by Atlanta Neudorf, operations assistant
The economic sword of Damocles that has been hanging over taxpayers since the autumn budget has finally fallen. With the inauguration of the new tax year this past Sunday, increased tax burdens have landed with a heavy thud on the heads of employers and workers alike, while newspaper headlines reporting on fleeing millionaires and non-doms have abounded in recent weeks.
As our latest research paper showed, you can see why. Domestic entrepreneurs are now forced to swallow bitter tax pills under the current government, with little sugar (in the form of tax relief) to help them go down. Our investigation into Britain’s ‘Tax on Entrepreneurship’ found that rising tax burdens weigh even more heavily on entrepreneurs than might initially be assumed, with exceedingly high marginal tax rates now established as the norm for many who are financially successful. Meanwhile, individuals possessed of an entrepreneurial spirit – who are crucial to job creation as well as wealth generation – face higher barriers to success than ever before.
Modelling the impact of both pre- and post-budget rates of income tax, corporation tax, capital gains tax, and inheritance tax on £1 over 35 years, the research finds that, excluding tax planning steps such as direct bequests, entrepreneurs now face a marginal tax rate of 90.4 per cent on their earnings.
Taking as its starting point calculations employed by Harvard macroeconomist N. Gregory Mankiw, the paper examines the journey of a marginal £1, from employer to investor to heirs. On this journey it is subject to income tax, national insurance, corporate tax, capital gains tax and finally inheritance tax. The inclusion of income taxes and national insurance contributions may seem surprising, but there are several reasons for this.
Firstly, ignoring the role of income taxes on entrepreneurs would be to exclude a key factor in the initial launch of a business. The overwhelming majority of entrepreneurs rely on their personal capital to start their business, much of which will include savings from work. Secondly, businesses take time to become profitable and many entrepreneurs do not quit their jobs, but rather continue to work in order to support their fledgling business. Thirdly, and perhaps most critically, the government taxes each stage of attempts to build personal and generational wealth. If HMRC takes a slice of the same pound multiple times over the economic cycle, it would be erroneous to ignore this factor in a calculation of the total tax burden faced by an entrepreneur.
To calculate returns on post tax income of £0.46, we compound the returns/profit (post corporation tax) over 35 years, with capital gains and inheritance tax levies applied to the final value of £5.79. This brings us to a final bequest figure of £2.71. Tax-free, compound returns on £1 over the same period would equate to £28.10, which leads us to our finding of a 90.4 per cent ‘tax on entrepreneurship’.
In comparison, scenarios where the ‘business asset disposal’ relief on capital gains tax or a ‘tax planned’ approach (where the entrepreneur bequeaths a business directly to their heirs rather than selling it) is applied, we found an ‘entrepreneur tax’ of 89.7 per cent and 83.5 per cent, respectively. If we take a ‘tax max’ scenario – where the money initially earned is above £100,000 but below £125,140, thereby being subject to an effective income tax rate of 60 per cent due to the claw back of the personal allowance– we find an ‘entrepreneur tax’ rate of 93.1 per cent under current tax rates.
When compared with pre-budget tax rates in the likeliest scenario (tax planned), we find that entrepreneurs have seen their tax rates rise by 4.3 percentage points in its aftermath. This is primarily due to the reduction of business relief from inheritance tax from 100 to 50 per cent.
So why does this burden on entrepreneurs matter? It is no secret that entrepreneurs are highly valuable to wider society, as well as to the economy. They create jobs, build wealth, and drive innovation. Britain’s post-pandemic business registration numbers were already falling in light of some of the highest tax burdens in our nation’s history. The current tax regime is pushing entrepreneurs away – quite literally, in the case of venture capital firm Andreessen Horowitz and the wider flight of the millionaires.
To stop this exodus of talent and capital, the government must commit to three core principles: tax stability, growth-maximising policies, and a lowering of the tax burden. Entrepreneurs must be able to plan for the future success of their businesses. This is near-impossible under a government with a history of backtracking on prior commitments (as we saw in the budget’s hike in employer National Insurance contributions). To restore credibility and confidence, government pledges to maintain current tax rates should be extended to include both capital gains and inheritance tax, with a firm commitment to longer advance notice of any upcoming changes. Economic growth is both the origin and consequence of entrepreneurship, and policy must reflect that.
The government should actively encourage investment, extend business rates improvement relief, abolish the top rate of income tax, and cut the rates of capital gains tax, inheritance tax, and corporation tax. Finally, to alleviate the tax burden on entrepreneurs, it should commit to modest annual reductions in tax rates and disciplined spending restraint in order to reduce debt interest costs and increase entrepreneurial confidence. Without bold action, the UK is at risk of becoming a place where ambition is punished even further, rather than rewarded.