Matthew Elliott is Chief Executive of The TaxPayers' Alliance. This is the first in a series of articles based on the TPA's 2020 Tax Commission proposals.
Ken Livingstone once wrote that everyone “should pay tax at the same rate on their earnings and all other income”. For all our differences, I agree. If you earn the same amount as a shareholder collecting a dividend or as a plumber fixing someone’s central heating you should pay the same amount in tax. And apart from the personal allowance, so you can earn enough to cover the basics tax free, if you earn twice as much, you should pay twice as much in tax. Doesn’t that sound like a reasonable objective?
Right now the tax system doesn’t work that way at all. Most people pay tax repeatedly on their income, and it all adds up to an eye watering rate. If you earn your income as wages from an employer, Employers’ National Insurance is first taken out before the money even reaches your pay cheque. Then you pay Income Tax and Employees’ National Insurance. The basic rate isn’t really 20% at all. It’s over 40%.
If you earn income from shares, first Corporation Tax is taken out of the profits. Then you pay taxes on the dividends. Then because those profits drive up the share price you pay Capital Gains Tax as well.
Even before the money is saved or spent, most people pay a series of taxes that add up to a dreadfully high rate, but a minority are able to avoid some of those taxes. From dodgy contractors, paid cash in hand, to paragons of public sector respectability like executives at the BBC and the Department of Health, paid through limited companies.
Cutting through all that takes some work, but at the TaxPayers’ Alliance, working with the Institute of Directors, we’ve put together a plan called the Single Income Tax that could do it.
The plan is that you’ll pay a single tax on your labour income, instead of Income Tax on labour income, Employers’ National Insurance and Employees’ National Insurance. For most people it will be taken out by their employer through PAYE just as it is now. And you will also pay a single tax on capital income – dividends, interest and rent – which will be charged to the company when it pays out. That will replace the current melange of taxes on capital income. Those taxes will be levied at the same proportionate rate.
There are some challenges to making that work, like ensuring that however companies return money to their shareholders, whether it is a straight dividend or a share buyback for example, they are taxed the same way. They can all be overcome though and it is fundamentally a far simpler and more robust structure than the status quo.
It is also just more honest. Giving income tax three different names, and only putting two of those taxes on people’s pay cheques, makes it harder for families to know how much they are paying. Politicians shouldn’t be abusing the historical accident that produced the three taxes to make it harder for voters to come to an informed democratic decision about the level of taxation.
Where I suspect that Ken Livingstone and I might part ways is the idea that you can combine a more sensible tax system with current high levels of public spending. You can’t. The complexity of our tax code isn’t an accident but a result of politicians introducing endless sticking plasters to mitigate the worst of the problems created by high taxes.
Simplify the tax code without reducing the overall tax burden and you get granny taxes, pasty taxes or worse. Tax cuts without tax reform are a missed opportunity, but tax reform without tax cuts is invariably a political disaster. By contrast, if you cut taxes overall then reforms can be popular even if some individual elements aren’t. We have seen successful examples of tax reform here with Nigel Lawson’s 1988 Budget and in the United States with the Kennedy/Johnson tax cuts.
The gap will partly be closed because introducing more efficient and competitive taxes can strengthen economic growth. More jobs and higher wages mean more tax revenue even if the rates are coming down. Eventually that will erode most, even all, of the cost of a tax cut but in the medium term, putting money back in taxpayers’ pockets means cutting spending.
From Ministers at the Treasury worrying over the economy to so many families trying to square rising prices with stagnant wages, the need for stronger economic growth is obvious. A more efficient tax system can mean more investment, bringing higher productivity and delivering that growth.
Tax reform needs to do more than that though. The tax system needs to be fair, and seen to be fair. At the moment too many taxes that really affect people’s standard of living are hidden away in higher prices or disguised as levies on business. And despite counterproductive high tax rates on the rich, many taxpayers have a sense that they exploit loopholes and don’t pay their fair share. The Single Income Tax could change all that: a single tax on labour and capital income, at the same rate, for a much simpler and more transparent tax code.
> Read the full 'Single Income Tax' report at The TaxPayers' Alliance (PDF).