If this graph seems confusing, it’s because it accurately describes taxation of income in the UK. What alternative can Lib Dems offer? I think there are four key problems and solutions.
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Firstly, while the personal allowance is rising (to £9,205 next year), the National Insurance thresholds lag behind. As I’ve written previously, raising these is more progressive and, so, equalising the thresholds and the allowance must be the priority before going beyond £10,000.
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Then there’s the withdrawal of the personal allowance at £100,000. This is identical in effect to a 60% tax rate on income between £100,000 and £118,410. Considering the many 50p rate headlines, it’s almost as if only those able to hire PR firms get the attention of the media and the sympathy of the Chancellor!
We should scrap the allowance withdrawal and extend the 45p rate to all income above £100,000. However, even this would be a tax cut for all involved so we must consider an even lower threshold, or other compensating measures.
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Third, there’s the simple observation that tax rates are higher and less progressive than the headline 20/40/45 rates. Taxation should be transparent on principle, but I believe a full merger of NICs and income tax would also help maintain progressivity.
Governments have preferred to increase NICs rather than income tax – the former are now more significant for most – and each change has tended to make the system less progressive. It should cost much more to give an extra £1 to someone on millions than to a minimum wage worker, but those rates will soon be 53.4% and 40.3%, respectively. Lowering taxes for the richest would be tougher if these were the headline rates.
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What’s more, the lack of clarity and the pretext of the contributory system have shielded dividend and savings income, capital gains, self-employment and other incomes from being taxed at the same rate as wages. As well as being deeply unfair, this creates tax avoidance and distorts behaviour.
The Mirrlees review from the Institute for Fiscal Studies proposes a rate-of-return allowance for savings and investment, in part to avoid taxing below-inflation returns, but that gains beyond this – accounting for corporation tax paid – should absolutely be taxed at the same rates as wages. This is something to champion immediately.
Other considerations include whether we really want a flat local income tax as another addition to this graph, and what form personal tax statements can take. These will improve the information voters have to work with but should include one’s position in the income distribution [pdf]: only 3.5% think they are in the top 25% of incomes!
We must push for a more liberal, sensible and efficient tax system. This graph helps show we’re clearly not there yet.
* The graph above is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike License.
* Adam Corlett is an economic analyst and Lib Dem member
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28 Comments
Just to point out a few extra things and pre-empt some comments:
– From the income distribution linked to above, 99th percentile pre-tax income amongst taxpayers in 09/10 was £149,000. 90th is £46,600, median income was £19,600 and 10th was £9.510. So most people pay the basic rate, even if that’s only a small part of the graph.
– Employer NICs really are an income tax too. We could move all income taxes to the employer-side if you really wanted.
– Marginal rate isn’t everything. Papers complained about more people being ‘dragged into’ the higher rate of tax alongside the personal allowance increases but this was overall a tax cut or freeze for them.
– Withdrawal of benefits – including child benefit now – and student loans (aka graduate tax) do create higher effective marginal deduction rates but that would be another article entirely.
– A merger of income tax and national insurance could easily retain the contributory principle (the Lower Earnings Limit is already distinct from the NICs thresholds), if desirable, and there a variety of ways in which pensioners could be protected (if desirable).
– Liberal Insight’s tax paper came to similar conclusions and is well worth a read. http://www.liberalinsight.com/ideas/publications/purchasing-civilization/
This is very interesting indeed. Crazy. Why is the effect of the withdrawal of the personal allowance at £100,000 only limited to income between £100,000 and £118,410?
It’s not so easy to have corporation tax rates the same as wage tax rates, because of the the tax threshold for wage earners, and because of the variable wage tax rates. Nor perhaps nare its benefits so clear cut. High corporation tax rates compared to nwage tax rates can make it tax-efficient for companies to pay staff more, while low corporation tax in principle makes it tax-efficient to pay staff less and plough profts back into growing the business. Am I wrong, and which is better?
@Richard: The personal allowance is ‘withdrawn’ at a rate of £1 per every £2 over £100,000. So anyone under 100k gets the full allowance, anyone on over £118,410 next year (£100,000 + twice the personal allowance) has had it completely withdrawn, and those in between get some proportion. But, as I say, it’s identical to an extra 20% tax rate.
