The director general of the Institute of Directors recently drew attention to the fact that combined marginal rates of child benefit withdrawal and income tax are effectively 73 per cent for those with four children earning between £50,000 and £60,000 a year. That’s an astonishingly high burden. His answer was radically simpler taxes. “I am all for a flat simple tax system”, he said. “It has been shown to raise a lot more money.”
He’s entirely right. Low and simple taxes stimulate economic activity and growth.
It’s not just that when people get to keep more of the money they earn they are more motivated. That’s important.
But it’s also that when taxes are easy to understand and simple to administrate, people and companies know what to expect when they think about taking on a new job or a new project. They aren’t put off by the unknown quantity of what the tax implications might be. And they don’t divert their best minds from working out how to produce better products and services to working out how to navigate the tax system.
Unfortunately, our tax system is bafflingly complex. It confuses both individuals and businesses, and an inestimable waste of time and effort is wasted trying to deal with it. Income is taxed differently depending on whether it’s received as earnings, dividends or interest. And if it’s as earnings, another two income taxes are due: National Insurance, one paid by the employee and another by the employer. These are levied per job and weekly instead of per person and annually. The rules for what counts as an expense and how pensions are treated differs, too.
Income received through a company is also subject to tax before it’s paid to you as a dividend, based not on your income but instead on how efficiently (i.e., how profitably) the company accrues its revenue. And then if you sell the right to an income stream for more than you paid for it, that capital gain will be liable for tax, too – even if it’s nothing more than inflation.
All these taxes hit us hard. Once National Insurance is factored in, real Income Tax rates aren’t 20, 40 and 45 per cent. They’re 40, 49 and 53 per cent. And if you earn between £100,000 and £118,880, your real tax rate is 66 per cent because of the sneaky way your tax-free allowance is taken away.
And Child Benefit withdrawal means some with four children pay 73 per cent. Meanwhile, many people on benefits, at the lower end of the income scale, find themselves losing over 90 per cent of their additional and already meagre earnings.
Some of the coalition’s measures have been steps in the right direction. The steady cuts in Corporation Tax and the plan to reduce the main rate to match the small companies rate have been welcome.
Economic evidence shows that corporate taxes end up being paid mainly by workers in the form of lower wages, so the cuts, together with falling real wages, go some way to explaining the comparatively benign levels of unemployment since 2007. The jobs market could have been much worse.
Last year the TaxPayers’ Alliance and the Institute of Directors published The Single Income Tax.
Our bold but practical plan would replace National Insurance, Capital Gains Tax, Corporation Tax, Inheritance Tax and the current Income Tax system with a new single income tax applied to all income above a generous tax-free allowance at a single low rate of 30 per cent. This would still capture 33 per cent of national income for Government services, more than £500bn.
Further spending restraint and a series of co-ordinated smaller reforms could take us towards such a system over the next Parliament.
That is what people thinking about manifestos and tax policy should focus on over the coming year.
• Rory Meakin is head of tax policy at the TaxPayers’ Alliance.