Opinion: Why the Liberal Democrats should propose a Flat Tax

The pre-budget announcement that the party will pledge to raise the income tax personal allowance to £10,000 by closing tax loopholes exploited by big businesses and the wealthy has been well received by members and by the mainstream press.

The headline cut in income tax of £700 is based on the increase in the personal allowance from the current level of £6,435 to £10,000 at the basic rate of 20%. No mention however, has been made of increasing the national insurance threshold by a similar amount, to effectively take out minimum wage earners from the tax net altogether.

A single combined rate together with the elimination of the upper earnings threshold currently applied to employee national insurance could both provide for further relief to low earners and mitigate the relatively small marginal reduction in tax take from the application of higher rate taxes.

By way of example, if the current basic rate of income tax (20%) and employees national insurance (11%) were combined into a single rate and the party’s proposal for a personal allowance of £10,000 implemented, the direct tax burden would be as follows:

Annual taxable Income Tax Tax as % of income
£10,000 £0 0%
£25,000 £4,650 18.6%
£50,000 £12,400 24.8%
£100,000 £27,900 27.9%
£150,000 £43,400 28.93%

In examining the areas of the current tax system targeted for reform much of what is proposed might be automatically achieved with the combing of income tax and employees national insurance to a single rate of tax.

* Tax relief on pension contributions is automatically restricted to the lower combined single rate.
* Capital gains could be taxed at the marginal rate of tax, allowing for indexation and retirement relief as proposed.
* Corporation tax could be levied at the same rate effective rates as income tax preserving the effect of marginal relief for small companies.
* Benefits in Kind and income from multiple jobs would automatically incur the combined rate thereby obviating the need to apply national insurance in these areas.

The case for a flat rate of tax has often been made on the grounds of tax simplification and has been introduced throughout Eastern Europe and other jurisdictions. See the briefing paper from the Adam Smith Institute for a more detailed review.

The appeal the system has for me is its transparency in an era of stealth taxes and the prospect of some sorely needed long term stability being introduced to the tax system.

No less an authority than John Stuart Mill is said to have railed against stepped rates of taxation in his time as being inherently unfair.

While the debate has moved on from the Victorian era, the current political climate presents an ideal opportunity to position the Lib Dems as the party with the will and determination to take radical measures in comprehensively overhauling the system of taxation in the United Kingdom.

Credible proposals to tackle double digit budget deficits in the next few years and a projected public service debt level rising to 80% of GDP, during what many economic forecasters expect will be a period of relatively low growth, will inevitably require both increases in the overall tax take and real cuts in public spending.

It may well be that a temporary hypothecated tax for debt reduction, such as the wealth tax employed in France or a capital transfer tax will also need to be deployed in an effort to release back into the economy accumulated wealth that has been concentrated in too few hands over the past several years.

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38 Comments

  • “By way of example, if the current basic rate of income tax (20%) and employees national insurance (11%) were combined into a single rate and the party’s proposal for a personal allowance of £10,000 implemented …”

    But how on earth would you finance such a huge reduction in the total revenue from income tax? Spending cuts? Increases in indirect taxation? Borrowing?

    The point is that for a flat-rate tax to raise the same amount that the banded tax currently yields, you would need to have either a much higher rate, or a much lower personal allowance, or some combination of the two. It would be hideously regressive and electorally suicidal.

  • Paul Griffiths 24th Apr '09 - 9:43pm

    “But how on earth would you finance such a huge reduction in the total revenue from income tax?”

    Calling Mr Duffield! Emergency! 🙂

  • matt severn 24th Apr '09 - 9:44pm

    I really think that a flat tax is the direct opposite of everything that Liberal economic policy has tried to promote and achieve since the People’s Budget of 1909.

  • But you don’t really make the case why we should support such a tax.

    On your suggested level I reckon anyone earning over about £40k would be better off. Your person on £15k would be over 60k better off.

    Mind you it’s almost completely economically illiterate to suggest a flat tax could be levied at 31%.

  • “Your person on £15k would be over 60k better off”

    £150k of course – if it acheived that I will concede it might be electorally popular 🙂

  • In current circumstances, tax changes that cost money are not worth considering.

  • Matthew Huntbach 25th Apr '09 - 12:01am

    Would you intend a flat rate of tax on all wealth that comes in, regardless of source?

    I.e. would you tax inheritance, capital gains from housing etc at the same rate?

  • “As a medium to long term objective, we should be moving towards a simple tax structure with a flat rate income tax also applied to capital gains and inherited income (the recipient pays, not the estate), a land value tax that includes other properties including broadcast spectra and pigouvian taxes on products to reflect externalities.”

    But why? Why on earth is it desirable – in the short term, the long term, or any other term – that someone with an income of £1m a year should pay the same rate of tax as someone on £20k?

