U-turn on Charity Tax Relief

George Osborne's budget in March announced that tax reliefs for high earners, including on donations to charity, would be capped for each taxpayer at one quarter of their income.  I commented at the time on the implausibility of the reasons they gave for the cap. On Thursday, Osborne recanted: donations to charity will not after all be included in the cap.

I can confirm that we will proceed next year with a cap on income tax reliefs for wealthy people, but we won't be capping relief for giving money to charity.
It is clear from our conversations with charities that any kind cap could damage donations, and as I said at the Budget that's not what we want at all. So we've listened.

Osborne did not in fact say anything in his budget speech about not wanting to damage donations, but he may well have made some such remark to someone "at the Budget".

What's remarkable about this is that either Osborne is more stupid than I think he is (and I am not an admirer), or he knew from the first that restricting tax relief on donations to charity would mean that charities got less money.  Osborne's colleague, Treasury Secretary David Gauke said (in a radio interview) that the charity tax relief cap would bring in £50m-£100m a year and that money has to come from somewhere.  No one knows just what the effect will be on donors' behaviour: if they make the same net donations as before, £100m saved will cost the charities £100m; if as seems likely the cap acts to discourage donations the effect on charities will be amplified (though the estimate from Oxford Economics that it would cost the charities £500m is highly unconvincing).

So what's happened is that Osborne announced his plan, and the charities who would obviously be adversely affected by it protested.  There was nothing remotely unpredictable about that.  And if Osborne wasn't willing to stand up to the protests, why did he announce the plan in the first place?

I have a suspicion that he planned this all along.  The sums involved are small enough not to make much difference to the budget, so he was always in a position to change his mind.  And by starting the fight then withdrawing from the field, Osborne leaves tax reformers on the left who support the proposal in the line of fire. And most importantly it's handy for a government to have a popular announcement up its sleeve for release when it wants to deflect adverse publicity, say when the Culture Minister is in trouble for his extraordinary closeness to News Corp (it will be recalled that he was brought in to oversee News Corp's bid for BSkyB because Vince Cable was found to be insufficiently neutral).

Hanlon's (or Heinlein's) razor advises "Never attribute to malice that which is adequately explained by stupidity."  But is Osborne really that thick?  Perhaps his supporters would like to help me on that.

Uncharitable donations

The government says that it is concerned that rich people may be avoiding tax by giving money to charities which do not "do a great deal of charitable work".  This follows a report in the Telegraph of an interview George Osborne gave them in which he included charitable donations as one of three "aggressive avoidance schemes" he wants to crack down on, based on a confidential report prepared for him by HMRC.  "Mr Osborne insists that he wants to protect and encourage philanthropy, but Treasury sources say the system is open to abuse as people are giving money to foreign charities which they have often established themselves."

There is something very strange about this.  Tax relief on donations to a charity is available only if the charity is "formally recognised by HM Revenue & Customs (HMRC) for tax purposes."  If the HMRC is unhappy about the validity of a foreign charity all it has to decline to recognize it for tax purposes.

I think talk of fake charities is a smokescreen.  If the government were genuinely concerned about what charities are doing, it could instruct HMRC to check them more carefully, or, if it thinks that's too difficult for HMRC to do properly, it could allow tax relief only on donations to charities registered in the UK.  I think this is simply a tax grab from charities genuine or not, which the government doesn't have the courage to admit to.

It's only fair to point out that there is support from the left for Osborne's view of this.  In the face of such an alliance, I am on the side of the charities.

More on marginal tax rates

In my post on optimum tax rates I mentioned as an afterthought that the 52% marginal direct tax rate in the UK goes through what seems to me to be a psychologically important level of 50%.  Comments on a blog that's easier to read than this one have led me to expand on the point.

The analysis of optimum marginal tax rates depends on how much taxable income changes when the tax rate changes.  Changes in taxable income can result from two causes: reduction of broad income and tax avoidance which reduces taxable income without the taxpayer actually earning less money.

Tax avoidance, through income timing or taking income in a different way, will involve careful planning, so all avoidable taxes should be considered.  But reduction of broad income by trying less hard to earn money, or by moving overseas to a friendly tax regime, will be caused not so much by considered analysis of what's worth it for the money as by one's gut reaction to the marginal tax rate - "Do I really want to do this piece of work just so that Osborne can get 52% of the reward?"

In that context it seems to me that 50% is an important level to breach.  It may be that the curve relating taxable income to marginal tax rate has a kink in it at about that level, so that either 42% or 62% might raise more revenue than 52%.

This is just speculation; empirical evidence would be hard to come by.  One can't simply experiment with tax rates from year to year: a temporary change will see more elasticity than a permanent change, because some top-rate taxpayers are able to advance or defer their income.

A fairer tax

The ConDems tell us that they want taxation to be fairer. It is widely assumed that they will increase VAT, perhaps to 20%. But the Office for National Statistics has reported that VAT as a percentage of disposable income is paid disproportionately by people on lower incomes. The ONS explains that "those in higher income groups tend to channel a larger proportion of their income into savings and mortgage payments, which do not attract indirect taxes".

I suggest that instead of a VAT increase, the government should introduce a tax on mortgage interest payments (more precisely, i suggest a tax on all personal secured loan interest) at the same rate of VAT. This would have the following advantages:

- it would compensate for the regressive nature of VAT
- it would tend to suppress the sort of house price bubble Vince Cable warned about in a Commons question in 2003 (this question has been cited to support the false claim that he "predicted the crisis").
- it would raise relatively little money now, with interest rates so low, but increasing amounts as the economy recovers and interest rates rise. So it would give the markets confidence that the deficit will be reduced, without imperilling the uk's fragile economic recovery.
- the tax would be paid by mortgage borrowers currently enjoying a windfall gain from the extraordinarily low interest rates brought in to boost the economy.

It would be easy enough to collect, simply by making secured loans, including mortgages, unenforceable unless they are registered with HMRC.

When Gordon Brown Got It Right

I disagree with a lot of what Gordon Brown has done as Chancellor and Prime Minister. But he did get one thing very right - when in 1997 he abolished Advance Corporation Tax (ACT) (with effect from 1999).

In the UK, companies are required to pay Corporation Tax on their profits. ACT required them to pay that tax in advance on that portion of their profits they chose to distribute to shareholders as dividends. The ACT paid was subtracted from the Corporation Tax charged at the end of the tax year.

Payment of ACT was deemed to discharge the shareholders' obligation to pay basic-rate income tax on dividend income. Shareholders not required to pay income tax, including Pension Funds, were entitled to claim back that tax.

So far so plausible, until one spots that the ACT was both set against the company's Corporation Tax obligation, and claimed back by Pension Funds. So despite its name, it acted not as a tax but as a government subsidy for Pension Funds. By abolishing it, the Chancellor not only simplified, for once, the tax system, but also removed a subsidy and so saved money for the public purse. This abolition is what is referred to in those journalistic and political circles which disapprove of government subsidies unless they go to the relatively wealthy as "Gordon Brown's Pension Fund Tax Grab".

And now George Osborne, in his speech to the Conservative Party Conference, has promised to reverse in some unspecified way this "tax grab". He made this pledge in a speech heralding economic austerity for all, including pay freezes in the public sector. Reportedly the pledge got the biggest cheer of the whole speech.

Sometimes I think the Conservatives might not actually be worse than the present lot. Then they kindly put me right.