UK Tax Essentials

An Overview Of The Tax System In The UK

An Overview Of The Tax System In The UK

A Guide To Direct And Indirect Taxation In The UK – How To Save Money
Chapter Two

Story Highlights:

In this chapter we will concern ourselves with an overview of the tax system in the UK and answer queries taxpayers may have about:

  • Why we should pay taxes
  • How much revenue the British government raises from taxes and from other sources
  • Where tax money is spent in terms of governmental expenditure
  • How much the public sector debt is in the UK
  • How the public sector debt could be reduced
  • The difference between tax evasion and tax avoidance
  • How much tax revenue remains uncollected and why
  • The meaning of the tax gap
  • Whether tax evasion is a victim-less crime
  • Governmental measures to crack down on tax evasion

The UK tax system – A comprehensive outline

People often have complaints about how much of their income is taken through both direct and indirect taxation. As a result, we attempt to answer questions people may have about taxation starting with the most basic: why should we pay any taxes at all? To fully explain, we consider how much revenue is raised through taxation and where this money is spent. After considering the size of the UK’s national debt we look at ways this could be reduced. One obvious solution could be to clamp down on tax evaders so that every citizen pays their fair share of taxes.



Before analysing the size of the problem (the tax gap), we clarify the differences between tax evasion, tax avoidance and legitimate ways to reduce the amount of taxes you pay. Finally, we answer the question of whether tax evasion is a victim-less crime before explaining the measures which have been taken in recent years to minimise the scale of the problem.

Why should we pay taxes?

Reading through politicians’ rhetoric of previous centuries, the phrase that is repeated over and over again is that it is every citizen’s ‘patriotic duty’ to pay taxes. (In fact, it’s no coincidence that the word ‘duty’ has become a synonym for the Latin word ‘tax’). You should, however, bear in mind that revenue was usually needed at the time to pay for military expenditure – whether this was to fight Napoleon or the Kaiser. Nowadays, politicians wouldn’t be able to appeal to people’s sense of patriotism to fund a war but this word could be replaced by the word ‘civic’. In other words, it’s everyone’s civic duty to pay taxes.

A young couple looking troubled over paperwork regarding their UK tax

Just imagine if the government were unable to raise revenue from taxes. How would schools, hospitals, law enforcement and so on be funded? You only have to look at countries with unstable governments to see how things quickly become chaotic and how nothing is able to function correctly. Whether we like it or not, taxes are a necessary evil in order to ensure the smooth running of a democracy. Even countries which are politically opposed to the state having a say in certain sectors such as healthcare realise that not everything can be privatised and the government needs to be in charge of certain services for the good of all its citizens.

Also On Family Money…
In our article on how to calculate your UK income tax you will find out information about your tax return, tax relief and fringe benefits in the UK. Read our article to help you calculate your tax return

Now that the necessity of taxation has been proven, let’s look at how much money is raised and how the money is spent.

Just imagine if the government were unable to raise revenue from taxes. How would schools, hospitals and law enforcement be funded?

How much revenue does the British Government raise?

In a report published by the IFS (Institute for Fiscal Studies) in November 2016 called ‘A Survey of the UK Tax System’, an analysis of data available for the 2016-17 tax year found that the UK government had a total revenue of £716.5 billion or 36.9% of the UK GDP. Of this amount, £665.1 billion was raised from taxes and the rest was from public sector industries, rent on state-owned property and so on.

Of the tax revenue, the taxes which raised the most money were income tax, National Insurance and VAT; they made up nearly 60% of all tax revenue. The exact figures are:

Tax Value (£ billions) Of tax revenue
Income tax 182.1 25.4%
National Insurance 126.5 17.7%
VAT 120.1 16.8%

Duties and other indirect taxation made up a further 10% (the biggest being £27.6 billion for fuel taxes) and another 10% was contributed by taxes paid by companies such as corporation and business taxes.

Now that we have an idea of how much revenue is raised by taxes, the next question is how the money is allocated and where it is spent.