  • Paul Griffiths 25th Apr '09 - 7:44am

    “Why on earth is it desirable – in the short term, the long term, or any other term – that someone with an income of £1m a year should pay the same rate of tax as someone on £20k?”

    Surely it is unequal treatment by the state that stands in need of justification.

  • when tax is at 50% you do not work for yourself but the government, 1/2 of that = 25% still feel too much, every 100 hours worked 5 are for the government, not on half that again = 12.5% that is more like it, the church had it about right all those years ago by the tithe = 10%
    There can be no reason at all for hvibg a tax higher that 12.5% all governments should work towards this. this would nake for a happier country.

  • “Surely it is unequal treatment by the state that stands in need of justification.”

    Now you’re talking!

    Why not just reorganise the system so that everyone ends up with the same amount after tax? Simple and fair.

  • MatGB wrote:
    “Reading comprehension not your thing then?”

    Oh dear. Did it not occur to you that it would be a good idea to read properly what _I_ had written, before making a comment like that?

    What I asked was why someone with an income of £1m should pay the same _rate_ of tax as someone on £20k, not why they should pay the same _percentage_ of their income in tax.

    It would still be interesting to have an answer to that question – though I realise many people here find rudeness a handy substitute for answering questions. Though – come to think of it – if you don’t understand what “rate of tax” means, perhaps your response wouldn’t be that enlightening after all …

  • Hi Fran, dont think I’ve seen you post here before. What is the Liberal Party’s tax policy these days?

  • Bruce Wilson 25th Apr '09 - 5:44pm

    In response to Anonymous1.
    There is a good political reason why stepped rates are a good idea. Flat rates give rise to increased disparities in income. Both directly and indirectly. Indirectly because the person with £1m has more money to invest in themselves and their offspring. Things like education. This gives rise to polarization (forgive my spelling) of society. This in turn gives rise to the unproductive left/right politics we have had for so long.

    Having said all that, I do not support the redistribution of wealth. This just undermines the sources of wealth in the society and in the long run leads to economic decline. This applies to social democrats too. What taxes are raised should be targeted at removing the causes of this disparity. This is a complex task. It would increase the economic performance of the country and allow a reduction in tax generally. Ideally leading to a flat rate tax.

    I am sure the government would argue that this is what it is doing. I have serious doubts. I will not ellaborate here on this issue. Other than to add that everything this government touches seems to turn to mud.

  • The thrust of the party’s tax policy in recent debates has been a dramatic increase in the personal allowances coupled with a withdrawal of exemptions that typically benefit larger companies and very wealthy individuals with higher rate tax relief on pensions contributions being specifically targeted.

    The budget has addressed in part the limiting of pensions relief on those earning over £150k per year. The amount of tax that can be raised from the new 50% top rate has been challenged by our own party leadership along with the Institute of fiscal studies and other commentators. In particular concerns have been raised about the ability of higher rate taxpayers to sidestep higher taxes by the use of more favourable capital gains tax treatment and salary sacrifice schemes.

    A change to a flat rate tax scheme that combines income tax and employee national insurance contributions at current rates (without any corresponding increase in the personal allowance) should not of itself constitute any significant reduction in the overall tax take,.as the reduction in expected receipts from higher rate tax collection can be largely mitigated by removing the upper earnings limit on national insurance contributions.

    Such a change however does not address the aim of taking minimum wage earners and those of low incomes out of the tax net altogether and generally ensuring that middle income earners bear a significantly lower proportional rate of tax on income than high earners. This is achieved by the proposal for a dramatic increase in the personal allowance to £10,000 per year, the limiting of pension contribution relief to the marginal rate of tax for all,and the taxing of capital gains and corporate profits at the same rates as income tax coupled with a targeted closing of tax loopholes subject to abuse.

    With respect to pensioners, the age related allowance on top of the proposed increased in the personal allowance serves to ensure that the great majority will not be disadvantaged by a higher single rate of tax.

    If, as appears likely, we can expect increases in the basic rate of tax after the next election than a flat rate may need to be set at a slightly higher level than at the present.combined rates of income tax and national insurance.

    This being the case, I would favour consideration of what the French call a ‘solidarity tax’ or wealth tax of 1% to 2% assessed on the net worth of individuals with assets in excess of say £1m as a means of addressing debt reduction over the next ten years or so.

  • Paul Griffiths 25th Apr '09 - 6:31pm

    But Anon1 has moved on. As his post @9.07 makes clear, he is advocating equality of income. Of course, if he were really radical, he would be arguing for pre-tax, not post-tax, equality.

  • MatGB

    I’ve no objection at all to taxing other forms of income at the same rate. No objection, either, to raising the personal allowance.

    But the question of whether there should be a single flat rate of taxation or more than one band is a separate one. What is the case for a single flat rate?

    PS to Paul. Aren’t you familiar with the phrase reductio ad absurdum?

