How do small business owners respond to the tax system?

Transcription

1 How do small business owners respond to the tax system? Kate Smith

2 Tax due ( ) on a job generating 40,000, The tax system favours business ownership 14,000 12,000 12,146 10,000 8,000 6,000 Employer NICs (13.8%) Employee NICs (12%) 8,713 Self-employed NICs (9%) 7,358 Dividend tax 4,000 2,000 Corporation tax 0 Employee Self-employed Owner-manager Notes: is slightly higher for the self-employed than for employees in this chart only because the latter are charged income tax on income net of Employer NICs.

3 01/01/ /01/ /01/ /01/ /01/ /01/ /01/ /01/ /01/ /01/ /01/ /01/ /01/2015 Incorporations per week People move between organisational forms 14,000 12,000 10,000 8,000 Employer NICs (13.8%) Starting rate reduced to 0% 6,000 4,000 Employee NICs (12%) Self-employed NICs (9%) Dividend tax 2,000 0 Corporation tax Source: Figure 7.6 in Chapter 7 Tax, legal form and the gig economy, The IFS Green Budget, February 2017.

4 Total income from income source ( = 100) People shift income when the tax system changes 350 Employment income Dividend income Employer NICs (13.8%) 50p top rate announced Employee NICs (12%) Self-employed NICs (9%) Dividend tax p top rate introduced 50 Corporation tax Notes: More individuals had to file tax returns in , leading to slightly understated income falls in that year.

5 Observations in 100 bins Owner managers bunch at kinks in the tax schedule Big increase Employer NICs in marginal (13.8%) tax rate Employee NICs (12%) Self-employed NICs (9%) Dividend tax Corporation tax 0-5,000-4,000-3,000-2,000-1, ,000 2,000 3,000 4,000 5,000 Distance from higher-rate threshold Notes: Distance from higher-rate threshold measured in prices. Distribution shown for company owner-managers, to

6 Observations in 100 bins Owner managers bunch at kinks in the tax schedule Big increase Employer NICs in marginal (13.8%) tax rate Employee NICs (12%) Self-employed NICs (9%) Dividend tax Corporation tax 0-5,000-4,000-3,000-2,000-1, ,000 2,000 3,000 4,000 5,000 Distance from higher-rate threshold Notes: Distance from higher-rate threshold measured in prices. Distribution shown for company owner-managers, to

7 Company owner-managers have a lot of flexibility over when to withdraw income Individuals with incomes that fluctuate around a kink point have an incentive to smooth taxable income over time By bunching at the kink point they can ensure they don t pay the higher rate of tax in good years Individuals with average incomes above the higher rate threshold have an incentive to retain profits until company liquidation Entrepreneur s Relief: lower capital gains tax rate paid on business income taken out on liquidation Adjustment of real activity is not the only way to bunch

8 New linked tax records crucial to get fuller picture of owner-managers behaviour New link between personal tax records of the owner-manager and the corporate tax records of the company Observe: company profit (total income), and timing and size of taxable income withdrawals by owner-manager Allows us to understand how much of responsiveness is driven by income shifting or adjustments to real business activity

9 Proportion Bunching in annual taxable income all responders Notes: Authors calculations using HMRC administrative tax records. Bin width is 100. Counterfactual density estimated using higher order polynomial.

10 Proportion Bunching in average taxable income takes out short term income shifters Notes: Authors calculations using HMRC administrative tax records. Bin width is 100. Counterfactual density estimated using higher order polynomial.

11 Proportion Bunching in average total income takes out longer term income shifters Notes: Authors calculations using HMRC administrative tax records. Bin width is 100. Counterfactual density estimated using higher order polynomial.

12 Retained profits are important, particularly for higher income owner-managers Notes: Authors calculations using HMRC administrative tax records. Average retained profits constructed across years observed for each owner-manager.

13 No evidence that investment is higher for those retaining profits above threshold Notes: Authors calculations using HMRC administrative tax records. Average investment constructed across years observed for each owner-manager.

14 Conclusion responses matter Business owners are very responsive to the tax system They have flexibility over how and when to take their income And use this to respond to changes in the tax rates they face We find intertemporal income shifting explains bunching at thresholds Understanding how these individuals respond is crucial Short term shifting: gives individuals with volatile income ability to smooth Longer term shifting: Distorts choices and reduces government revenues We find no evidence that retained profits are linked to higher investment