Where do taxes in the UK go?

In a report prepared by HM Treasury in December 2016 and also distributed to taxpayers, there’s an analytical breakdown of how our taxes in the UK are spent.

Public Spending (December 2016) – the amounts spent (and the percentage of total expenditure)

Spent on Amount spent (£ billions) Of total expenditure
Welfare (excluding pensions) 174.9 25%
Health 138.7 19.9%
State Pensions 89.3 12.8%
Education 84 12%
National Debt Interest 36.7 5.3%
Defence 36.6 5.2%
Public Order/Safety 30.2 4.3%
Transport 28.1 4%
Business & Industry 17.1 2.4
Government Administration 13.8 2%
The Environment 11.6 1.7%
Culture 11.4 1.6%
Housing & Utilities 10 1.4%
Overseas Aid 8.2 1.2%
UK Contributions to the EU Budget 7.7 1.1%

It’s interesting to note that over a third of total UK state expenditure is spent on welfare payments (including state pensions) whilst health makes up a fifth of governmental expenditure. It’s also worth noting that the expenditure on education is over double that of defence. In comparison the amounts spent on areas such as culture or overseas aid seem negligible.

Summary:

Although people complain about taxes, they’re necessary for the smooth running of the state.

In 2016-17 the UK government received £665.1 billion from direct and indirect taxation.

Nearly 60% of tax revenue generated in the UK came from income tax, National Insurance and VAT.

Almost 70% of UK state expenditure is used to fund welfare (including state pensions), healthcare and education.

How big is the public sector debt in the UK?

It’s an undeniable fact that governmental income generated from taxes, rents and so on is insufficient to meet the demands of the day-to-day running of the state and any investments in infrastructure. In the table given above, you may have noticed that 5.3% of total state expenditure (or £36.7 billion) was earmarked for making interest payments on this national debt.

Income generated from taxes and rents  is insufficient to run the state with

According to the ONS (Office for National Statistics), the government had to borrow £47.8 billion between April 2016-February 2017. Of this amount £16.4 billion was needed to fund various government departments whilst £31.4 billion was used for capital spending and net investment.

Taking into account money borrowed in the past, the public sector owed the private sector just under £1.7 trillion at the end of February 2017 (or 85.4% of the UK’s GDP). Over the past 22 years, this debt has dramatically risen from £230 billion in 1995 (13% of the GDP) to £1,000 billion in 2010 (or 50% of GDP) to reach the figure it is today.

Reducing the UK national debt

Is it really feasible – or even desirable – to pay off this national debt? One way to reduce it could be to raise taxes. The question is whether any political party would put themselves in this position as it could be seen as political suicide and lead to a definite defeat at the polls. Moves to cut expenditure on welfare, pensions and education could also be seen as another way to lose an election. The IFS have calculated that tax revenue generated is the equivalent of £13,500 for every adult in the UK – is it really possible to increase taxes any further and put a heavier burden on the British taxpayer?

Man carrying a boulder with the word tax written on it, symbolising the burden of tax

Another way to increase revenue which has been suggested is to be more active about chasing up unpaid taxes, vigorously persecuting tax evaders or fraudsters and attempt to tackle the issue of the ‘black economy’. How big a problem is this and how much does tax evasion cost every British taxpayer? Let’s look at this issue in more depth.

Also On Family Money…
In our dedicated article about road tax you will find out about the different rates, what car tax you must pay and the history of vehicle tax in the UK. Read our article about How To Pay Your Car Tax

Questions:

How many taxpayers are there in the UK?

According to the IFS (2016-17), there are 30.1 million taxpayers in the UK out of an adult population of 53.2 million.

Who collects the income tax in the UK?

85% of income tax in the UK is collected through the monthly PAYE system.

Who pays the most taxes?

It’s impossible to calculate how much money UK citizens pay in indirect taxation such as VAT but those on lower incomes spend a greater proportion of their income on such taxes.

