Saturday, October 23, 2010

Making the progressive case for a flat tax

The release of the comprehensive spending review in the UK focuses attention on the expenditure of the government. However, if there is to be real progress in improving the state of health of the UK economy, then the revenue- tax- side of the equation must be considered too. This is not just the rates of taxation, but the costs of collection too.

The UK spends roughly 1.15% of net revenue on the administration of its tax system. For comparison, the USA spends 0.52% of net revenue: that is to say that Britain spends roughly three times more on administering its tax system, per Pound raised, than the US does per Dollar raised.

This is before we discuss the return of revenues via tax credits and especially benefits. Benefits, which may be taxable, are counted as part of the social security budget. It is safe to say, then, that the UK has an extremely expensive cost of administration of taxes and benefits combined.

According to Alan Johnson, the Labour Shadow Chancellor, the cuts that the coalition are imposing should not be implemented since they will tend to reduce employment. Indeed we now know that over the course of the next four years or so, up to half a million public sector jobs may be lost.

If we follow Mr. Johnson's logic, since reforming the tax system would cost jobs in administration, it should not, therefore, be attempted. I think this exposes the essential fallacy at the heart of Labour policy: the goal of the Labour Party is to maintain levels of employment, no matter what value added those employed may be offering. This may be kind to individuals but is is a disaster for society. It is also something of an insult to suggest that those who are currently in jobs that are adding little or no value are unable to work in jobs that do actually create value.

The fact is that there is a huge amount of inefficiency in the UK tax system, and the staggeringly complicated regulations have led to large mistakes. It is next to impossible for an average person to accurately calculate their tax liability. So on top of the issue of the huge costs of administration we should add the social cost of the need for so many tax accountants. Tax is an industry that - by definition- only takes value, and does not add to the productive capacity of the overall economy.

It has been quite clear that the costs of such a complicated system of taxation are not worth the supposed extra revenue they might bring in. Tax simplification is now a not only increasingly popular policy, it is an increasingly necessary policy.

The fact is that the system is so complicated that it hides an essential injustice: at present the poor pay a higher percentage of their wealth in tax than rich people do. The fact is that the supposedly progressive taxation of higher rates for wealthier people not only does not work, it actually does the opposite of what it is supposed to do.

The cheapest tax system of all is one with a single all encompassing rate of taxation with no loopholes. This idea of a flat tax has been derided by left wingers who believe that it is unfair that everyone, both rich and poor, pays the same rate of tax: they argue that this is regressive.

Except a flat tax is NOT regressive.

If you set a flat tax, you also set a tax free allowance. Removing the high costs of administration and benefiting from lower levels of tax avoidance- which is what a flat tax usually creates- allows the tax free allowance to be much higher: in the UK, it could be set at a level of nearly two thirds of average salary: say £15,000. which means that if you are earning the average salary of £25,000 then you are paying income tax on only £10,000, instead of -as at present- roughly £19,000. Even allowing for the fact that in a transition period the tax rate might rise from the current 25%, this would only be a percentage point or two, so the overall tax paid by those on the average salary or less would fall sharply. Meanwhile the wealthier would not have loopholes to hide behind and would be paying the tax- albeit at a lower rate- on all of their income and wealth.

In other words a flat tax is not only more efficient, it is also more progressive than the current system that despite it progressive goals actually contrives to take more money from the poor than from the rich.

Meanwhile the simple flat tax is dramatically cheaper to collect and removes a significant burden from those who want to become entrepreneurs but who are put off by the red tape.

The current taxation system is complicated, expensive and unfair.

A flat tax is clearer, cheaper and fairer.

It is time for Liberals to consider these facts and work accordingly.


Span Ows said...

..and as some bloke once said

"In doubtful cases the more liberal interpretation must always be preferred."

Or maybe that's just a bad translation of 'the lesser of two evils...'

AndrewM said...

A simpler tax system would certainly be a good thing, I don't think you'll find much disagreement there, but you need to move to a flat tax to do that.

You might find these links interesting:

A flat tax is not quite as simple as its proponents make out.