How you probably pay a higher rate of tax than the wealthiest in society
We are often told that the UK tax system is progressive: the better you are doing financially, the higher the rate of tax you pay. In this way, you do your bit for others as you enrich yourself.
And looking at some individual taxes, that appears at first sight to be true – the higher your earned income (wages, salary, etc), the higher tax you pay; the higher your (realised) capital gains[1], the more tax you pay, etc. However, something strange happens when you are extremely rich. Your effective tax rate drops dramatically. And it keeps dropping as you get richer and richer! The rate of tax on wealth and on unrealised capital gains on that wealth in this country (and most others) is zero. This has the extraordinary effect that if you are super-rich, you can easily pay a lower tax rate than almost everyone else. This does not happen for others who are merely rich, and it makes a significant difference to the country’s tax revenue. Tax reform should start with the richest. That is where it produces no hardship for those being taxed. And it will give the country the money it needs and a system that really does what it says it does (i.e. ensure that the rate of tax you pay is progressive). Addressing this should be one of the Treasury’s highest priorities.
There is a lot of confusion in discussions around this. One reason for that is the concepts are expressed in complicated technical jargon. Here is a simplified version (which is still complicated enough). A more comprehensive explanation of the assumptions underlying this analysis is in the Appendix.
How different people receive their income
The bottom 99% of the income spectrum earn between £0 and £180,000 and have wealth of £0 to £5,500,000. We can imagine a very well-off person just about to enter the top 1% (let us call her Miranda) earning £180,000 and with wealth of £5,500,000. In the middle of the income spectrum, the median person (average Joe), has an income of around £30,000 and median wealth is around £300,000. We can be reasonably certain what income tax and NI they pay – around 38% for Miranda earning £180,000 and 16% for the median earner (Joe). Therefore, although Miranda and Joe’s income differ significantly, the rate of tax they pay on their income is progressive.
Estimating the tax they pay on their wealth is more difficult as capital gains tax is charged only on realised capital gains and primary residences are exempt. However, this complication does not change the picture significantly. Within the bottom 99%, most people’s wealth is tied up in their houses and is therefore exempt. It is likely that Joe would pay zero tax on income from his wealth and Miranda would be likely to be paying under 10% on the income from hers. Both Joe and Miranda are largely taxed on earned income, and the taxation is progressive.
We normally think of our income as our earned income: our wages, salaries (and bonuses, if any) – but really, we should think of our total income as being how much richer we would be at the end of the year, if we did not have to spend anything. For most people, that would not make very much difference, but for very seriously wealthy, that way of looking at things changes the picture beyond recognition. If you are extremely rich, you are likely to have huge amounts of unearned income, all of which makes you richer: dividends, realised capital gains and unrealised capital gains. With our tax system, this means you can easily be paying less than normal people pay on earned income.
How that affects our tax
To show just how much that changes the picture, journalist Ben Stein reported in the New York Times some analysis carried out by Warren Buffett, one of the world’s richest men:
“Mr. Buffett compiled a data sheet of the men and women who work in his office. He had each of them make a fraction; the numerator was how much they paid in federal income tax and in payroll taxes for Social Security and Medicare, and the denominator was their income… It turned out that Mr. Buffett, with immense income from dividends and capital gains, paid far, far less as a fraction of his income than the secretaries or the clerks or anyone else in his office.
Further, in conversation it came up that Mr. Buffett doesn’t use any tax planning at all. He just pays as the Internal Revenue Code requires. ‘How can this be fair?’ he asked of how little he pays relative to his employees. ‘How can this be right?’”
As Buffett’s analysis showed, to get a realistic picture of the very wealthy, we cannot just look at their earned income: we must look at how much wealth they have, and what total income they get from that wealth – including their unrealised capital gains. This is what we call their ‘total economic income’. When we do that, we see that in a typical year – when returns on investment are around their long-run averages – the tax paid on total economic income will look something like the picture below[2]. What is striking about this picture is that beyond a certain point, the wealthier you are, the lower the percentage you pay. That shows us where to start looking for the under-taxed: it has to be the super-rich: the billionaires.
Now you can see why Warren Buffett pays so much less than his staff.
Note that taxing unrealised capital gains themselves is fraught with difficulty (what would you do in a year of falling stock markets, how would you prevent fraud, etc?); a wealth tax on the seriously wealthy is the most practical way to address the issue.
The government says that it is ready to take some tough decisions. The picture above shows that the fair place to start being tough is at the far right of the picture with the wealthiest, not at the left with the most vulnerable, in the middle with Joe or even at the top of the 99% with Miranda, who is already paying significant tax. The injustice is on the right.
From a purely political perspective, it is worth remembering that although the bottom 99% may make up only a small proportion of the people that top politicians spend their time talking to, they still represent 99% of voters.
Conclusion
If you think it is time for a progressive tax system in the UK, please share this with your MP. You can do that easily using this website https://www.writetothem.com/ You do not even need to know their name, just your own post-code!
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Notes
[1] If you buy some shares, for example, and they rise in price, you have a capital gain. If you sell the shares and take the cash, you have realised the gains. If you hang onto the shares in the hope of future gains, you have unrealised capital gains.
[2] Of course in any single year, the picture could be very different – in a year with a stock-market crash, the total economic income of the wealthiest may even be negative – but over time, it is likely to average out roughly as the picture shows.
7 comments so far
While I fully agree that things like dividend and realised capital gains income should be taxed the same as earned income, I do not believe that taxing unrealised capital gains is either practical or desirable.
You have already alluded to the former “what about a falling stock market?”, but also what about the market value of artworks or collectables? It’s an admin nightmare.
But the real issue is that unrealised capital gains are imaginary wealth. A person (e.g. Warren Buffet) who holds shares valued in millions cannot spend that wealth without selling some holdings, at which point the capital gain is realised and should be fully taxed.
We have become accustomed to valuing people’s wealth based on what we guess that someone else would pay for their possessions, be those physical objects or investments like shares. But until such a sale is made, such wealth is actually illusory, and as we know, if the market changes, such apparent wealth can vanish almost instantly.
Elon Musk is described as being worth hundreds of billions, but almost all that is the current market value of his shares in Tesla, a company which by all rational measures is overvalued by a factor of as much as 10. That valuation is tumbling, and if that trend continues he could well become bankrupt. I have no sympathy at all for him, but simply present this as an example that what we keep telling ourselves is a measure of wealth is not. It’s just an illusion, taxation should be restricted to actual money.
As the article says, “Note that taxing unrealised capital gains themselves is fraught with difficulty (what would you do in a year of falling stock markets, how would you prevent fraud, etc?); a wealth tax on the seriously wealthy is the most practical way to address the issue.”
Instead of taxing these super-wealthy people, why not just ask them all to make a voluntary contribution to HMRC of a minimum sum that can then be earmarked for use by the government of the day for the benefit of the country as a whole.
If this were done transparently with full acknowledgement of their gift to society surely this would be a win-win situation!
The danger is that if it were purely voluntary, it would turn into a tax on the ethical. And since wealth tends to equal power, the ethical would be disarming in front of the unethical.
Great article. Just to point out the obvious – this would be a great start to reducing the deplorable inequality in the UK.
How would you stop a substantial proportion of the very wealthiest (well above Miranda) taking their loot & buggering off elsewhere to WFH & popping back to UK on brief visits (<180 days a year at present)?
(As Jagger, (Elton) John & (Eddie Jordan) all did when it was worth their whiles. And that is just the "J's"
Like this: https://99-percent.org/what-if-we-shrug/