Jul 2009 27
  • New report argues that government tax changes will reduce the incentives to become an entrepreneur.
  • The top marginal tax rate on income earned, saved, invested in a company and then passed on to children is currently 90 per cent.
  • With the forthcoming 50 per cent top tax rate, that will rise to 92 per cent.  That means the measure will take 20 per cent of the money entrepreneurs are left with the current 40 per cent top tax rate.

The TaxPayers' Alliance is releasing a new report by Dr. Jonathan M. Scott, Teaching Fellow at Queen's University Belfast whose research focuses on entrepreneurship, and Matthew Sinclair, Research Director at the TPA.  The report shows that the new 50p tax rate will push the total tax burden on high earnings to crippling levels and argues that will mean fewer entrepreneurs and jobs.  To read the full report – including a foreword from Julie Meyer, online "Dragon" and Chief Executive of Ariadne Capital – click here (PDF).

There is rightly increasing political and popular concern about unemployment.  In response, parties are putting in place or proposing new schemes to provide specific incentives for employers to take people off the unemployment register or take on new interns and apprentices.  The new TPA report, Tax and Entrepreneurship, shows that these policies do little to encourage the new firms that create the vast majority of new jobs.  Despite a notional commitment to ‘enterprise for all’ and significant public expenditure on business support services to encourage entrepreneurship, there has been little progress on that measure in recent years with just a 0.3 per cent increase in new business registrations between 1997 and 2006.

The report also covers the effects of the new 50p top rate of income tax, which are highly controversial, some politicians have argued that it will put off entrepreneurs, while others have argued that the low amount of revenue expected from the change means it will make little difference.  Tax and Entrepreneurship demonstrates how the tax system affects the decision over whether to become an entrepreneur in two key ways:

  • It reduces the amount of capital they can access from their own wealth or their family.  In particular, existing research suggests that receiving an inheritance leads to higher levels of self-employment. Inheritance Tax, in particular, may reduce the extent that entrepreneurs can obtain finance without the risks that come with a bank loan.
  • The tax system undermines the large rewards that justify the risks attached to starting a new business.

When entrepreneurs earn a large amount of money they will often earn substantial amounts above the various tax thresholds, before saving and investing that money then eventually passing it on to their children.  That money is therefore taxed repeatedly before it is spent and winds up facing a very high top marginal rate:

  • Under the present tax system that rate is around 90 per cent.
  • With the proposed 50 per cent top tax rate, the marginal rate facing successful entrepreneurs could rise to 92 per cent, reminiscent of the up to 98 per cent tax rates seen in the 1970s.  That means this measure has taken 20 per cent of the money entrepreneurs are left under the present 40 per cent top tax rate.
  • Even if entrepreneurs take their initial reward as capital gains and benefit from the Entrepreneurs’ Relief, they will still face a total marginal rate of 86 per cent.

To read the full report, which includes an Executive Summary, click here (PDF).
Matthew Sinclair, Research Director at the TaxPayers' Alliance and co-author of the report, said:

"Politicians are promoting a huge range of schemes to try and hold down unemployment but they aren't paying nearly enough attention to how their policies affect entrepreneurs, who create the vast majority of new jobs.  The new top rate that the government are proposing won't just fail to raise significant revenue, by putting off potential entrepreneurs, it will reduce employment and make it more likely that ordinary Britons can't find work.  The 50p rate of income tax was a political stunt that isn't worth the price of higher unemployment, so it should be abandoned."

Julie Meyer, Chief Executive of Ariadne Capital and author of the foreword, said:

"For those of us who are interested in building a truly entrepreneurial country, Tax and Entrepreneurship is a must read as it fleshes out the cause and unintended effects of current tax policy on the "goose" that lays the "golden eggs" for society – entrepreneurship."

Jonathan Matthew Scott, Teaching Fellow at Queen's University Belfast and co-author of the report, said:

"Entrepreneurship is recognised as a major force for job creation in the economy, something which is particularly necessary in the current recession. Any disincentives to start up a business will put a significant brake upon the creation of such new firms and the jobs that accompany them. Taxation of entrepreneurs is a particularly controversial issue, which academics and politicians have been arguing about for decades. Hopefully our report will be a landmark in this debate, given that it shows the scale of tax disincentives to entrepreneurship."

  • Alfred T Mahan

    But surely the Great Leader loves entrepreneurs? This is what he said only two years ago:
    I can’t believe he’d introduce taxes that do the very opposite of what he says he wants. Would he?

  • Patrick

    I’m not sure about the naive formula used here with the personal income, business and inheritance tax components simply multiplied together.
    The formula used assumes a certain kind of stupidity on the part of the enterpreneur.
    Firstly, the enterpreneur will usually keep the personal income down, since the marginal taxes are high if transfered out of the company and there are many ways of using expenses from the company he runs to live a decent lifestyle. Also, dividends are taxed at a lower rate than income to reflect the tax already paid by the company. This will change the weighting for the first component between enterpreneurs, depending on their preferences and circumstances.
    Secondly, there is a confusion between the tax on the corporation and the tax on the individual. The market value of the company is impacted by the corporate tax rate, but this only comes out at an event such as a share sale, which is addressed as a capital gain.
    Thirdly, there is strong exemption from inheritance tax on “family” owned businesses. Effectively, it is possible to pass on a very large company at zero inheritance tax, while personal assets would be counted towards in the inheritance tax calculations.
    Finally, your 35 year projection does not factor in the effect of inflation, so the numbers really mean nothing.
    In short, if the owner of a company keeps his personal income modest (which is possible over 35 years e.g. once he has a house), can claim company expenses and keeps his assets incorporated in a company structure the tax rate would fall far short of the 90% predicted by this “model”.
    This is how the economy functions at all – if none of these exemptions were possible nobody would act.
    I agree that the 50% tax rate will reduce revenues to the treasury. I also think that the overall system of taxes is pathetic, particularly the marginal tax on minimum wage earners.
    However, I find this system of calculation to be a pretty flawed one. It kind-of demonstrates how much tax it is possible to pay if somebody acts in an unbelievably stupid fashion, but it really shows nothing of any substance, I’m very sorry to observe.

  • http://www.taxpayersalliance.org/ Clifford Singer

    Patrick is right about the flawed calculations – there’s more about this at the Other TaxPayers’ Alliance website (see the comments as well as the main post):