I didn’t say that corporation tax should be the same as wage tax rates. Where I mentioned corporation tax, I was saying that dividend income, for example, should be taxed at those wage rates but with a reduction reflecting the fact that corporation tax has already been paid.
Osborne did say in his budget speech that he’d like corporation tax to be aligned with personal income tax at 20%, but as the graph shows, that’s ridiculously misleading. As you suggest, the level of corporation tax has important consequences. I’d say that lowering it at the moment is useless as many companies are already sitting on big piles of money, and we would indeed be better off lowering barriers to spending that money on investment, new jobs and higher wages.
Richard Dean “This is very interesting indeed. Crazy. Why is the effect of the withdrawal of the personal allowance at £100,000 only limited to income between £100,000 and £118,410?”
Because there’s no personal allowance left once someone’s earning £118,410!
@Adam Corlett , Graeme Cowie. Thank you very much for your clarifications. Now I see that you re talking sense.
I imagine that companies take account of tax rates in setting the pre-tax salaries that they offer to attract staff. So the blip due to the withdrawal of personal allowance perhaps does not affect staff and dtaff motivation as much as it affects wage costs. Would this inference be correct,and does it have implications?
Excellent article! I’m not much of a fan of Osborne, but he does seem to have been swayed by the tax “simplifiers” which is a good thing, so now is the time to be pushing arguments about these issues.
Good article. But we mustn’t forget the politics of this.
If, say, a government were to merge National Insurance and Income Tax, you can be sure the Labour party would be putting out leaflets that the government has raised income tax by 12%. It wouldn’t be a direct lie, just deceitful spin, so they’d probably get away with it.
To get around this, the two shouldn’t initially be merged, but, as far as possible, just synchronised.
Once that happened, the government could introduce a new term, say, “Combined Income Tax”, to mean the combined rate of “Income Tax” and “National Insurance”.
Over time, the terms “Income Tax” and “National Insurance” would drop out of use. Once that happened, they could be formally merged, and then rename “Combined Income Tax” to “Income Tax”.
If there were a plan to merge Employers National Insurance with Income Tax and National Insurance, a similar plan should be followed.
Stage 1) Wage slips changed to introduce a new term, say “Original Salary” which describes what they would be earning if “Employers National Insurance” were not levied.
Stage 2) Synchronise the various forms of income tax.
Stage 3) Start to refer to the combination of Income Tax, National Insurance and Employers National Insurance by a new term, perhaps “Full Income Tax”.
Stage 4) Merge them.
The above wouldn’t change any of the detailed policy, but if that plan weren’t followed, the changes would cause terrible political problems for the government who implemented them.
…or stop basing our main personal tax on income altogether. Get a massive supply side boost by eradicating a huge deadweight loss caused by income tax, together with the massive reduction in cost of living and entrenched privilege by taxing land value the most.
A well presented article Adam.
I think Vince Cable’s is basically right when he suggests that in general marginal tax rates on income should not exceed 50% and the overall tax take from the economy (and therefore public spending) should be contained at or below 40% of GDP.
The Mirrlees review, you refer to above, sets out a comprehensive platform for tax reform that can be usefully built on.
My preference would be for a combined income and national insurance flat tax of 32% on all sources of income (irrespective of nature), a replacement of the personal allowances with a Citizens Income and substitution of higher rate income taxes with a property tax
It would be good to see Centreforum publishing a critique of the proposals put forward in the Mirrlees review.
@George Kendall: You’re quite right. I think that’s another reason to prioritise aligning the personal allowance and NICs thresholds. Then it would be a lot easier to at least talk about a basic rate of 32%. I imagine the opposition would also suggest we were scrapping some contribution-based entitlements so it might be worthwhile moving the few that remain – like the state pension – onto an income tax basis first.
The political flipside, however, is that a campaign that pointed to how people have essentially been deceived on what NICs are for could be quite effective.
