Thursday, 26 July 2012

Cash in Hand

David Gauke, a minor Treasury Minister from the Conservative side of the coalition has said it is "morally wrong" to pay cash in hand seeking a discount.  This did not actually have the connotation of a pronouncement from on high that some of the later press coverage has imputed.  The minister was answering questions after a speech.  The phrase "morally wrong" was not chosen by the minister, it was chosen by the journalist asking the question.  The minister seems to have been saying (somewhat clumsily) two things:
  1. People should not ask for a discount if they pay in cash in the knowledge that the tradesman will use the cash without declaring it; and
  2. Stopping tax avoidance is important, but the "hidden economy" is a "very substantial" part of it as well.
One of these points is interesting; the other is mundane.  The attention each has received looks to me to be the wrong way around and that says something about us and our priorities.

The mundane point is that people should not say to their plumber or cleaner something along the lines of "I'll pay you in cash; you then don't need to report the income; and you can give me a share of the money you save on taxes through a discount from your usual rate".  As statements go, it is difficult to see why this has attracted the attention it has.  All it is really saying is that you shouldn't ask someone to commit a crime on your behalf, albeit a relatively minor one given the amounts involved.

Note that this is quite different from what I suspect usually happens when cash in hand payments go undeclared, which is where the tradesman offers a discount if you pay in cash.  This is a bit more of a grey area.  Not being a Philosopher, I think I'll leave off this point and move onto the second part of what the minister was (mis)communicating.

The minister was saying that stopping tax avoidance schemes at the top of the income distribution was important, but the hidden economy of tax evading plumbers and cleaners is just as important.  There was a sense in which the minister was equating the two and suggesting that if we are going to crackdown on one, we should also crackdown on the other.  Again, as I am not a Philosopher, I shall leave the ethical analysis to others and just consider the economics of this statement - in economic terms, this is palpable nonsense!

According to the HMRC, the median income is approximately £19,600 per year.  Whereas the income of the 99th percentile (this is the minimum income to claim membership of the top 1%) is £149,000.  The post-tax median income is £17,200.  The post-tax income of someone at the 99th percentile is £105,000.  A very rough and ready calculation (assuming the order of taxpayers remains the same before and after tax) suggests that the median taxpayer pays £2,400 per year in tax and the taxpayer at the 99th percentile pays £44,000 per year in tax.  So (on a very rough and ready calculation) catching a tax avoider or evader at the top of the income distribution will recover for the Treasury more than 18 times as much money as catching a tax avoider or evader in the  middle of the income distribution.  So the minister is right only if with the same effort and cost that it takes to catch one tax avoider at the top of the income distribution, we could catch around 20 tax avoiders in the middle of the distribution.  This may in fact be the case, and so there may be greater net benefit to the treasury from going after tax avoiders in the middle of the distribution, but that needs to be part of the discussion and it wasn't.

There are, of course, factors which should be considered but have been left out of this analysis for lack of data.  One example that would make the calculations even less favourable for the Minister is that we shouldn't be comparing the 99th percentile with the median, but the mid-point of the top 1% with the 25th percentile which might have a higher concentration of self-employed tradespeople.  That would put a much higher threshold on how much easier it would have to be to catch people at the lower end of the income scale in order to make targeting them worthwhile.  However, in the Minister's favour, there are a greater number of people at lower points of the income scale, and there may be economies of scale in targeting these groups that improve the economic argument for doing so.  There may be some reason to believe that tax evasion is more common at lower income brackets, though the Minister has not stated any reasons why we might think this, but if it were the case, that would change the analysis somewhat.  Some combination of these two points seems to have been what the Minister was driving at when he referred to "the hidden economy" being a "very substantial" part of the problem.  Although this does raise the question: If this part of the economy is "hidden", how do we know how big it is?

There is one final point to consider in all of this and I shall have to try not to sound too much like I am gloating.  The ideas of providing a "Nudge" to effect change described in the book of that name by Thaler and Sunstein have apparently been influential in Downing Street.  The idea is one that can work well when there is a behavioural bias to be overcome.  Increasing pensions savings by making pension schemes "opt-out" rather than "opt-in" is a good example.  One could (generously) read David Gauke's statement as an attempt to nudge the population into not accepting "cash in hand" discounts and even reporting tradespeople who suggest it.  If  that is the case, then it would seem to have backfired.  Nudges work best when they overcome a behavioural bias and point us in the direction of our own interest.  A Nudge will have a great deal of difficulty in getting us to take actions which run counter to our own interests.

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