a basic understanding of the way company accounting works suggests that this is in fact two financial years, 2008-2009 and 2009-2010 (their financial year runs from 1st March to 28th February the following year; so this is not actually ‘three years’. Also, confusingly, why is there such a variance in the revenue figures of £47m and £88m – that’s quite an error margin!

Corporate Taxation 101

Now let us start with some basics for those not initiated in corporate taxation; if you are then please skip this paragraph. Revenue is the money the company earns due to its principal business activities. Then a company has costs, or outgoings. These costs are paid for from the revenue or from savings (capital carried over from previous years or other investments, such as share capital or loans). If the costs cannot be met by revenue or savings and investments then the company is insolvent and can be declared bankrupt. If the outgoings are less than the revenue then the difference is called a profit (the opposite case is called a loss). These profits are subject in most countries to some form of taxation on profits. In the UK this is called Corporation Tax (or CT). If a loss is made then no tax is due. Losses can be carried over to subsequent years when profits are made to balance them out. This is logical, otherwise a company gets taxed on the upside, when it is profitable, but has no help on the downside.

The Guardian’s analysis

Now let us go back to the Guardian’s first sentence: “A mobile phone company that has paid no corporation tax for three years”. Can you see where this may be going yet? So having checked the published company accounts from Companies House I can clarify this misstatement as containing a number of errors:

  1. The figures are in fact for two financial years: 2008-2009 and 2009-2010 (24 months), as I suspected. Reporting this as “for three years” is factually incorrect and either professionally negligent or deliberately misleading.
  2. The revenue figures quoted are £47m for 2008-2009 (actually £47.9m, conventionally rounded to £48m) and £83.9m (not £88m) for 2009-2010 respectively. To report this as “between £47m and £88m” is semantically incorrect as well as professionally incompetent.
  3. The company made a loss in both 2008-2009 (-£10.9m) and 2009-2010 (-£8.3m). Therefore no UK Corporation Tax should be due on earnings in these years. However £8,465 was paid in CT in 2008-2009, possibly due to its minimal profits carried over from the previous year of £40,863. Therefore the statement “paid no corporation tax” is also untrue and either professionally negligent or deliberately misleading.

Interestingly the company did make a profit in 2010-2011 of £4.6m from revenues of £116.8m. And paid no Corporation Tax! This is because it was able to completely legally offset this profit against its loss of £8.3m the previous financial year. Some of those with a socialist leaning may not like this ability to offset losses against profits, but it has been around for a long time. I am surprised the Guardian didn’t lead with the more sensational, but at least factually correct, headline that ‘the company made £249m in revenue over three years (correct as 2008-2011) and has paid minimal corporation tax‘(£8,465). In reality across four years it has made a £14.6m loss and has paid 8,465 Corporation Tax on that, which seems pretty fair. Even if it hadn’t made its enormous political donations of £300,000 to the Conservative Party, alleged by the Guardian, this would not have reduced those losses.

The Company’s market

It could be implied from the article that the company should somehow be more profitable; to the innumerate that this could all appear to be some elaborate tax-dodge. However Lycamobile, which started in late 2006, operates as what is called a ‘virtual network mobile operator’; that is it has no physical mobile telephony infrastructure itself, only usually having the billing platforms that are traditionally associated with the real mobile provider (of which we only have 4 now in the UK[2]). Frequently the virtual network operator is supplied all the necessary IT and network infrastructure by the actual network services provider company, who ‘white-labels’ its service to them. Virgin Mobile is a well-known operator in this market place. This type of company makes an extremely low profit margin as it is typically taking a few pence per transaction and relies on huge volumes to drive revenues sufficient to overcome its fixed costs and therefore make a passable operating profit.

History repeating itself?