@Jock: I hope fans of LVT would support a much more transparent income tax system – increasing pressure for equitable change. And tax cuts such as raising the NICs thresholds need to be paid for somehow – I’d love it to be via land taxation.
@Joe: Thanks! I too would like to see a decent critique of the Mirrlees review – given the faith I have in it as an excellent starting point for reform – but it would be a big task!
I have my doubts about simplifying IT/NIC being a good way to promote LVT ;). I agree that it needs doing, if the longer term aim is to retain an economically distorting tax base.
There will probably not be as good an opportunity in the remainder of my life to promote a radical shift in the tax base as now. It would blindside the anti-austerity crowd and prove we can achieve hater equity with less robbery.
Sadly, after asking about it for a century, Lib Dms seem to have own weary of it and are wasting this historic opportunity to make the case.
I am surprised that no-one seems to have considered the impact on pensioners of combining national insurance and income tax. Most pensioners are standard rate tax payers but pay no national insurance on their pension. I presume the logic is that the pension is a form of deferred income derived from earned income which was originally subject to national insurance contributions. However the situation is less straight forward since a pension derived from a non-contributory scheme, such as the civil service scheme, avoided national insurance payments, both employee and employer. Moreover, many “middle income” pensioners reply on interest from savings to supplement their pension. Indeed you can convert savings to a pension by buying an annuity. This is different from the conventional annuity which most people buy (because the purchase is voluntary rather than obligatory) but is broadly taxed in the same way as a compulsory purchase annuity. Another complication is income derived from ISAs. This is currently entirely tax-free, and is another way of building up an income in retirement. Lastly, it should be remembered that anyone who continues working beyond the state retirement age does not pay national insurance (as they cease at retirement age t o employment related state benefits).
I can therefore well understand why governments of all political persuasion have been unwilling to combine tax and national insurance. The current system may be illogical and in some respects even unfair, but combining tax and NI and applying it to pensioners would make Osborne’s granny tax look like a walk in the park. On the other hand trying to exempt pensioners from the effect of combining tax and NI would open a Pandora’s box of bureaucracy, complexity, and a whole range of new opportunities for tax avoidance.
Given that we can’t even introduce a consistent rate of VAT on hot food without a huge row (including an idiotic campaign by LD MPs) the chance of a radical change in the tax system by combining income tax and NO seems fairly unlikely.
@Graham: I mentioned the effect on pensions in the first comment above. I do imagine applying these full tax rates to pensioners would be politically impossible, but I can’t believe that protecting them would be more complicated than retaining employer NICs, employee NICs and class 2, 3 and 4 NICs. At the moment we indeed say those over pension age don’t pay NICs: how difficult would it be to simply have different income tax rates for them instead? But I think really this needs to go alongside developing a consistent approach regarding which stage pensions should be taxed at (while bearing in mind that not all pensioners are the same – they’re not all poor and some have far higher incomes than others and than most young people).
Adam – very interesting, but I think you can’t ignore student loans. For any graduate in their 20s this effectively means a 9% additional marginal tax rate over £15k (£21k for new students), and puts young graduates at a significant disadvantage in the job market compared to those who started university before Labour introduced tuition fees and student loans in 1998. As your graph shows this results in a 25 year old graduate earning £25,000 having a 49% marginal tax rate (incl employer NI), the same as a 40 year old earning £80,000. Doesn’t seem fair!
Excellent graph, as it shows clearly what should be in the plan. (LVT Jock, is still in the manifesto, but won’t get anywhere until another party agrees, or we form a LibDem Govt, hence not prominent with the more immediate pressures, but we should put it alongside PR in the next coalition negotiations)
‘What should be in the plan’? the basic tax threshold should go up to the level of a notional average week on the minimum wage, and then be pegged with a ‘triple lock’ mechanism similar to the one devised by Steve Webb for the pension. The first tax rate should be 10p, paid on income up to twice the threshold rate, which then becomes the threshold for the 20p rate payable up to the current 40p threshold .
We should consider then moving the 40p threshold up, but introduce a 30p rate from its present threshold.
If we are trying to help the lower and middle incomes, this is a fair way to do it, and is simple to understand.