  • Paul Griffiths 25th Apr '09 - 7:51pm

    “Aren’t you familiar with the phrase reductio ad absurdum?”

    Of course. But if you’re suggesting that support for a flat tax on grounds of equal treatment logically entails income equality, I think you’re going to need a better argument than just three words in Latin.

  • “But if you’re suggesting that support for a flat tax on grounds of equal treatment logically entails income equality, …”

    Eh? Of course I’m not suggesting that support for a flat tax “entails” income equality. How could it? It would have exactly the opposite effect.

    The point I’m making is that it’s meaningless to argue for a particular tax policy on the basis of “equality”, because “equality” could mean any number of things, many of them just as absurd as a flat tax system (and anathema to its proponents).

  • Bruce Wilson 25th Apr '09 - 8:44pm

    Anonymous1

    If you are referring to my remark in my previous posting, I retract that remark. There is no case for a single flat rate. I got ahead of myself.

  • Paul Griffiths 25th Apr '09 - 11:48pm

    Anon: Now I’m wondering if you actually know the meaning of the phrase reductio ad absurdum. I suggest you look it up.

    While you are doing that, of course the term “equality” can indeed mean many things, which is why I was careful to be explicit about the sense in which I was using it.

  • Paul

    “… of course the term “equality” can indeed mean many things, which is why I was careful to be explicit about the sense in which I was using it.”

    In fact you weren’t in any way explicit about what you meant by equality – your post, in its entirety, read as follows:
    “Surely it is unequal treatment by the state that stands in need of justification.”

    And you still appear to be missing my point. If you are arguing on the basis of a general notion such as “equality”, you can argue in a favour of a hundred different systems of taxation, including some I’m sure you’d find abhorrent.

    Why don’t you explain why you think a flat rate would be more equitable than other systems, if that is what you think?

  • Paul Kennedy 26th Apr '09 - 6:37pm

    Apologies if I have not read everyone’s comments fully. In the 1990s, the Lib-Dems used to support the idea of a ‘citizen’s income’ (basically a universal benefit to replace the existing means-tested welfare benefits) coupled with a single but fairly high rate of tax on all income, say the current marginal rate of 40%, to replace all the complicated tax allowances and means-tested credits we have at the moment.

    This is a lot fairer because the marginal rate of tax is uniform rather than wildly and often randomly fluctuating. It is fairer for low earners, whose marginal loss of means-tested benefits plus tax is often much higher than 40%. Higher earners would still end up paying a higher percentage (average net tax paid starts negative for low earners but increases towards 40% as your earnings become infinite). It would also be fairer for families.

    If you choose the right rate of tax, it needn’t cost any more than the current system, because broadly it reproduces the existing system. But it would remove all the anomalies and perverse disincentives. And because it is simplier it would give employers less excuse for not paying tax.

    Although we abandoned the idea because we were afraid the other parties would misrepresent it as a tax increase (by ignoring the universal tax credit), I am pleased to say that we have adopted the idea of a citizen’s pension to replace the absurd means-tested pensions credit which deters pensions saving.

  • Yes let’s listen to the notoriously right wing think-tank the Adam Smith Institute… that would be very liberal.

    This is a stupid proposal, and belongs on Conservativehome, not here.

  • Matthew Huntbach 26th Apr '09 - 10:38pm

    Joe,

    I asked a question, you did not answer it, though you did post after I asked that question.

  • Matthew Huntbach 28th Apr '09 - 12:25pm

    Niklas,

    Yes, Joe says that, but I want to see complete clarification on whether that includes capital gains on sale of one’s own home, and inheritance.

    This is important because these are the two forms of substantial income apart from wages that most people are likely to experience in their lives and people have go used to these things not being taxed. As they are so substantial and widespread, whether they are included or not would make a big difference to the flat rate we could have. But as people are used to these things not being taxed or at least not without allowances substantially more than for yearly income on income tax, they’re what would most likely cause this proposal to be howled down if it were put in place.

    The logic of the flat rate idea seems to me to say they should be taxed as part of it. Political expediency might suggest they should be made exempt. But once you start having exemptions for any form of income, you’ve blown a hole in what you are trying to do, and it’s difficulty to resist the clamour for further exemptions.

    And since benefits in kind are included, Joe might also like to consider whether this should include imputed rent from owner-occupied property.

  • Why do people have to be so insufferably boorish to simply dismiss something as a ‘Tory idea’ rather than usefully engage on the substance of a proposal? I oppose this idea but not because I am stupidly tribal.

    Is there any way to play around with the allowance and the rate in order to show how much revenue each would yield compared to what we raise currently.

  • Kumar devadasan 21st Apr '10 - 8:10pm

    Your tax calculation is incorrect if national isurance is administered as it has been and is – the £10,000 is not exempt from NI.

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