Sadly for verity, the Guardian has form with this type of financial legerdemain. On Saturday the 18th of February 2011 the Guardian published a front page article entitled: “Barclays bank forced to admit it paid just £113m in corporation tax in 2009”. This article, by Jill Treanor, rather luckily coincided with a time of UKUncut protests, and as such caused a firestorm on Twitter over that weekend. The article suggested that Barclays had earned £11.6bn of profits in 2009 (their tax year is also the calendar year) and only paid £113m Corporation Tax. A quick reference to the accounts shows firstly that £6.8bn was a one-off profit due to the sale of Barclays Global Investors (BGI) to Blackrock, which is treated differently for tax reasons (possibly under legislation introduced by Gordon Brown, though I am happy to be corrected on this, if wrong). In that year Barclays incurred a £43m tax liability on the disposal of BGI. Excluding the one-off disposals this leaves the profit from operations of £4,559m (notice that £4,559m plus £6,777m do not make £11.6bn, but £11.3bn – the Guardian appears as bad at basic maths as its reputation is for spelling). On this £4,559m operating profit it paid £1,047m in tax, an effective rate of 23.0%. The Guardian claimed that Barclays only paid £113m in Corporation Tax: It did; Corporation Tax is the UK’s name for its tax on company profits, but a tax on profits isn’t unique to the UK. Companies usually pay their tax on profits in the country in which those profits are earned. This is common and obvious: why would a government let a company trading locally repatriate all of its profits to pay tax in a lower tax regime, unless forced to by tax treaties[3]? So Barclays paid overall 23.0% tax on its operating profits, although only 10.8% of this was to the UK tax authorities. Is that a bad thing? For the UK, possibly yes. For the other countries in which Barclays operates, employs people, offers their services and pays tax: no, it’s a good thing. If people want to be jingoistic, racist or just ‘patriotic’ and believe that UK-based companies should only pay a tax on profits in the UK, then let them have their outdated attitudes. However we should recognise that we inhabit a global market, and so many UK brands and companies are no longer owned by UK companies: Santander owns a whole swathe of former UK banks and building societies; Telefonica owns O2; etcetera. To believe that a UK company is UK only and should only pay tax here is a ridiculous view in this day. In addition to the payment of tax in the locale that the profits are earned in there is another mitigating factor already covered: the carrying over and offsetting of losses in previous years. Barclays was one of many UK banks that suffered due to the nearly global collapse of the banking markets in the sub-prime crisis of 2008, the preceding year to that targeted by the Guardian’s article. There were undoubtedly considerable losses: its value on the balance sheet fell by £673bn in 2008 and £111bn in the following year. As a comparison Guardian Media Group earned £591m in revenue across the two comparable financial years covering 2008-2010 and paid ‘no Corporation Tax’ by their definition (actually receiving a £30m tax credit, equating to 5.1% tax refund). This was because they made a loss of £267.7m.

Conclusion

At a time when journalism as a profession is under detailed scrutiny from both the Leveson Enquiry and the Select Committee for Culture, Media and Sport, I would expect the Guardian to ensure an article that is couched in such accusatory terms (“Tory donor firm paid no corporation tax”) is at least technically correct. On the financial aspects it is not; it could be considered professionally negligent of Syal and Hughes at best, or deliberately misleading by its enemies. It highlights a potential lack of governance controls at the paper, which Alan Rusbridger and the rest of the Guardian Media Group board should be concerned with, for the attention that sloppy reporting like this may bring in the current climate. Also if Lycamobile was an exchange-listed company there could be a significant impact on its share price and trading volumes following publication of an article such as this, potentially resulting in investigations from the Financial Services Agency or other exchange-based authorities.

For the sake of the Guardian, a newspaper I love, I would hope this is just basic negligence on a long bank holiday weekend. They should be concerned, as it wouldn’t take much scrutiny from Jay and Leveson, with their power to access emails and texts, to get to the cause of such sloppy reporting and identify governance failures. Guardian: I expect better.


[1] Declaration: I was a member of Essex University’s Conservative and Unionist Association, affiliated to the Federation of Conservative Students, in 1987-1989. I resigned on principles of libertarianism.

[2] Telefonica O2, Everything Everywhere (the merged Orange and T-Mobile), 3 and Vodafone.

[3] The Republic of Ireland is a useful example: at 12.5% its corporation tax rate is one of the lowest of major countries in the EU and so many companies, especially from the UK, have relocated their head offices there to take advantage.