Nola Leach is Chief Executive of CARE.
CARE was privileged to inaugurate our ‘Taxation of Families’ annual report in 2008. Each year, these have looked at the way in which different OECD countries share out the tax burden between those with and without family responsibilities.
The message over the years has been remarkably consistent, and demonstrates that the UK gives one-earner families, especially married one-earner families, a particularly rough ride compared with other OECD countries.
We have always been clear about the reason: the radical individualism of the British tax system. Now, with just one week before the new Chancellor’s first Budget, our Twelfth Report drives home the same message yet again.
The advent of independent taxation in 1990 was an important step in the modernisation of our fiscal arrangements. We have no desire to return to the pre-1990 world of the ‘married man’s allowance’.
But we have consistently pointed out that while the decision to embrace independent taxation was not unusual or wrong, the UK adopted an unusually individualistic form of it which is almost entirely blind to family responsibility. This has created no end of problems.
In the first instance, households where the earner has family responsibilities have been taxed exactly the same as single people with no family responsibilities. Imagine this: at Number 1 lives a single person with no dependants, Mr Smith, who earns £30,000 per annum. At Number 2, meanwhile, lives Mr Jones, who also earns £30,000 but who has to support his wife, who is a full-time mother to their two pre-school children.
In a radical divergence from what happens in most countries, where taxation accounts for the numbers of mouths that must be fed, in the UK both Smith and Jones pay exactly the same amount of income tax.
“So what?”, you might say. Jones will end up about where he started once benefits are accounted for. This arrangement, however, saps energy in two regards.
First, it wastes money paying for the Treasury bureaucracy to take the money and then for the Department for Work and Pensions (DWP) bureaucracy to pay it back again. Second, it creates one of the great fiscal travesties of the modern world: Britain’s uniquely exorbitant effective marginal tax rates.
For the uninitiated, the effective marginal tax rate (EMTR) is the amount of tax you have to pay on any additional pound of income that you would earn on top of your current salary, through tax, national insurance, and withdrawn benefits, if you were to accept a pay rise as a result of a promotion or working longer hours.
The EMTR is therefore a key measure of social mobility. As someone earning the median wage considers the prospect of taking on more responsibility and a promotion, they ask themselves: to what extent will I benefit? If most of the money arising from the increased effort goes towards supporting their family, it is worth their while. If, however, most of it goes to the Treasury in tax and lost benefits, they will probably prefer their current arrangements.
A country that is committed to social mobility – that is, to empowering low-income families to be creative and earn their way to greater things – will prioritise keeping their EMTR as minimal as possible.
Successive British governments have done the exact opposite! Hitting low-income families with a comparatively big tax take and then compensating them through generous benefits creates a huge problem when they seek to withdraw those benefits as income rises. They relieve the family of what is, by international comparisons, a lot of income tax and then simultaneously claw back a significant portion of their benefits. It is the impact of this double whammy of the high tax rate and high benefit withdrawal that makes the British EMTR so problematic.
Across the OECD as a whole, the average EMTR on a one-earner married couple with two children earning 75 per cent average wage is around 34 per cent. If the average OECD family of this type has an opportunity to earn more money, they will take home the equivalent of 66 pence in the pound, which isn’t too bad. You get to keep most of it!
By contrast the equivalent family in the UK (with an annual income of just under £30,000) faces an EMTR of 73 per cent, meaning that they only get to take home 27 pence in the pound. Not good. They lose most of every additional pound earned. But if the family is on housing support as well the situation gets even worse, rising to 90.6 per cent, so they only earn 9.4 pence in every extra pound brought home.
While the tax credit system is still operational in most parts of the UK, some now receive Universal Credit. You may recall that part of the rationale for Universal Credit was to help make work pay. So, has it brought effective marginal tax rates back towards the OECD average?
It’s a mixed picture: rather than causing the 73 per cent effective marginal tax rate to go down, the introduction of Universal Credit actually causes it to go up to 76 per cent, but the 90.6 per cent figure does come down to 80 per cent. Even under the new regime, then, Britain’s EMTR is not only bad – it is the worst anywhere in the developed world!
What then should we conclude? Have the designers of Universal Credit messed up?
Absolutely not. The designers of Universal Credit were only given the opportunity to move the deck chairs around the Titanic in relation to work incentives because the only way to bring down our monstrous effective marginal tax rates is to address the root of the problem – namely, the extraordinary form of independent taxation we have in this country. It is only when we bring fundamental reform to our tax system, by recognising family responsibility, that we can make progress.
This year, in addition to looking at a number of solutions that make adjustments to the current system, we are calling for something more profound – a fundamental review of the system itself. If we want to be free to find some of the most efficient ways of dealing with the presenting problem, like income splitting, we should not limit ourselves to tinkering with the current system.
The Government needs to step back and consider designing a new form of independent taxation that, taking account of family responsibility, does not call into being inflated benefits and a crippling effective marginal tax rate, but which rather lays the foundation for liberating Britain’s low-income, in-work families to earn their way out of poverty to greater things.