Are billionaires paying their “fair share” of tax?

Most people, if they’re asked whether billionaires pay their fair share of tax, answer with an emphatic “no!” But whatever your views of billionaires might be, it’s fair to say that some pay a lot more tax than others.

It can’t be because they lack access to top-notch financial advice. Your average billionaire has almost instant access to the finest legal and accounting minds on the planet any time they want to find a way to pay less tax.

Some just choose to work the system to their own personal advantage as much as they can, while others take the view that they should be paying tax in the same way as any of the employees in their business would.

I’m not expressing a moral judgement on that decision, one way or the other. It’s just an observation.

However, this debate has been ignited in the UK recently by the publication of the Sunday Times Tax List 2019, which aims to identify the UK’s top tax payers.

A couple of caveats though.

Firstly, I do understand the position might be different in other tax jurisdictions. All I can offer is a UK perspective on this as that’s where I work as a Finance Director and Chief Financial Officer (or CFO).

Secondly, as the Sunday Times itself acknowledges, their analysis is prepared from publicly available documents so this may well be less than the complete picture of any one individual’s tax affairs.

However their analysis recognises one important aspect…again, under UK tax law…which is that once someone is paid a salary or dividends in those legal forms, the same tax rules pretty much apply to everyone.

Unlike the US, for example, where there are multiple write-offs and exemptions which could significantly reduce someone’s pay for tax purposes, relative to their “headline” pay packet, things are pretty clear in the UK and, nowadays at least, there are very few ways to massage the salary appearing in your publicly available accounts into a much lower number to share with the tax office.

The Sunday Times has also added in the Corporation Tax paid by those companies run by high earners and a few other things as well.

Again, this is a pretty reasonable approach. If you’re running your a business, even a very large one, which you own personally, or perhaps close family members, it’s your own efforts which create the business profits which the Treasury assesses for Corporation Tax.

If your business didn’t exist, it wouldn’t make the profits that get paid in Corporation Tax, nor would it generate the salary payments that will be accounted for under the same PAYE arrangements as every other UK taxpayer.

So, the Sunday Times’ methodology is probably good enough for a “sighting shot” of the top-earners’ tax payments, as long as you accept that, again in the UK at least, every taxpayers’ tax affairs are strictly confidential. The only people who really know the true picture are your local friendly billionaires and HMRC themselves.

Reading the Sunday Times’ article, and a lot of the subsequent comment pieces on it, however, it’s clear that most people don’t understand how the UK’s tax system works.

For better or worse (more on that in a moment), the UK tax system over the years has become much more highly dependent on catching money-flows and removing a slice of those money flows as they pass through the system.

Again, for better or worse, VAT is a good example of that. Most things you buy in a shop in the UK have a 20% VAT uplift applied to them which the shop-owner sends on to HMRC after deducting any VAT they’ve had to pay on the things they bought to sell to you. The “added value” (the clue is in the title) is taxed at the point the money flows through the retailer’s till.

Last year, £125 billion was collected by HMRC for VAT in this way.

PAYE is another good example. If you’re paid a salary, however large, your employer has to account for the tax due direct with HMRC and pay it across on a monthly basis. The tax arises when the money flows from the employer’s bank account to the employees’ bank account so it’s easy to see and track, and there’s no dispute about the value paid across.

Systems like this, which work for many other taxes as well in the UK, use the exchange of money to capture the value that has been created and raise whatever tax charge Parliament, in their infinite wisdom, has chosen to apply.

But it comes as a big surprise to many people that wealth isn’t really taxed at all in the UK. There are some exceptions, but they are relatively minor for your average billionaire, so we’ll leave them on one side for the moment.

And there’s a good reason for that. Just because you’re wealthy, that doesn’t mean you’ve got any money.

I know…sounds crazy, doesn’t it, but it’s true.

Let’s consider a tech founder whose start up has just taken in some early stage funding from a VC or angel investor for a relatively small percentage of their business. If the founder gets £1 million of funding for a 10% stake in their tech startup to find the development of an idea (ie the business itself isn’t selling anything to customers yet), that means the business is “worth” £10 million in total. £9 million of that belongs to the founder, £1 million of it to their investor.

By most measures, someone who owns a £9 million share in a business would be considered rich. But people I know personally in that situation are earning nothing at all or are getting along on something like an average UK wage, currently around £25,000 per annum (on which they, too, pay tax of course) because any cash that comes in, whether from investors, customers or elsewhere, is used to build their business. Most founders don’t get paid unless everyone else is paid first.

