Executive summary
With the tax burden set to grow to an 80-year high, the burden on entrepreneurs is unsurprisingly heavy. But it may be heavier than many might expect. This is because when entrepreneurs earn, they often exceed numerous tax thresholds, save and invest their earnings, and ultimately pass them on to their children. As a result, the same money is taxed repeatedly before it is ever spent, leading to an exceptionally high marginal tax rate.
- If we assume that financially motivated entrepreneurs work to give their children an inheritance, the total combined tax on entrepreneurship is 84 per cent if they arrange their affairs with some reasonable tax planning, after the recent budget’s measures take effect. This involves the entrepreneur not selling the business but bequeathing it directly to their heirs, thereby enjoying business relief from inheritance tax and no capital gains tax.
- The measures in the budget increase the tax planned rate by 4.3 percentage points, from 79.2 per cent to 83.5 per cent, a 5.5 per cent increase. This is primarily driven by the reduction of business relief from inheritance tax from 100 to 50 per cent.
- This means the share of entrepreneurs’ gains that they can give to an heir falls from 20.8 per cent to 16.5 per cent, a 20.8 per cent reduction.
- Without tax planning steps, the entrepreneur will face a tax rate of 90.4 per cent, up 0.6 percentage points from the pre-budget rate of 89.8 per cent.
Literature on entrepreneurship finds that:
- Entrepreneurs perform a function that cannot be achieved by the research and development of existing firms alone without a visionary individual who persists in overcoming obstacles.
- New firms are responsible for most net new job creation.
- Entrepreneurs are often motivated by financial success.
- Larger governments serve as a barrier to entrepreneurship.
- Entrepreneurship provides non-financial benefits including autonomy, flexibility and skill utilisation.
To encourage entrepreneurship to flourish, the government should:
- Commit to tax stability, extending the pledge not to raise employee national insurance, income tax, corporation tax and VAT to employer national insurance, capital gains tax and inheritance tax. This should include not cutting thresholds or reliefs.
- Commit to growth-enhancing tax reform, including:
- Extending business rates ‘improvement relief’ on new buildings from 12 months to 9 years and extending its scope to all new buildings.
- Extending corporation tax ‘full expensing’ to structures and buildings.
- Abolishing the top ‘additional rate’ of income tax and the personal allowance withdrawal.
- Cutting the rates of capital gains tax, inheritance tax and corporation tax.
- Commit to reducing the tax burden. Entrepreneurship is negatively correlated to the size of the spending and tax as a share of the national economy, so the government should commit to cutting the tax burden over time along with spending restraint to make the pledge credible.
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