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Give or take: who’s making a positive net tax contribution?

Alex Hurrell

Date: 12. October 2012 / Category: Tax and benefit system

In recent days there has been a lot of discussion about net tax contribution, and in particular at what point in the income distribution households start to make a positive net contribution, i.e. pay in through taxes more than they receive in cash benefits.

However, there are two issues of critical importance when considering net tax contribution levels:

Firstly, it matters whether retired households are included under consideration or not. This is because state pensions are classified officially as cash benefits. Since pensioners generally pay low tax their net tax contribution is often negative; they tend to receive more out of the system in cash benefits than they pay in through taxes. (Though pensioners have of course been paying into the system over the course of their working lives.)

Secondly, the specific measure of net tax contribution also matters. Many refer to net tax contribution as direct taxes (income tax, employees’ NICs, council tax, etc) minus cash benefits received. This, however, ignores the fact that households also pay a large amount of tax through indirect taxes (VAT, duty, etc). A more accurate measure of an individual or household’s net tax contribution is therefore total value of all taxes paid, direct and indirect, minus cash benefits received.[1] Since indirect taxes are generally regressive, taking them into account results in fewer low and middle income households being considered as ‘net takers’ from the system.

Both these issues were discussed in an insightful recent blog by Jonathan Portes. The charts below use ONS data to highlight these two key messages more explicitly. The data comes from the ONS release ‘The Effects of Taxes and Benefits on Household Income, 2010/2011’ .

The first chart shows that, when all households including those that are retired are considered, the poorest 40% receive more in cash benefits than they pay through taxes. But this includes many pensioner households, who have low incomes, receive large amounts of cash benefits in the form of state pensions and generally pay low taxes. So once we restrict the analysis to non-retired households (see second chart) it is only the bottom quintile (i.e. poorest 20% of non-retired households) that are so-called ‘net takers’ from the system; as a whole, the other 80% pay in more through taxes than they receive in cash benefits. Since pensioners can be considered to have ‘paid in’ to the system over their working lives, this illustrates that, when considering net tax contribution rates, not restricting analysis to non-retired households risks overstating the proportion of households that are ‘net takers’ from the tax-benefit system.

Incidence of taxes and benefits and net tax contribution by quintile groups, 2010-11

Source: Resolution Foundation analysis of ONS data (‘The Effects of Taxes and Benefits on Household Income, 2010/2011’).

Notes:

(1) The bars show cash benefits received, direct taxes paid and indirect taxes paid by household quintile groups and relate to the left hand axis.

(2) The points shown joined by the black line relate to the right hand axis and show net tax contribution. Net tax contribution as a proportion of original income is calculated for each quintile group as average direct taxes plus average indirect taxes paid minus average cash benefits received, all divided by average original income. A negative net tax contribution figure means the group receives more in benefits than it pays out in taxes.

(3) Households are ranked by equivalised disposable income, using the modified-OECD scale, but the average direct and indirect taxes and cash benefits figures shown on the chart by quintile group are unequivalised. Disposable income is defined as original income plus cash benefits minus direct taxes.

(4) Direct taxes cover income tax (net of tax credits received), NICs (employees and self-employed) and council tax (rates in NI); indirect taxes includes VAT, duties (alcohol, fuel, vehicle, insurance premium, etc) and licenses (driving, television).

(5) Cash benefits include contributory benefits (state pension, job seekers’ allowance, incapacity benefit, widows’ benefit and statutory maternity pay) and non-contributory benefits (income support, income-based job seekers allowance, child benefit, housing benefit, sick pay, carers’ allowance, attendance allowance, disability living allowance, child tax credit and working tax credit, etc). Note that child tax credit (CTC) and working tax credit (WTC) are classified by ONS as a cash benefit only for recipients for whom income tax less tax credits remains greater than zero, otherwise they are classified in as a negative income tax.

(6) Following the definition used by ONS for their release, a retired household is defined as one where the combined income of retired members amounts to at least half the total gross income of the household, where a retired person is defined as anyone who describes themselves as ‘retired’ or anyone over minimum National Insurance pension age describing themselves as ‘unoccupied’ or ‘sick or injured but not intending to seek work’.

[1] It is possible to extend the measure of net tax contribution to account for the value of in kind benefits (e.g. health and education services, housing and travel subsidies, etc) using the same ONS data as used here. However, the focus of this blog is specifically on the net cash contribution, i.e. what you pay into the system less any cash benefits received.

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