For income tax, the picture is slightly different. According to the IFS, the majority of taxpayers pay the basic income tax of 20% but as they earn less, they contribute about a third to income tax revenue. There are 4.4 million taxpayers in the higher tax rate bracket of 40% (earning £32,000-£150,000) and they contribute 38.5% of the total income tax revenue. Only 330,000 people in the UK belong to the additional income tax rate of 45% (earning over £150,000 per year) and they contribute 28% of the total income tax revenue.

What are the main taxes in the UK?

The main taxes in the UK are income tax, National Insurance, VAT, excise duties and business/corporation taxes.

What’s the difference between tax evasion and tax avoidance?

Before we go further into the whole issue of unpaid taxes and the ‘black economy’, it’s necessary to make clear the difference between tax evasion and tax avoidance since they’re sometimes mistakenly used as synonyms.

Tax evasion differs from tax avoidance, yet both constitute illegal activities

Tax evasion means to illegally hide acts from HMRC in order to avoid paying taxes whilst tax avoidance is taking advantage of legal loopholes to avoid paying taxes especially exploiting tax breaks in a way which were never intended by Parliament when bills were passed.

Let’s take some examples to show how they differ. When someone puts some of their earnings into an ISA (Individual Savings Account) to avoid paying tax on the interest, this is legitimate since the Bill was intended to encourage people to save.

On the other hand, deliberately investing funds in money-losing film projects is tax avoidance since the original bill was intended to offer an incentive for film production companies to make their films in the UK. It may be legal but it isn’t what the law was intended for.

Finally, doing paid work and receiving money cash-in-hand without reporting it to the HMRC is clearly tax evasion.

Also On Family Money…
In our dedicated article about understanding UK income tax you will find out information about your tax code, the PAYE tax system and tax bands in the UK. Read our article to help you understand your tax code

Summary:

Every year the UK government needs to borrow money – both for the day-to-day running of government departments but also to fund investments.

The amount of public sector debt in the UK has risen dramatically from 13% of GDP in 1995 to over 85% of GDP nowadays.

To reduce the national debt, the government could raise taxes or cut public funding, both of which are seen as political suicide.

Another way to reduce debt could be to cut down on tax evasion and tax avoidance.

Tax evasion means illegally avoiding the payment of taxes while tax avoidance involves exploiting legal loopholes to reduce your tax bill.

How much are unpaid taxes in the UK worth?

The most recent report on the issue of unpaid taxes was released by HMRC in 2015 and the estimates below refer to the 2013-14 tax year. In total, there were uncollected taxes of £34 billion. Of this sum, it’s estimated that £2.7 billion was lost because of tax avoidance and £4.4 billion was due to tax evasion. However, because of the illegality of tax evasion, it’s extremely difficult to come up with accurate figures since many people are never caught so the sums involved could be much higher. So how does HMRC make these estimations?

It’s extremely difficult to come up with accurate figures for tax evasion so the sums involved could be much higher.

One way HMRC calculate missing taxes is to investigate randomly selected taxpayers. Their other method is to work out how many taxable products are bought and compare this to the tax collected.

What is the tax gap in the UK?

The tax gap in the UK is the difference between what taxes are owed and how much is collected. For the 2013-14 fiscal year, the estimated figures for uncollected taxes are as follows:

  • Differences in legal interpretation (of tax laws): £4.9 billion
  • Unregistered paid work: £6.2 billion
  • Organised criminal attacks: £5.1 billion
  • Non-payment: £4.1 billion
  • Failure of people to take reasonable care with tax returns: £3.9 billion
  • Honest errors: £2.6 billion

The government statistics do carry a warning though – ‘The tax gap is difficult to measure – there are many sources of uncertainty and error’.

What can be said is that the tax gap is falling, from 8.4% of all taxes in 2005-6 to 6.4% in 2013-14. Although tax avoidance is also falling (possibly because of negative publicity received in the press over recent years), tax evasion seems to have remained the same.

UK tax evasion – A victim-less crime?