So, how would you tax someone who owns a share in their business worth £9 million, but who has to live on, say, £1500 per month, after tax?

If you taxed their wealth at even a measly-sounding 1%, that would be £90,000 a year, or more than three times the income they have to live on each year.

And that assumes the business really is worth £10 million…the truth is that the business might turn out to be worthless, or it might turn into a billion-dollar business. At the time an investor puts their development funding in, there’s no way of knowing which the business will turn out to be.

The rate of tax on a business worth nothing is clearly zero. But how do you tax a business that might be worth billions, but on any look at the entrepreneurial odds is probably, on average, worth even less than its £10 million theoretical valuation, if it’s worth anything at all.

And, on a much smaller scale…in economic terms at least…taxing people on assets rather than income was the thinking behind the Poll Tax (properly called the Community Charge) which doomed Margaret Thatcher’s Prime Ministership and brought the career of one of the UK’s most transformational politicians of the last century to an end.

(Whether or not you supported her, I’m sure we can agree she transformed a lot of things in the UK during her time in office.)

So taxing wealth rather than income is a tricky business. You have no way of knowing what an asset is worth, really, until someone buys it or sells it and money changes hands.

And even if you do assess its value somehow, which was the idea behind the Poll Tax, to make people pay a tax based on the value of their property (an asset) irrespective of how much they earned, that’s not without its own problems.

Some 90 year-old lady living on her own, eking out a state pension in a house happens to be worth £1 million just because she and her husband bought a derelict wreck after the war, did it up, and 60 years later the “in crowd” decide that part of London is a desireable place to live for some reason…how would you tax her?

She’s got no money, but she’s a millionaire on paper.

Some people might say she should sell up, live somewhere cheaper and hand over some tax, but I think most of us would agree that’s no way to treat a 90 year old widow, whether she’s worth £1 million or not. Destroying an old lady’s life memories in the home she’s lived in for 60 years just so you can shake her down for some cash is no part of the values of any civilised society.

And that’s the problem with taxing wealth. If you start putting in too many exceptions and exemptions…even perfectly plausible and reasonable-sounding ones…you’ll end up with such a minefield of complexity that people who are minded to do so will work with their lawyers and accountants to find a way around that. (In a nutshell, that’s how the US tax system works.)

Billionaires the world over would be signing over their fancy London homes to their 90 year-old grandmothers because we don’t make those people pay tax on the value of their home. Designing a tax system which discriminated correctly between 90 year-old widows living in fancy houses would likely be outwith the skills of even HM Treasury’s most gifted parliamentary bill-writers.

So, if you read the Sunday Times article…or perhaps one of the many other articles that followed on from it to say “why isn’t this billionaire or that multi-millionaire on the top tax payers’ list?”, just remember that wealth and income are not the same thing, even though a lot of people think they are.

90 year-old grandmothers, tech founders and the like might have plenty of wealth, but very little income. And, at the end of the day, people can only pay tax out of the cash they’ve got.

The UK tax system isn’t perfect…far from it…but at its heart is the pretty sensible realisation, especially after the Poll Tax debacle, that the most unambiguously fair way to collect tax is to focus most of HMRC’s attention on picking up the money flows in the economy and leveraging a percentage of whatever cash is changing hands into HM Treasury’s coffers.

Of course, some people abuse the system…all the way from tradespeople who work for cash and don’t report their earning for tax purposes right up to billionaires who use offshore trusts and complex tax planning to sneakily move their wealth out of the reaches of their home country’s tax authorities.

But once you accept that people can be wealthy and not have any money because they don’t get much of an income, the UK tax system starts to make a lot more sense.

And it’s also good to see that some of the highest earners in the UK declare their income from salaries and dividends, just like you and I do, when it wouldn’t be the hardest thing for their accountants and advisers to put everything through complex tax minimisation arrangements.

Here, if you being paid a salary or dividends, as declared in your business’s end of year accounts which the team at the Sunday Times dug out for their Tax List 2019, HMRC will be automatically picking up the proper amount of tax as laid down by Parliament. There’s little or nothing those billionaires can do about it.

So I take my hat off to the ladies and gentlemen of the Sunday Times Tax List 2019 for not taking advantage of the tax system the way some others might.

Billionaires aren’t perfect, I’m sure, but at least this lot are playing fairer than most with the tax system. And in a country currently mired in Brexit gloom, I’m looking for positives everywhere I can find them at the moment.