Bill Jamieson: PAYE hides the reality of taxation

The illusion created by tax taken from that already received offers no comfort to the self-employed, writes Bill Jamieson

The 31 January deadline for tax return forms is a welcome date in the governments diary. Picture: AFP/Getty

September may be the month of destiny for Scotland. But spare a thought for those struggling just to get past January. For this is the month for the paying of tax. The deadline for tax due is now less than three weeks away, on 31 January.

It is a testing day for small business and the self-employed. But without tax revenue there is no government, separate or federal. So for government, January brings reassurance. Receipts flowing in briefly exceed money flowing out. And for the briefest of periods the arithmetic of government seems sound and the nation solvent.

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But for a large swathe of the taxpaying base, the reverse is true: the cheque to HMRC leaves us denuded and stripped bare. There is no greater astringent than a tax payment due. This winter of money deforestation stretches across the opening months of the year. Little can be contemplated, still less undertaken, until we have made good some of the gaping hole that 31 January has left.

For millions on Pay As You Earn all this barely signifies. The tax has been paid before earnings are credited to bank accounts. There is the residual dribble of interest on bank accounts and perhaps dividends to be declared. The tax paid is not missed because it was never in our possession to begin with. It is a figure on the monthly pay slip, a statistical subtraction that may cause a passing irritation. In this way the transference of £150 billion a year from citizen to government proceeds without riot or disturbance: minimal discomfort of the paying party and the maximum convenience of HMRC.

For the self-employed, it is different. And having joined their ranks I can vouch for how very different it is. Earnings are received gross of tax. There are no deductions for National Insurance. Here are your earnings, full and unmolested. There is a pleasing illusion, if not quite of wealth, then of a fragile solvency. Out of this, of course, you have to accumulate a surplus to see you through holidays and any period of illness. You are responsible for your own pension contributions. And throughout the year you have to keep accounting score and make provision for the tax that will inevitably fall due.

Quite how fragile your financial position is does not become fully clear until 31 January draws near. The realisation dawns that this accumulation has to be surrendered and handed back. You have a full and painful consciousness of how much exactly that taxes are costing you. My thanks to the wag who sent me an email this week encapsulating the basic law of finance: teach your children about tax: Eat 30 per cent of their ice cream. To say that the experience makes you view the activities of government in a different light barely begins to cover it.

One of the reasons why council tax is so voter sensitive is that it is paid out of income already received, which then has to be paid back. The anaesthetic of prior monthly extraction does not apply. Voters are more acutely aware of how much local government really costs. Little wonder that the council tax freeze has proved so popular and why a reversion to annual determination is so politically difficult.

PAYE has many advantages. But it proceeds on the basis that earnings not paid out to the earner are not really missed. As such, it survives by a delusion. The money you didn’t receive you didn’t really know: now you see it, now you don’t. But how can voters make a fair assessment of the value of the money extracted from them in this way?

Now there are very few who do not recognise the legitimacy of taxes in some form, for external defence and for the maintenance of internal law and order. There are basic infrastructure commitments – roads, bridges, street lighting, flood prevention, education and basic public health. Beyond this, a balance must be agreed between liberty and collective welfare, personal responsibility and the presumption of government ‘good’. And how far can the tax system be used as an instrument for the equalisation of income and the extraction of more from high earners?

On these issues there can never be a firm of precise determination. The restless ride of voter opinion ebbs and flows on what level of tax should be levied and who should pay what. The bill for tax-funded welfare rises while any attempt to slow its growth, as George Osborne is finding, instantly resolves itself into a raucous row over which benefits exactly would be cut and who would lose. The result? Greater pressure to maintain high tax levels, not of course from those “hard working families” invoked by politicians, but from the hefty rich: they should pay more.

But already the tax system is heavily skewed. The vast majority of 29 million taxpayers pay tax at the basic rate. Some 4.3m are higher rate taxpayers. And some 290,000 pay the top rate of tax of 45 per cent. According to HM Revenue and Customs estimates, in 2013-14, the best-paid 1 per cent across the UK forked out almost 30 per cent of all income taxes. This percentage has risen steadily in recent years. In 1997, it was 20 per cent; in 2007, before the financial crisis, the figure was 24.4 per cent.

But taxing the rich has hit the law of diminishing returns. Thus the definition of ‘rich’ becomes ever broader. The 3.7m who earned more than £35,000 pay 40 per cent tax. They now contribute more than £57 billion in tax, equivalent to 34 per cent of the total. The lower-earning 50 per cent pay £17bn – less than the housing benefit bill. Overall, 90 per cent of all income tax is paid by half the working population.If reductions in the rate of increase in welfare spending are blocked, and governments, whether Labour or Conservative, still wish to raise the threshold for paying tax, then the “squeezed middle” looks set to remain in the firing line. While taxes have been cut for the low-paid and the wealthy, aspirational middle-earners have not fared so well, squeezed by higher National Insurance contributions and lower thresholds for higher rate taxes.

What used to be a level of taxation aimed at a small number of rich people now ensnares more than four million earners. And the more tax creamed off from them, the greater the disincentive effect and the greater temptation to pursue tax “avoision” – that murky terrain between legitimate tax avoidance and illegal tax evasion.

There comes a point when, self-employed or otherwise, the tax system ceases to be seen as tolerable and legitimate. That it has survived as long as it has owes much to the conjuring trick of PAYE. But as the ranks of the self-employed and small firms continue to grow and more face the reality of the tax they pay, the tolerance of the taxpayer will wear dangerously thin. “31 January” may in time become a bigger “day of destiny” than 18 September.