Some people might see tax evasion as morally different from mugging or burglary but is it really a victim-less crime? You could argue that the victims are many – every single citizen of the UK. Tax revenue falls and this can have a knock-on effect on state expenditure and how much money needs to be borrowed to top up the missing billions. Who in the UK isn’t affected by this in some way or other?

So what is being done to solve the problem of tax evasion and how successful have the government been in recent years on cracking down on this phenomenon?

Measures to reduce UK tax evasion

Since 2010, HMRC have pursued a vigorous policy of zero tolerance towards tax evaders even prosecuting marginal cases and in this period have collected £130 billion of funds from people convicted of tax evasion, avoidance and non-compliance.

Documents regarding offshore accounts, which can in some cases be used for tax evasion

In a January 2017 Press Release, the HMRC revealed how it had convicted 679 individuals in 2016, who received a total of 730 years in prison sentences. They were found guilty of crimes such as excise smuggling (mainly alcohol and cigarettes), hiding assets in offshore accounts and frauds disguised as tax avoidance schemes.

To make it even more difficult for people to avoid or evade paying their taxes, it was announced that from July 2017 accountants, bankers, lawyers and other financial advisors who give advice to help people commit tax fraud will be liable to a fine equivalent of the value of the tax which they helped their clients avoid paying (up to a maximum of £3,000). There will also be a ‘Name & Shame’ policy where the companies involved will also be publicised. Hopefully, this will make it more difficult for tax evaders to receive morally dubious advice.

Summary:

It’s estimated that in 2013-14 there was £34 billion in uncollected taxes, of which £2.7 billion was owed for tax avoidance and £4.4 billion for tax evasion.

The tax gap refers to the difference between how much tax is collected and how much is owed.

The tax gap in 2013-14 was 6.4% of all tax revenue but has fallen in recent years.

Tax evasion isn’t a victim-less crime as it directly affects everyone in the UK.

HMRC has been much more stringent in prosecuting tax evaders and from July 2017 financial advisers will also be fined for encouraging their clients to avoid taxes.



Questions:

How much has the collection of taxes changed over the past 40 years?

Falls in income tax rates have meant that an increasingly high proportion of tax revenue is raised from indirect taxation. According to the IFS, the amount raised by VAT, for example, has doubled as a proportion of total UK tax revenue since 1979.

What is the situation in Scotland as regards income tax revenue?

In April 2016, all income tax rates in Scotland were reduced by 10%. However, the Scottish Parliament set their rise at the same amount so Scottish taxpayers saw no difference in the amount they paid. The Smith Commission has recommended further changes and devolution.

How does the HMRC treat tax evaders?

Tax evasion is usually treated as a civil offence so tax evaders have to pay the tax and any interest on the amount owed. There’s also a fine of up to 200% of the back taxes which are owed.

Tax evasion is only treated as a criminal offence when there is evidence of criminal intent, for repeated tax evaders and for people who deliberately conceal evidence from the HMRC.

What’s the prison sentence for tax evasion?

Sentencing in the UK comes under the jurisdiction of the Ministry of Justice and depends on the severity of the crime and the amounts of money owed/concealed. On average it could be anything from 18 months to 4 or even 5 years.

What happens to taxes owed if someone declares bankruptcy?

Taxes used to still be owed despite personal insolvency. However, now such debts are also wiped out when someone declares bankruptcy.


Interested In This Article?

Continue to Chapter 3

Go to article introduction and table of contents

About the author

Thomas Henderson

Thomas worked as a consultant in personal finance in the UK for 18 years. He has found a passion in sharing his experience on familymoney.co.uk

Thomas also takes pleasure in woodworking, reading and observing stock market trends.

Add Comment

Click here to post a comment

About The Author

Thomas Henderson

Thomas worked as a consultant in personal finance in the UK for 18 years. He has found a passion in sharing his experience on familymoney.co.uk

Thomas also takes pleasure in woodworking, reading and observing stock market trends.

Jump To A Category

Quick Read: Money Magazine