Tackling high pay through the tax code – to collect £4.6 billion in tax

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I have contributed this piece to a new Class Think Tank publication to mark what is called Fat Cat Day:

Tackling high pay through the tax code

Who pays tax, and how can we design a system where the rich pay their fair share? Richard Murphy proposes some solutions.

A New Proposal

As this report has already made clear, it is now widely accepted that there is a problem with the growing pay disparity within UK business. Unfortunately, efforts to tackle this issue have, to date, largely failed. Corporate governance regulations should not rely on the good will of corporations and new proposals for taxation need to be robust in order to counteract the levels of tax avoidance so common at the upper end of the distribution.

The proposal made in this section does, then, rely upon changes to the corporation tax system to impose an additional tax charge on those employers making payments to employees in excess of 10 times UK median pay in the year. This is at present a sum of £300,000 per annum (we have defined high pay to be a sum approximately ten times UK median pay, which according to the UK Office for National Statistics, was £29,588 in 2018).

The proposal has the objective of making the tax system more progressive by creating an additional tax charge in these cases, and of producing a disincentive to make payments of high salaries.

The proposal works by disallowing a claim for the offset of expenditure in excess of £300,000 per annum incurred when paying any one employee of the company in that company’s corporation tax return, so increasing their effective corporation tax liability by 19 per cent of the excess sum paid, at current tax rates.

A range of anti-avoidance measures are discussed in the proposal. The consequences are that this charge will fall very heavily on employers, and so on the owners of capital who will, as a result, have an incentive to reduce income inequality.

If no change in behaviour takes place as a result of this charge it is suggested that a sum of corporation tax of in excess of £4.6 billion per annum would be collected as a result of this proposal. For reasons noted, significant behavioural change is not anticipated.

The proposal is that the cost of all pay to an employee, director or other officer of a company that exceeds £300,000 per annum should be disallowed as an expense when calculating the taxable profits of a company or other entity subject to UK corporation tax.

The stated objectives of this proposal are to:

  1. Increase the tax payments due as a result of the payment of high salaries;
  2. Bring pressure to bear to reduce such salaries, and so income inequality as a result.

The effect of disallowing an expense for corporation tax purposes is to increase the taxable profits of a company. As a result, if that company does declare taxable profits an additional sum equivalent to the amount of high pay expenditure disallowed will be subject to corporation tax. The UK corporation tax rate for all companies is 19 per cent at the time of writing in 2018.

A Brief Example

This is a simple example of how the scheme might work. Suppose a company has taxable profits of £1,000,000 and pays one of its employees £500,000 a year. Under the new proposal, only £300,000 of this employee’s wage is tax deductible with the remaining £200,000 reclassified as profits and taxable at the rate of corporation tax, which is currently 19 per cent.

Profits would increase as a result to £1,200,000. The tax bill payable by the company, which would have been £190,000 (i.e. 19 per cent of £1,000,000) before the adjustment will increase by £38,000 as a result of the adjustment being made (19 per cent of £200,000). This additional sum would now be payable by the company taking its total corporation tax bill to £228,000.

It should be noted that the employee pays no additional tax as a result of this arrangement. It should also be noted that the company would still have to pay all the PAYE and national insurance that would have been due whether or not the sum of £200,000 was disallowed in its tax computation. In other words, the change is only to the employer’s tax bill. Absolutely all other tax bills remain unchanged as a result of this high pay expenditure adjustment which only impacts corporation tax owing.