How you can do your bit to distort the UK economy

As the Budget approaches, Merryn Somerset Webb outlines a few things you should think about doing before George Osborne shakes up the tax regime.

As the Budget approaches, there is a non stop clamour from almost all sides for new taxes of one kind or another.

Some people want a tycoon tax. Some want a mansion tax. Some want a higher top rate tax for those earning over £150,000 - or perhaps over £1m. Some want more VAT, some want less VAT, and some want to see a new tax on universal benefits.

But all these conversations about tax focus far too much on one thing: their proponents all talk about how much money they will raise, and how that money should then be spent. What they don't do is talk about how much money every single one of those taxes will waste.

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All taxes come with a cost - something referred to by economists as the 'excess burden' or deadweight loss of taxation, the amount by which a country's GDP is reduced by the distorting effects of tax.

Taxes on employment reduce employment. Taxes on income reduce the incentive to work. Taxes on consumption stop people shopping. Taxes on property transactions reduce the mobility of labour. Taxes taken from the well off and given to the poor encourage everyone to reduce or at least disguise their economic activities (the rich to cut their tax bills and the poor to keep their benefits).

Add it all up, and much of the research on the subject suggests that the total deadweight loss to the economy of our various taxes is around 30p in the pound collected. Some taxes are less distorting than others (income taxes are the worst; land value taxes the best).

But the most distorting thing of all is too many complicated taxes piled on top of each other. For proof, look no further than the pension debacle. The tax relief system is already a mess. But fear that it is to be changed again is causing people to act in ways in which they otherwise would not have. Fidelity reports that applications to deposit £20,000 or more in personal pensions are up 155% this year on last, as people try and beat the budget. This might produce excess burden (by frontloading their savings, applicants are reducing total consumption and hence growth) but it still makes sense for the individual.

It has also made me wonder what other distorting behaviours we should all be indulging in pre Budget. Clearly, pension contributions are the right thing if you are a 50% payer: whatever happens, you are bound to lose out - the annual allowance of £50,000 may well be cut, and the ability to carry forward previous allowances and so contribute up to £200,000 in one year surely will.

Other things to think about. If you earn just under the 40% tax threshold and have children, you should refuse any pay rise offered unless it more than covers the child benefit you will lose as it gets taken away from you. The same goes for anyone at or just under £50,000 there is speculation that you might get to keep your child benefit under £50,000.

If you are about to buy an expensive house and are planning to avoid stamp duty, get on with it. Those loopholes are bound to be closed (and not before time) and stamp duty on top houses may also rise significantly. If you are selling a £2m-plus house and you've got a good offer, take it fast: when taxes on expensive houses rise prices fall.

If you are a tycoon, start checking out other tax havens the idea of the 'tycoon tax' forcing a minimum rate of tax on those who prefer not to pay at all is gaining ground (although I have yet to see a convincing explanation of how it might work.

You might also stock up on Bentleys if you are planning to remain a UK resident. There is talk of a 25% VAT band for luxury items an interesting one if only in that we would find out what the Treasury thinks is a luxury. If you are thinking about buying a large non-luxury item, wait: those wanting a VAT cut might yet get it and it seems most unlikely that VAT will rise across the board.

If you are expecting a large bonus or income surge of some kind, try and delay it. The top rate won't go up, and there is a chance it might come down to 45% (or 47% if you take National Insurance into account). That might seem silly to you - it uses a lot of political capital yet doesn't abolish the emergency rate as promised. But the leaks suggesting it is at least part of the draft budget are fairly convincing.

If you are a heavy smoker, give up or stock up: the Chancellor has pledged to keep rising cigarette tax by the RPI plus 2%, and there is no reason for him not to do so. Note that a pack a day already costs you around £2,500 a year.

Finally, if you are thinking of setting up a company and funnelling your freelance earnings through it to cut your tax bill in the style of Ken Livingstone, keep going: the corporate tax rate is already 25% and there are suggestions that Osborne is targeting 20%. You'll have to pay tax when you take money out as dividends of course, but nonetheless, if you are smoothing your income to keep yourself in as low a tax band as possible, that's a rate that might well make it worth taking on the excess burden created by the bureaucracy of a small company.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.