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Our author
Tax Freedom Day is calculated for the Adam Smith Institute by Gabriel Stein, a Swedish economist who has lived in the UK since 1990. In 1981 he worked in the Israeli Ministry of Finance. From 1982 to 1991 he ran his own economics and public affairs consultancy, Stein Brothers. He is currently a director of Lombard Street Research Ltd.
What Tax Freedom Day means
Tax Freedom Day shows the total tax paid each year by a taxpayer on average income, including indirect taxes, local taxes and National Insurance contributions, as a percentage of that individual’s total income. It is calculated by comparing general government tax rev¬enue with the Net National Income (NNI). The total of all government tax revenue — direct and indirect taxes, local taxes and National Insurance contributions — is calcu¬lated as a per¬centage of NNI at market prices. The result is then converted to days of the year, starting from 1 January.
There is some debate on which measure is the more correct to use when measuring the tax burden. One school holds that to use NNI is to complicate matters. In the general political debate, the tax burden is generally referred to as a percentage of GDP. Also, GDP is a measure published everywhere, including in the Budget. By measuring Tax Freedom Day as the tax burden relative to GDP rather than relative to NNI, it is possible for anyone simply to look up one single table and find the figures. It also makes it easier to compare the UK with other countries without going through the complications of calculating their NNIs - which in any case may be defined in different manners. Further, it could be argued that capital consumption should not be deducted from gross income before calculating the tax burden since this is done on taxed capital.
GDP is a larger measure than NNI. Measuring the tax burden by using GDP rather than NNI also has the effect of making Tax Freedom Day appear earlier in the year. But this is, as it were, a once-off effect. The development of Tax Freedom Day over the years would be identical.
The income side. However, for various reasons, the Adam Smith Institute has chosen to use NNI. The reason for using NNI, rather than the more commonly known measure Gross Domestic Product (GDP), is that it excludes capital consumption, which is an expense and not part of net income, while it includes net property income from abroad. NNI is thus the closes macroeconomic equivalent to personal income on the individual level. This method is essentially the same as that used since 1929 by the Tax Foundation (www.taxfoundation.org) for calculating Tax Freedom Day in the United States.
The tax side. All taxes are included in the tax burden as calculated here. This includes direct taxes, such as income tax, capital gains tax, inheritance tax and corporate taxes (which ultimately are paid by the owners of each business). It also includes all kinds of indirect taxes, such as VAT, duties on petrol, alcohol and tobacco, stamp duty, vehicle tax, council tax and so on.
Government income from various fees and charges is not included (because they represent a payment for goods or services, which would still be due even if they were supplied by the private sector). Government interest and dividends received are similarly excluded (because they are pure business income, which is not levied by legislative force).
Transfer payments. One point that has been raised in the calculation of Tax Freedom Day, is that it does not take into account the fact that a large number of people receive various transfers from the government — child benefit, unemployment benefit, and so on. Should these really be included in the tax burden? Are they not really a kind of “negative tax”?
The answer to these two questions must be that transfers should indeed be included when calculating the tax burden. First of all, they are a tax in the sense that they involve the government taking money away, at least from those who pay relatively more in taxes than they receive in transfer payments. Second, even if we all received roughly the same sum in transfers as we pay in taxes, we would still incur the not inconsiderable administrative costs connected with such a turnaround of money. For these reasons, it is feasible to argue that all tax revenue should be included when calculating the tax burden.
The Tax Freedom dates given for the years 2007 and 2008 are an estimate and a forecast respectively. This is because the calcula¬tions use official gov¬ernment statistics, some of which are published as provisional, with definitive figures appearing only later. In addition, one of the relevant figures for these calcula¬tions, capital consumption, is published only after an in¬terval of about two years. As definitive figures are published, Tax Freedom Day dates may there¬fore be subject to minor revisions.
Changes in national statistics
From 2004 the editions of Tax Freedom Day is not entirely comparable to previous editions. This is mainly because in 1998, the National Statistics changed the system of calculating GDP to chain-weighted measures (there were also some minor revisions on other points). As a result, the entire series of GDP going back to the 1960s was revised. The result is that the dates for earlier Tax Freedom Days given in this year’s version may be slightly different from those published in earlier years. The general pattern is still the same, but the new definitions have changed some of the precise figures. For details of the changes to the National Accounts, see National Statistics. A further revision in 2006 again altered the history of Tax Freedom Day.
In addition, the Treasury from time to time changes its definitions of the budget deficit. Most recently, in 1999, from the previous PSBR (public sector borrowing requirement) to three different measures:
• PSNCR (public sector net cash requirement, i.e. the month-to-month borrowing needs)
• PSCB (public sector current budget, i.e. current as opposed to capital spending); and
• PSNB (public sector net borrowing, the broadest measure of the budget deficit, showing the change in the public sector’s indebtedness).