Do you think a LVT could replace NI altogether? That would make the tax system MUCH more progressive.
The graph just isn’t accurate as it doesn’t reflect the impact of tax credits – which means that many lower down the scale now experience marginal tax rates in excess of 70%. Funny how the disincentive effects of taxation seem to me more of an issue for those earning in excess of £150k than those with lower incomes – but then of course they aren’t a priority for the Coalition.
@Adam Corlett. Is it possible for you to provide an adjusted graph to take account of toryboysnevergrowup’s important point? Thanks in advance. Maybe also a graph of total tax a person pays versus income (which is a mathematical integral of the graph of marginal rates). It would even be nicer if some estimate of VAT effect could be included.
@Joel, toryboysnevergrowup and Richard: As I said in my first comment, effective marginal rates due to student loans or withdrawal of benefits are very important but not something I could fit into this article or graph. The graph shows rates that apply to pretty much every working-age employee – and apply equally – while student loans and various benefits clearly don’t.
What’s more, the Universal Credit should start to be introduced next year so – as with student loans – we’ll have multiple systems overlapping. Credit to the Tories on this – the UC is a good policy (if the tech works!) and will limit the marginal rates the poorest experience. But yes, they could be lower, and that’s another reason to increase the NICs thresholds and perhaps then move them and the allowance to the minimum wage.
@Daniel: I think I’d be very happy to see LVT replace all NI (and council tax, business rates, stamp duty land tax and more) but given that we haven’t even been able to replace business rates yet I shan’t hold my breath.
I disagree that empoyer and employee taxes are in some way equivalent and interchangable. Wage bargaining, for the most part, occurs in terms of gross pay, not on total cost to the employer, nor on the basis, except in very few cases, of net pay.
To give you an example, if an employer gives an incrememnt equivalent to RPI (and many employers will use that as a starting point for determining individual pay rises, even in the absense of any formalised pay awards) then it is the gross salalary, after deduction for employers’ NI but before employee deductions, that is expected to rise in line with RPI. If this pushes the employer’s NI contributions into a lower band, that doesn’t change the effect of the award on the employee. If, on the other hand it pushes the employee into a higher tax bracket, the employee would not expect the employer to compensate them for the fact that their net pay had gone up by less than RPI.
To give another example. If the government were to increase employers’ NI, it would be pretty unlikely that most employers would attemp an accross-the-board pay cut, to pass on this cost to employees. If, on the other hand, the government were to increase income tax (or employees’ NI contributions) no one would particular expect all employers to immediately increase the amount they pay their employees to compensate.
I remain unconvinced by the claimed equivalence of employer and employee taxes.
roy
Any chance of a graph showing effective tax rates?
@Graeme, Richard: I’ll look into doing a graph of effective tax rates for a future article or report.
@Roy: I agree that in the short-term there is a difference between tax changes on the employee and employer side, but they disappear in the medium/long-term. To use your example; if we increased employers NICs this generally wouldn’t mean instantly lower pay, because wages aren’t that flexible in the short-term (it may mean job cuts instead), but do you really think wages would then continue to rise as if the increase hadn’t happened?
Employees mostly only care for their take-home, disposable income, and employers only care how much it costs to employ them. How the tax in-between is apportioned doesn’t affect either.
This is an excellent article. Taxation of Income should be dramatically simplified.
Combine Income Tax and Employees National Insurance. Call it the INI tax and then after a few years just Income tax again. Be honest with people about the tax they are paying.
Make Employers National Insurance a separate payroll tax at 12% on all employee compensation, giving employers a substantial tax cut, encouraging them to hire more and pay more, and vastly simplifying the whole system.
For god’s sake extend INI to ALL INCOME. Whether pensions, dividends, etc. Pensioners would still not be paying Employers NI and so are still getting a tax subsidy. The flip side is that pension tax relief is the whole INI tax rate, not just the income tax rate for people currently saving for pensions.
If that is too politically toxic just operate on a rolling basis. Current pensioners continue to pay current income tax, current workers pay the full INI and then continue to do so when they become pensioners. As current pensioners die off everyone will be paying the simplified INI. This is what we currently do for married tax credit and different tax thresholds so can’t be impossible.
