How much does tax really affect your decision making?
From VAT on school fees to business taxes, we’re living through a live experiment with the effects of tax on people’s choices. Evidence suggests the results could be far from clear-cut, says Tim Sarson
Last week, I was lucky enough to be on the panel for the Women in Tax network’s annual debate. The question was, “How do taxes affect behaviour?”
A very topical question in a month when private schools start charging VAT on their fees. It’s entrance exam season. Are there fewer 11-year-olds sitting them this year? Will dozens of schools go out of business, or is this a fuss about nothing?
And there’s plenty more examples. This week, I’ve seen warnings that British food production is at grave risk from the cut to Agricultural Property Relief and that we’re on the cusp of an exodus of international talent when the non-dom changes come into force in April.
It’s one of the recurring themes in the narrative around tax policy, which can skew towards the negative. The focus can be on the law of unintended consequences or deliberate policy objectives that may or may not succeed. Those carrots, tax incentives to do good things, or sticks, the so-called sin taxes, impact both consumer behaviour and business decisions.
Is tax really that important an influence in making decisions? As a consumer, do I choose a cheaper bottle of sugar-free pop over a highly taxed sugary drink? As a business, do tax incentives make me build my new R&D centre or factory in one place rather than another?
I’ve looked at the evidence – this is a well-studied topic – and the answer is: sometimes.
Let’s consider those intended consequences first.
The most clear-cut success story would be the ‘plastic bag tax’ were it not for the fact it’s not actually a tax but a mandatory charge large retailers have had to make since 2015. Nevertheless, the results are striking. According to HM Treasury, the 5p charge reduced plastic bag usage by over 80 per cent – around 9bn bags per year.
We’ve also had some actual taxes along similar lines: plastic packaging tax and the Soft Drinks Industry Levy. The evidence here is less dramatic but still compelling. Data shows that the average sugar content of soft drinks declined by 43.7 per cent between 2015 and 2019. There is less data available on the relatively recent plastics packaging tax, but revenue raised from the tax in its first two years is broadly in-line with government expectations and showing a downward trend.
Elsewhere, it’s a cloudier picture. The tax rate certainly has an effect, but it’s not determinative. National culture seems more important to alcohol consumption than duty rates, and car usage has more to do with geography and the availability of public transport than fuel duty.
Gentle nudge or massive shove?
If you want to nudge behaviour with tax policy, then tax must be more important than other factors. That’s either because it’s easy for people to change habits and only requires a gentle nudge, as with the plastic bag charge, or because the tax impact itself is big, as is the case with something like tobacco duty.
This seems true in corporate decision-making too. One reason European governments have been so nervous about the US’s Inflation Reduction Act (IRA) incentives is their sheer scale. It is hard to compete for green investment with a country handing out hundreds of billions of dollars in credits. Data from Clean Investment Monitor shows that in the two years since the IRA was signed into law, business and consumer investment in clean technology and infrastructure increased by 71 per cent, totalling $493bn. HMRC would argue that our R&D tax credit is similarly big enough to make a difference. Their statistics suggest that for every £1 of support, the UK’s R&D scheme incentivised £2.40 to £2.70 of R&D.
Last week, the OECD helpfully contributed more reference material. They’ve published a study into how effective tax rates across the world affect where multinationals put their operations. The conclusion: tax has a clear statistical relationship with the location of holding and group finance functions. The correlation between intellectual property, R&D and purchasing is surprisingly weak. Is that because low tax rates or incentives don’t work? It probably tells us that other things are equally or more important: the size and sophistication of the market, the availability of skilled workers and the liveability of the country.
Now what about those unintended consequences we’re hearing so much about?
Let’s take a few recent examples. The most straightforward is Capital Gains Tax (CGT). Both in the UK and elsewhere, we see predictable behaviour before and after any major rate change. Transaction volumes go up before a hike and fall after one. This is modelled in Treasury forecasts and explains why a rise in the CGT rate can sometimes be revenue-negative. Why so clear-cut? Because the timing of these transactions is usually under the taxpayer’s control, and the tax at stake is material to them.
It’s a more mixed picture for other taxes. There is a reason most OECD countries have scrapped their wealth taxes, although it’s difficult to attribute their failure solely to taxpayer behaviour. And the jury’s out on the effect of the non-dom regime.
There is a reason most OECD countries have scrapped their wealth taxes
Whether we’re talking deliberate tax nudges or unintended consequences, the truth seems to be that tax drives decision-making when the other underlying drivers are weak or when the tax effect is very large.
But never mind statistical robustness. I predict we’ll see a lot more of this. It’s a popular go-to whether you’re campaigning for emissions reduction or cutting obesity. Just remember, whenever you hear anyone making dramatic claims about it, take a step back, check the stats and reach your own conclusion.
Tim Sarson is head of tax policy at KPMG