The UI of Income Tax

I like looking for trivial things that have profound consequences when they are redesigned to make things clearer. One of these quirks exists in the way taxes are thought of and represented. A form of poor everyday ‘user interface’ design, it creates confusion and doesn’t allow instant comparison between different jurisdictions or employment types. Fixing it will become extremely important if we move towards a more freelance economy.

Below are what the principal components of salary deductions look like in most parts of the world. There is an income tax, an employer contribution to social benefits and an employee contribution.

In general, government, states or regional districts tend to refer to Income tax when referring to tax rates. The reason for this is pure semantics — social taxes have no consistent terminology: in the UK they are called National Insurance; Payroll Taxes in the US and Social Charges in France.

Not calling social contributions taxes is actually quite a big deal. The issue has ended up in court as governments have used the ambiguity over the terminology not merely for the ‘headline’ benefit but to skirt rules between member states within the European Union.

Because the idea that income tax is how much tax you pay on your salary is useful for PR purposes, as headlines in newspapers, I’m referring to it here as the ‘headline’ tax rate.

The most visible difference between the headline tax rate and reality, is what percentage of your salary you see in your pocket, after taxes — which I’m calling the perceived tax rate.

The semantic issue over social contributions is further compounded by what we consider to be a salary, when it comes to accounting for the employer component of social contributions. The convention is to take a percentage of the salary and then add it as an extra charge for the employer, rather than deducting it from your salary.

In effect, what the employer has to pay and government receives are based on a different salary, a ‘fully loaded’ salary, rather than the one the employee considers his or her deductions to refer to. This means that calculating the correct percentages is not merely a question of instant mental arithmetic (they are based on percentages of a different thing) it also means that the perception of how much tax you are paying is lowered if the employer contribution is higher.

This might seem like it is only an issue for employers, an us vs them workers vs owners thing, until you realise that for a freelancer, the employer view is no different from the employee one. For a freelancer, how much of what you earn as a business you get is the same as how much you earn as an employee.

Ideally, to create a level playing field between business, employees and freelancers, the employer deduction should move to the left and become part of the overall deduction, with the term salary always referring to a ‘fully loaded’ one. What I call ‘actual tax’ should possibly have a memorable name.

Again this might seem so obvious to be pointless, but it is not the current convention and changing it would reveal some startling differences.

To illustrate these differences I looked at tax rates in Paris, London and New York, three global cities with similar costs of living as measured by Purchasing Power Parity.

The results for headline (income tax) show that Paris has lower taxes for less well off people and that taxes are somewhat similar to those in London and New York.

When you add in employee social contributions the story flips. Taxes for less well of people are similar across the board, but Paris has significantly higher taxes for higher earners.

But look what happens when you look at ‘actual’ tax rates (i.e. how much of what a business or freelance activity generates compared to the income you get)…

The results are astounding, not only are the differences between Paris and the others much more pronounced, rising to an eye watering 70% tax for people earning a bit less than what a pilot typically gets, but the biggest change is that lower earners, instead of being taxed at the lowest rate of the three cities, are taxed the most. More than that, they are taxed at the same rate as the high earners in the other cities.

How extreme France is vs the US and the UK can be viewed by looking at just the social charges:

Employer % of salary social charges (payroll tax) by country
Employee % of salary social charges (payroll tax) by country

Of course, what you get for your taxes varies and the principal difference between Paris and the other is pension entitlements. This would be the most rational thing to pull out of the figures. Demographic changes and the low retirement age in a country where the majority of people don’t work after 55 and have high life expectancies make France’s pension system unsustainable.

By fixing the ‘UI’ of income tax, the charts make immediately clear why wages are low in France and productivity has to be high, because employees are expensive so employers mechanise as much as possible. And with social charges making de facto taxes for freelancers prohibitively high it doesn’t allow for people to create work for themselves. The most pernicious aspect of this simple accounting sleight of hand, however, is that with lower wage earners paying high taxes, the social contributions UI trick is a tax on the poor as unlike income tax, their rates are fixed for everyone, at the same rate.

In a period of change, where old jobs will have to be replaced by new ones, the social charge trick will become a truly a dangerous element of numerical design deception unless it is fixed by labelling fully loaded salaries as salaries and social charges as taxes.