Jimmy Carr thinks his terrible error was in avoiding tax. Actually, it was in not realising that he was fulfilling a nefarious plan by the government...
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| That's right Jimmy - punch that taxman! Or just blind him with your forehead glare. |
Yes, it's bandwagon time, and I'm going to hop onto it. This week Jimmy Carr has been roundly criticised for avoiding paying a significant chunk of income tax by using a scheme called K2, provided by a company based in Jersey. Naturally, and justifiably, the idea of a millionaire public figure like Carr paying a disgustingly low rate of income tax and shafting HMRC in the process was a slight irk to pretty much everyone. Joe Bloggs was pissed off. John Doe was pissed off. David Cameron and Ed Milliband both came out claiming that Carr was the anti-christ and was responsible for slaughtering Santa's elves, or something along those lines. Amidst all this, about the sanest piece of commentary came from, remarkably, the ever-insightful gynaecological mastermind Christian Jessen:-
But I can't help but feel that even Dr Christian has missed the point on Jimmy Carr. He is right that politicians shouldn't stigmatise Carr personally, given that he is just exploiting a loophole that ultimately they designed. He is also right that the incident should be raising concerns about tax structures, rather than the moral failings of the wealthy. But what he and everyone else is missing is that Carr has not avoided paying tax entirely, and to a much greater extent than they think. Consequently, the question is not "how can we make sure Jimmy Carr pays more tax", but rather "how do we make sure Jimmy Carr stops being so smug about the fact that he employs an accountant.". In short, most commentators have focused on the fact that Carr pays less income tax than he should, but they've forgotten to ask themselves a key question:-
Where does all the money he is not paying in income tax go?
At risk of reiterating the obvious, let's go over exactly what it is that Carr has done. He was a member of a tax avoidance scheme called K2, which is designed to drastically reduce an individual's exposure to income tax. Under K2, Carr has essentially become an employee of the K2 company (based in Jersey), and any earnings he makes through his onshore activities are paid to K2 as an employer, rather than Carr as the employee. K2 then pays Carr a nominal salary, in order to justify its incorporation, but at the lowest rate of income tax possible. The remainder of Carr's earnings are then given to him as an interest-free loan. As it is a loan, which can theoretically be recalled at any time, then it is not liable for tax, thus eliminating any further exposure to regular onshore UK tax rates. If that seems a bit confusing, think of it like this:-
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Jimmy Carr's income tax performance - standard
Earnings: £1m p/a.
Taxable income: £1m
Tax rate: 50% (higher rate of income tax)
Therefore
HMRC receives: £1m x 50% = £500,000
Carr's take-home pay: the remainder = £500,000.
Jimmy Carr's income tax performance - K2
Earnings: £1m p/a. This goes to K2, not Jimmy Carr
Salary from K2: £10,000. Administration fee to K2: £98,000. Loan from K2: £892,000
Taxable income: £10,000; loan not liable for income tax.
Tax rate: 20% (lower rate of income tax) on £10,000 salary. No tax on the loan.
Therefore
HMRC receives: £10,000 x 20% = £2,000
Carr's take-home pay: the remainder + the loan = £8,000 + £892,000 = £900,000.
Jimmy Carr gains: +£400k = +80%
HMRC loses: -£498k = -99.6%
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I know what you're thinking: THAT SMUG FUCKER - HOW DARE HE SHAFT HMRC LIKE THAT. HE PAYS LESS TAX THAN MY CLEANER!*
And you'd be right, to an extent - it seems Carr has reduced his overall tax liability from 50% to only 10%**. And I'm assuming your cleaner is just as pissed off as you right now.

The thing is, to be irked at Carr going home with so much extra wonga is to forget what he does with it all. I somehow doubt that he just goes home with £900k in £50 notes, throws them in his jacuzzi and rubs them all over himself in a state of ecstasy. Instead, he has to do something with it, and a smart man like Jimmy Carr is going to do two things - spend and invest. And this is why Carr's absurdly low rate of income tax is so misleading. He will still be paying tax on all his subsequent economic activity, and this economic activity has been explicitly preferred by the government.