For a detailed explanation of the changes to the deficit definitions, see Lombard Street Research Monthly Economic Review March 1999, which also explains how the new definitions fit into the tradition of British budget practice going back to the Nineteenth Century. This publication is available from the author.
It should be noted that changing definitions make comparison more difficult, and enable the Chancellor to make claims which would not have been valid under the more traditional measurement methods. Given a Chancellor widely accused of preferring “stealth taxes”, and of deliberate obfuscation and an addiction to impenetrable complexity, the changes do not augur well for those attempting to monitor Treasury activities.
But there is a more insidious trait in Gordon Brown's handling of the tax burden. Ever since his first Budget in July 1997 (of which more below), the Chancellor has been given to pre-announcing tax changes - preferably increases. For instance, the abolition of mortgage tax relief, which took place in 2000-01 was originally announced in a previous Budget. The same holds true for the abolition of the married couples’ allowance, which also disappeared in that year. The effect of pre-announcing tax increases is that by the time the Budget is presented, all comments focus on the contents on the Budget speech and very few think about what is already decided. A recent example of this was the announcement in the 2006 autumn Pre-Budget Report of a doubling of air passenger duty.
In a broader perspective, both the previous Conservative and the current Labour governments have, with some success, attempted to bring the public sector finances back into balance. But this is done partly through higher taxation, plus the dynamic effects of the very strong recovery since 1993, and very little through lower expenditure. But in the current Parliament, this has given way to widening budget deficits. The current government is still committed to increasing spending on certain parts of the public sector by more than the economy can be expected to grow - which by definition must, at some stage, be paid for by higher taxes. If this higher-tax path continues to be chosen, there is a risk that Britain could still end up as a high-tax economy, less attractive for foreign investors, and less friendly to home-grown entrepreneurs. Such a trend would be deeply disturbing.
The international comparisons
A problem in such comparisons is that capital consumption data are no¬toriously unreliable. In an attempt to circumvent this problem, the chart as¬sumes that the relationship between Net National Income and Gross Domestic Product is roughly equivalent in industrialised countries. Our chart showing the international comparisons shows the actual Tax Freedom Days for Britain, Euroland and the United States. For the other two country groups total tax revenue as a percentage of GDP at market prices has been compared to the equivalent British figures. The difference between these two figures has then been translated into days of the year, and this difference has been added to or subtracted from the British Tax Freedom Day, thus giving a Tax Freedom Day for that specific area. But it must be remembered that this is at best a rough approximation.
The chart shows that Tax Freedom Day 2006 in Britain occurred 37 days – more than five weeks– later than in the United States. However, compared with the average for the European Union and for Euroland, Britain is still a low-tax economy. In 2006, Tax Freedom Day fell eight days earlier than the average for the EU (including Britain) and 21 days earlier than for Euroland. The latter point is particularly important. There is a general move towards tax harmonisation in the single currency area. With taxes among the fifteen euro members generally considerably higher than in Britain (and budget deficits generally wider as well), such moves must mean a substantial increase in the British tax burden over and above what is already being planned. However, cyclical movements aside, the overall British tax burden is rising and the differential with other European countries is narrowing.
Tax Freedom Day and government borrowing
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The amount of tax we pay is not the same as the amount which the government spends. Because the government is also a big borrower. While governments may aim to keep their finances in current balance, the heavy borrowing of the early 1990s will still have to be paid back in the form of higher taxes and/or a weaker economy.
Since Tax Freedom Day measures taxation only, public sector borrowing (which can be said to be a form of deferred taxation) is not in¬cluded until the time ac¬tually comes to repay the debt. This is in a sense unfair. It will make a squander-bug government, which borrows instead of raising taxes, look virtuous: while its fiscally more responsible successor, which attempts to pay off the public debt, will look like a high-tax government.
If Tax Freedom Day is to show the “true” long-term fiscal attitude of each year’s government, we need to adjust for this factor. It is thus of some interest to calculate Tax Freedom Day, taking into account not only government revenue, but also the broadest measure of government spending, i.e. PSNB (public sector net borrowing).
Calculated this way, the “true” Tax Freedom Day for 2008 would be 14 June. This would be one day later than in 2007and otherwise latest date since 1995! Is an improvement on the budget-deficit adjusted TFDs of the early 1990s, which were in mid-to-late June. But it is a sharp deterioration from 1998, when the adjusted date was 26 May. It is true that the budget deficit frequently is a hostage to the business cycle - rising in bad times, falling or being turned into a surplus in good. But this just increases the importance of maintaining a prudent fiscal stance over the whole business cycle in order to avoid the violent swings that characterised Britain - and other western countries - during the 1970s, 1980s and early 1990s. In contrast to previous years, the difference between the nominal and the “true” Tax Freedom Days is minimal — something which is to the credit of governments of both parties in the 1990s, having laboured to bring the budget deficit under control.
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