I did not think I'd be writing about this issue so soon after my last post, but Roger Bootle's piece on flat taxes in today's Sunday Telegraph, Is a flat tax a fairer way to raise revenue? (registration may be required) has re-opened the debate. He nails the fundamental flaw with the flat tax proposal - it is not revenue neutral:
A recent paper by Richard Teather for the Adam Smith Institute has tried to provide a way out. It argues for the introduction of a flat tax at 22 per cent, combined with a tax-free personal allowance of £12,000. The result, Teather says, is that top earners would see an increase in their post-tax earnings of 0.5 per cent, while below-average earners would see their post-tax earnings increase by more than 12 per cent. Sounds too good to be true? It is. The problem is that this produces a massive loss of tax revenue - some £38bn in the first year.
The article is a good basic introduction to the issue. Interesting to note that Dr Eammon Butler from the Adam Smith institute is not concerned about a mere trifle like £38 billion:
But of course the merely administrative savings proposed in the James Review, plus the expanded tax base and the economic growth unleashed by the new low tax rates, would easily take care of that. And as he says, the potential gains are worth striving for.
Ah yes, if only it were that easy. I have serious doubts about just how easily the somewhat glib assumptions contained in the Tory's James Review could be implemented. Also checkout Tim Worstall's critique. Worstall lambasts Bootle for committing "something of a howler" by addding in the employee component of National Insurance (NI), but not the employer component:
When you add the NI and income tax systems together the UK already has something pretty close to a flat tax system (horribly riddled with examptions etc but...). For there is not one NI tax, but two, so called Employer’s and Employee’s. Together these amount to some 22% of wages from anything just over spit to just below the 40% income tax band. Add the 22% income tax that applies to most of that income (personal allowances for income tax are very low in the UK and the 10% income tax band is very thin) and you have for anyone earning the minimum wage full time a marginal tax rate of 44%.
I commented on Tim's blog that:
Ultimately of course the public pays for all taxes one way or another, but simply adding income tax, employee NI and employer NI together is simplistic. Employer NI matters principally because of the tax wedge it creates, which raises the cost of hiring workers.
The distributional issues of who would lose and who benefit from a flat tax, and of how progressive the current income tax system really is anyway, are complex. But from both an equity and public policy perspective, well worth investigating. This is something the IFS might usefully get their teeth into.
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