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Tax dodging? It's harder to do - and rarer - than you think

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Video So you'd like to know how to avoid tax. After all, everyone else seems to be doing it, so why end up as the Muggins who has to pay while everyone else mugs the Treasury?

The simplest and most obvious method of not paying taxes is simply to avoid doing anything. If you're not taking part in economic activity then no one will be able to tax you. This does have a downside to it as starvation is a likely outcome.

This is what famously occurs towards the second end of the famous Laffer Curve: a taxpayer decides to do a little bit less of something - whether it be running a business or working for someone else - if tax rates become insupportably high.

At the one extreme – 100 per cent taxation – the government receives zero revenues as no one is prepared to work for "free", while at the other extreme – 0 per cent taxation – the government receives zero revenues for obvious reasons (see video below for a back-of-the-napkin – yes, literally – explanation from former Reagan White House economic adviser Arthur Laffer himself).

Laffer draws his famous curve on a napkin and explains how it works.

Yes, it's really true. The argument is about the shape of the curve, not its existence. If you push tax rates too high, a sufficiently large number of people will do sufficiently less such that overall tax collections will fall.

There are Laffer effects at any level of taxation. A decent guess is that what we call the "deadweight" loss of taxation is 20 per cent. Raise £1 in tax and 20p of economic activity doesn't happen purely and solely as a result of that tax.

At the margin, where we already take 40 per cent of GDP in tax, that deadweight might rise to one-third or so. Given that at least some of what the government does is worth more than 130 per cent of what the taxpayers themselves would do with the money, this is fine.

Allowances - governments make them, so use them

You still want to save on your taxes but don't want to give up on the work? The next step is to use all of the allowances that are made available to you. Stick your savings into an ISA (a 401k, sorta, for our friends over the Pond); maximise your pensions contributions; make sure you claim absolutely everything you can as a work allowance (if you're wearing a boiler suit to work in a dirty environment make sure to claim for cleaning it) and so on.

So far no one is going to accuse you of tax dodging in any manner: this is just some combination of the usual human response to incentives plus things specifically put into law to persuade you to act in certain ways.

Call in the contractor... or be one

After this though it becomes a tad more tricky. Because there will be those who insist that this next stage is tax avoidance, not good old tax compliance. For example, you could, if you were a contractor, incorporate yourself as a company. Put the husband on as 49 per cent shareholder too. Earnings go into the company and you pay yourself £3k a year each or so.

This is enough for you to be credited with paying national insurance (and so earning your state pension) but not enough for you to be actually paying any NI. You then pay corporation tax out of profits and you pay what's left as a dividend. Corporation tax plus individual income tax on dividends is pretty much the same rate (not quite, but close). However, crucially, dividends attract no NI. So you save both the employer and employee NI costs.

The actual saving isn't all that large because the alternative to incorporation would be to be self-employed, where you pay lower NI anyway. But it's still a cute scheme. For you have now also moved some of the income over to hubby who, being the stay-at-home look-after-the-kids sort, has an unused personal allowance and a further standard rate allowance to use up before hitting your exalted income tax levels.

It's so cute in fact that Gordon Brown tried to ban many from doing this (leaving a company as an employee and returning as a contractor to avoid NI) with the IR 35 legislation, but it didn't work all that well. As an aside I know a certain tax campaigner who rants and raves against this “misuse” of incorporation, calling it tax abuse. He did pipe down after one wag checked at Companies House and proved that this was the scheme that he and his own wife used.

But these of course aren't the sort of schemes that are making the recent headlines. There's all those complex, completely legal Jimmy Carr-type schemes out there but they don't last long and don't, usually, save any tax either.

As soon as HMRC finds out about them (and they must be disclosed in advance now), they close them down, pass a nice bit of retroactive legislation and everyone has to cough up the tax and still lose the fees they paid to the scheme promoters. Shame, eh?

Then there's all the other stories, all those tech companies adhering to the just and righteous law but nevertheless not coughing up a bean. The Googles, Apples, Dell, Microsoft and all the rest are dancing around the edge of the law and the grannies die of starvation while corporate execs heap the profits high.

Except, actually, in those large corporations there's almost no one at all in the know who suspects any dancing at the edge of the law. What they're doing is clearly established in the relevant tax law: it's just that times have changed since the laws were written.

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