In the seventh of the CPS' 'UK Policy Resolutions for 2012' series, Nigel Knight, Director of Studies in Economics at Churchill College Cambridge, calls for an investigation into a flat tax for personal income . This morning, in the sixth in the series , CPS Research Fellow David Martin looked at how the Government simplify business taxes.
UK Policy Resolution for 2012:
Gordon Brown helped to transform the UK tax system into one of the most complex anywhere in the world. Whereas previous Chancellors, particularly the Conservative ones, attempted to keep the tax system simpler, the Coalition government inherited a system which was so complex it was grossly inefficient. Complex tax systems are expensive to administer, they encourage avoidance schemes, and incomprehension of the system by the public causes considerable inaccuracies in tax returns.
Even more importantly, such a tax system adversely affects initiative and enterprise in the economy as a whole – the sole exception being the initiative and enterprise exhibited by tax accountants and lawyers when developing avoidance schemes!
At his worst Gordon Brown created three rates of income tax: 20%, 40% and 50% starting at different income thresholds. Plus, he inherited a system of National Insurance contributions which he subsequently increased to 12%. This system had, of course, been advocated by William Beveridge in his 1942 report and led to Clement Attlee’s 1946 National Insurance Act. Those of working age are required to make these contributions and so create an entitlement to receive social security benefits. The National Insurance Contributions made by British subjects are not however hypothecated to provide those benefits (except for 1% point of Brown’s 12% which was supposed to be used for health spending), but rather they are just dumped into the general tax pool and are spent by government on all forms of expenditure. Thus National Insurance contributions are in fact an additional tranche of income tax.
UK POLICY RESOLUTION FOR 2012
A ‘flat tax’ is a very simple system both to comprehend and to operate. A single marginal rate of income tax is imposed on all income above a given tax allowance. It eliminates the current tiers of income tax, merged with National Insurance, the flat tax would eliminate that tier as well. The system is still progressive, albeit less so than the current system.
The flat tax is not simply a matter of academic debate on both sides of the Atlantic, it is a reality in a number of states around the world. Jersey introduced such a system in 1940, Guernsey did in 1960, and Hong Kong did in 1947. Also, a number of Eastern European states have recently introduced it including Russia, further encouraging inward foreign direct investment. More recently, the idea has been re-floated by Steve Forbes and two of the original Republican presidential candidates in the US.
If the marginal rate of tax is set at a modest level it will stimulate economic growth via the supply-side ‘Laffer curve’ effect, through increased consumption on the demand-side, and via increased resource allocation efficiency. If the personal allowance is set high (which the coalition government are committed to anyway) the problem of ‘churning’ is reduced, where the low paid are both taxed and provided with benefits. For middle income earners the tax allowance would reduce their income tax liability noticeably. This would, in the short-run, reduce tax yield to the government and require yet further government expenditure cuts, but it would also reduce the demand for benefits by the working poor.
It is now time for the Treasury to fully investigate the potential effects of a flat-rate income tax in the UK. A detailed study in 2012 should investigate both the short-run and dynamic implications, and identify the lowest rate through which a broad base can generate sufficient revenue.
Dr. Nigel Knight is a lecturer in British Government at Cambridge University and a Fellow and Director of Studies at Churchill College, Cambridge. He recently began blogging for the Centre for Policy Studies.
This article represents the views of the author only and does not necessarily represent the policy outlook of the Centre for Policy Studies, its board, staff or affiliated members.