And while we’re here, replace business rates with an LVT. It would be a powerful pro-growth move that would really help the construction industry.
The problem with all changes to the tax and benefits system is that those who lose from the changes shout much louder than those who gain. I can think of only a few scenarios in which it would be possible to overcome this problem. The first is if we had an elected executive president whose term of office was restricted. Such a person might be willing to introduce rational changes, though whether his/her party would countenance such radical action is also questionable. The second is when the economy is prospering, so it becomes possible to “buy-out” the losers. However the Canadian experience of fiscal consolation under the Liberal government is hardly encouraging – sure the Canadian economy was put on a strong fiscal basis, but the Liberals still suffered big loses in the subsequent election. Moreover, much of the complexity of our current tax and benefit systems arises from attempts to protect the losers, even if this can be afforded.The third possibility is when there is political consensus across the parties, but even that can be shorted lived. For instance Barbara Castle introduced SERPS with all party support but barely a decade later the Conservatives scaled back the benefits dramatically. Moreover, as Greece demonstrates, even if the main parties agree, unpopular changes provide opportunities for new parties which oppose the changes.
If we were starting from a blank sheet of paper I am sure no politician, of whatever political persuasion, would devise our current tax and benefits system, but the practical politicians has to live in the real world, and changes which adversely affected a major proportion of the electorate are doomed to ultimate failure. The best that often can be done is to implement change at the margin, as and when the opportunity arises, Proposing radical change, no matter how rational, is just as likely to merely frightens the horses.
For god’s sake politicians should have some balls then. Who cares if you’re voted out. If your name goes down in history as the man who took radical change for the good of your country then who cares? All political careers end in failure eventually anyway. What’s the good of hanging on a bit longer if your legacy is a load of rubbish anyway.
@Graham I have to say that @Stephen W is probably right, altho’ strongly put.
If you have ideas for the perfect, or near perfect, or best tax and benefits system then it behoves you to suggest it…
That way, we can agree/disagree/modify your proposals and the reason therefor, and thus have a model to which we should aspire.
Every change then in our policies, and as we are in power, our enactments, can then be measured first against how well we progress towards that model, and it is only then a secondary consideration of whether there is a political hurdle of taken that action. Such hurdles may well be insurmountable of course, and we may have to delay or modify the actions needed. However, aspirations, kept fresh in the mind have way of becoming reality eventually.
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I actually produced a graph like this for the ALTER exec. What struck everyone was how flat it was. Income Tax and NI just are not really that progressive, you may as well have a flat tax with very high personal allowances and use Land Value Tax instead of the higher rates. I once ask Ken Clark at a director institute lunch why the Tories abandoned the idea of Flat taxes and he said you would need very high personal allowances. I came to the conclusion the Tories had abandoned it because they realised the burden of tax would be removed from low incomes and the higher incomes would end up paying more tax as avoidance by turning income into dividends or capital gains would be lost. As with poll tax and the council tax the Tories are always trying to find ways of shifting the tax burden down the income scale.
LVT would be far far more progressive than any income tax rates proposed in recent history. A flat tax with very high personal allowances and LVT would be a lot simpler for everyone to understand and administer. HMRC will always struggle to enforce such a complex tax system while highly paid Tax advisers run rings round them. I cannot help feel that vested interests like the complexity of the tax systems because it provides more opportunity for avoidance. The defenders of the present tax system are rather naive or worse self serving.
Merging Income Tax and NI is first step to taking most employees out of income based taxation. NI is a lie, Gordon Brown cut income tax only to increase NI a few years later. NI is second only to Council Tax as the most regressive Tax, far worse than VAT. Income tax suffers from tax avoidance by the wealthy, effectively turning a progressive tax into a regressive tax. Again the problem with employers NI its a Tax on jobs and has increased from around 10% in the 70’s 80’s and 90’s to 13.8% now. If taxing Carbon emissions is to reduce CO2 then what the hell are we doing increasing taxes on employment.