Before K2 he would be taking home £500k and sticking half of it in a savings account and spending the other half on consumption. Now all he's doing is increasing the amount he saves and/or the amount he consumes, and thus becoming liable for more tax in these areas. For instance, before K2 he might have had to put £250k in a savings account, paid £150k on living costs, and then spent the remaining £100k on some crappy Aston Martin and been jolly miserable about the whole thing. With K2, let's say he still puts £250k in a savings account, and pays £150k on living costs, but he can now spend £500k on the Pagani Zonda he had his heart set on. He will still pay VAT on that supercar. And HMRC will still gain tax revenues from the extra consumption by the extra employees hired by Pagani to make the more expensive supercar. Consequently, Carr isn't shafting HMRC. Well, not as much as we thought:-
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Jimmy Carr's real tax performance - standard
Earnings: £1m p/a.
Income tax @ 50% = £500k. Available to spend = £500k
Saves £250k. Tax on earnings through interest of 4% = £10k x 20% = £2,000
Consumes remaining £250k. VAT @ 20% = £50k
Therefore total tax = £500k (Income) + £2k (Savings interest) + £50k (VAT) = £552k
Therefore tax rate = £552k / £1m = 55.2%
Jimmy Carr's real tax performance - K2
Earnings: £1m p/a.
Income tax+K2 fees = £2k + £98k = £100k. Available to spend = £900k
Saves £250k. Tax on earnings through interest of 4% = £10k x 20% = £2,000
Consumes remaining £650k. VAT @ 20% = £130k
Therefore total tax = £130k (VAT) + £2k (Income) + £2k (Savings interest) = £134,000
Therefore tax rate = £134k / £1m = 13.4%
Jimmy Carr actual gains: Still +£400k = +80%
HMRC actual loses: 552k-134k = -£420k = -76%***
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The point is that Carr has not escaped paying tax entirely, he's just shifted the majority of his earnings liability away from income tax @ 50% to VAT @ 20%. In so doing, HMRC loses a large chunk of revenue, but it is no way as large as if Jimmy Carr was not consuming at all. And he is able to do so because the tax system is designed to promote investment and consumption, and private economic activity (more employees making supercars) rather than public economic activity (more civil servants delivering public services). The tax system is designed to do this, otherwise why else would consumption be taxed at a flat rate of 20% and income taxed on a sliding scale starting at 20%? HMRC is haemorrhaging revenue not because the tax rate is wrong, but because they've made the mistake of not taxing Carr's earnings at the point between him taking cash from the punters and passing it on to a company based in Jersey.
If you think I'm happy with this situation, you'd be wrong. I think it is preferable to tax rich people more, and I happen to think that expenditure on public services is a lot more productive in many instances than leaving investment to the private sector and allowing capital to accumulate in the hands of wealthy individuals. The questions this incident has raised are not about how immoral the rich are; if the government really didn't want individuals like Jimmy Carr to use such elaborate income tax avoidance schemes, then it wouldn't put up with a tax system designed to promote consumption and investment, rather than accumulation of capital. The question is instead how to ensure that tax rates are consistent across different income bands whilst still maintaining adequate levels of private investment and consumption. And I suspect the way to achieve that would be through greater restrictions on capital flows and moving towards equalising tax rates levied on income, investment and consumption.
Back to the comedian. Contrary to his statement, Carr's "terrible error" is not in using a scheme which rebalances his tax liabilities away from income and towards value-added tax. With a system set-up specifically to promote consumption and investment rather than income growth, one might argue that he is practically obliged to do so. His great error is when he claims that he pays 'the bare minimum in tax, and not a penny more". It is an error because this is a lie. If he were really so concerned about preventing his income going to HMRC as tax, then he would be doing everything physically possible to convert his earnings directly into cash and consuming via non-taxable transactions. He'd set up a company in the Marshall Islands to receive his earnings and pay it all back to himself as cash dividends, whilst concentrating his consumption entirely on cash, non-value-added services. To put it simply, if Jimmy Carr really wanted to make sure he paid the bare minimum of tax, his consumption would consist solely of crack cocaine and hookers. Although whether his jokes would have the same impact, I'm not so sure...
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* You don't have a cleaner? Well, you clean, don't you...?
** The net liability is 10%, as he takes home 90% of his earnings. Obviously the tax liability is a meagre 2%, but from Carr's perspective the important thing is not how much HMRC gets, but rather the difference between losing 50% of his earnings and losing only 10%, so I've gone with the latter figure for simplicity.
*** Actually, it's not quite as bad as this, because HMRC will still gain revenue from taxing the incomes and consumption of the extra Pagani employees. However, I can't be arsed to speculate what value this might add up to.










