A flat tax is a single-rate tax on income (and possibly on other things as well). The idea is to have as wide a tax base as possible, so for a given amount of tax revenue collected, the marginal rate will be lower than in a non-flat tax; this is intended to boost economic activity.
Chris Dillow notes that The Times is reporting that Britain’s two main opposition parties, the Conservatives and Liberal Democrats, are considering flat tax proposals:
THE case for a Ã¢â‚¬Å“flat taxÃ¢â‚¬Â is to be studied by the Tories as part of a review of the tax system.
George Osborne, the Shadow Chancellor, said that he would set up a commission to investigate a much more straightforward set of tax levels, including a single rate.
It is likely to be headed by a senior businessman and report next year on the way that the system works in other countries and the viability of introducing it to Britain.
The Times has also learnt that the Liberal Democrats are considering a radical new tax policy dubbed the Ã¢â‚¬Å“double deckerÃ¢â‚¬Â. This hybrid of a flat tax would cut demands on the low-paid andn middle-earners but progressively squeeze the better-off.
The Conservative Party, to adapt Disraeli, is a low tax party, or it is nothing. As we report today, George Osborne, the shadow chancellor, will this week launch a commission that will look at flat taxes and tax simplification. This excellent initiative has the potential to liberate the Tories from a long period of self-censorship on tax policy, and to re-establish the Conservative Party as a force for modern, dynamic and just public policy.
As Mr Osborne has evidently grasped, flat taxation – where all (or almost all) tax exemptions are abolished and a single rate of tax is imposed – is an idea whose time has come. Already, 11 countries have introduced such a system, and others look set to follow. The most spectacular examples of success have been in so-called “New Europe”: Lithuania, Latvia and Estonia. But “Old Europe” is waking up to the idea, too. In Germany, Angela Merkel, the CDU leader in this month’s election, has appointed a prominent advocate of flat taxation as her economic adviser.
Under Godon Brown, tax has become a positively neuralgic matter, a forest of bureaucracy, reliefs, rates and allowances. A simple system would reduce evasion dramatically. It would also – in time – encourage increased revenues, as the disincentives to enterprise posed by higher tax rates were removed and the economy grew. Flat taxation would remove from politicians the tool of tax policy as a weapon of electoral bribery, or a means of dictating the public’s behaviour. Mr Brown wants a complex system of tax credits as a mechanism of social engineering. The natural Tory response should be to sweep away such measures: in the case of flat taxation, liberty, prosperity and simplicity march together.
Once More is a pro-Tory group blog, so the discussion naturally turned to whether this would be electorally beneficial to the Conservatives. One concern was whether it would be presented as a tax cut for the rich. For example, “srs” commented:
The major danger is the media, they along with Labour/Lib Dems will present it as a tax cut for the rich. Added to the fact that they will not give the tories a chance to counter will be the greatest danger, along with the Wets who will appear claiming that you are the nasty party.
Whether it could be presented as a tax cut for the rich would depend –at least in part — on whether it was so. One of the main problems with the tax and benefits system as it currently stands is that people on low pay often pay absurdly high marginal tax taxes:
Take a married couple with two children under 11 and pre-tax earnings of Ã‚Â£200 a week. If they get a better job, raising their earnings to Ã‚Â£300 a week, by how much does their net income rise?
Ã‚Â£60? Ã‚Â£50? Ã‚Â£40?
Yes. Ã‚Â£8.52. ThatÃ¢â‚¬â„¢s a marginal deduction rate of 91.5 per cent.
One way to help alleviate this would be to reduce marginal tax rates for people on low pay. Why should someone on the minimum wage pay income tax at all? they shouldn’t; the minimum wage works out as about Ã‚Â£10,000 a year, so the annual tax allowance (the amount you can earn which doesn’t attach income tax) should be set at this amount.
If the Tories were serious about having a flat tax in order to make the economy grow faster (as opposed to having a flat tax in order to make the rich richer), they would include these proposals:
- Raise the income tax allowance. It should be equal to working on the minimum wage for a year — about Ã‚Â£10,000. The higher the allowance, the more lower-paid workers benefit from any changes.
- Abolish national insurance, and increase the rate on income tax to make up for any shortfall. This is both administratively more efficient (NI is just income tax under and other name), increases the tax base (because you only pay NI on earned and not unearned income), and egalitarian (because people whose income is mainly unearned tend to be richer than people whose income is mainly earned).
- Abolish tax avoidance schemes. (Of course, flat tax schemes tend to result in lower marginal tax rates, which in themselves will tend to reduce tax avoidance). Tax avoidance schemes tend only to be available to the rich, and ending them will have the beneficial effect of increasing the tax base.This could be done by ruling that any complex financial scheme whose only or main purpose is to pay less tax is null and void; and that people using such schemes not only have to pay the tax that they would have had to, but also the amount they would have avoided on top.
- Tax inheritances the same as any other income; in other words, add inheritances to the tax base on which income tax is levied.
I suspect the Tories will do none of these things, particularly not the last one. To misquote John Major, the Tories want to see “inherited privilege cascade down the generations”; they are anti-egalitarian and anti-meritocratic, even when this leads to a loss of economic efficiency.
(This article is also posted on my blog here).