Friday 21 November 2008

Sensible tax cuts

I have perhaps been guilty of extolling the merits of replacing all existing property/wealth based taxes with Land Value Tax or replacing the entire Welfare State with a Citizen's Income scheme, so today, let's look at slimming down The State and simplifying/flattening The Big Taxes - Income Tax, National Insurance, VAT and Corporation Tax - i.e. taxes on enterprise, work and investment. The total revenues from these four taxes was expected to be about £395 billion in 2008-09 (HMRC, Table 1.2).

Step 1 is to work out what sort of savings the State can make without actually reducing 'frontline services'. A cautious estimate* would be around £100 billion per annum, so that means we need revenues of £295 billion per annum.

Step 2 is to work out what flat tax rate we'd have to apply to incomes/profits currently liable to Income Tax, Insurance, VAT and Corporation Tax (which are applied more-or-less at random to different types of income - which is why marginal tax/WTC withdrawal rates are anywhere between 20% and 77%, with an overall average total rate of 46%) to generate £295 billion per annum.

Step 3 is to sketch out a Laffer Curve. We know that at tax rates of 0% or 100% that revenues will be £nil; and have also established - on the basis of marginal tax rates and employment rates of married/cohabiting and single mothers - that at a marginal tax rate of 49%, revenues are 37% of earnings potential and at a marginal tax rate of 75%, revenues are 41% of earnings potential. Subject to mucking about with formulae**, we get a chart (the x-axis is the tax rate imposed, the y-axis is the % of the potential tax base that is actually collected) that looks like this:


Step 4 is to map marginal rates on all the different types of income onto the likely actual yield (from the spreadsheet used to generate the above chart) and to establish that the current mish-mash probably collects about 33% of taxable incomes/profits, which works back to a 'tax base' of £1,200 billion, which looks about right - UK's GDP is £1,400 billion, less £100 billion pure waste (see above) less £100 billion spent on core functions of the State - police, immigration control, defence etc

Step 5 is to read from the chart what flat rate would be required to generate tax revenues of £295 billion on a tax base of £1,200 billion. The answer is 31%*, give or take a %, which very conveniently is the same as the current basic rate of Income Tax plus Employee's National Insurance and a smidge more than mainstream Corporation Tax.

NOW That's what I call a flat tax system! For avoidance of doubt, there'd be no VAT, National Insurance nor higher rate tax. Corporate and personal incomes would be taxed at a flat 31% and that would be the end of that. Next.

* Maybe a flat rate of 31% wouldn't be enough to cover current expenditure on the five million remaining public sector employees, in which case a more radical 'zero-based-budget' approach would be to estimate that we need one million people to exercise the 'core functions' of the State (law'n'order, immigration control, defence etc), another million working in education (that's one adult per ten school age children) and another million in the health sector (the latter two services denationalised and replaced with health and education vouchers respectively, of course).

** The formula I used is to assume that the 'deadweight cost' to the economy (i.e. the amount by which the potential output of economy is depressed by the tax) = the tax rate to the power of 4. This gives us the 'tax base'. The actual tax is then the tax rate x the tax base, less a reduction of one-fifth to account for tax-free personal allowances and hardcore evaders. This is not particularly scientific, but produces a 'curve of best fit'.

9 comments:

Anonymous said...

Mark
You make no mention of tax allowances. Does no one get them with a flat tax?
Charles

Mark Wadsworth said...

C, the corollary of a Citizen's Income scheme (say £60 per week per working age adult, non-taxable, non-means tested, but no personal allowance) is that you can waive it and opt for a £10,000 personal allowance - thus saving as much in tax as you would have received in CI.

I've crunched the numbers in several different ways and £10,000 looks about right, mathematically and politically.

Anonymous said...

MW

Excellent analysis - and (of course) reeking of common sense. The trouble is that those who are in charge (most politicians and all civil "servants" nationally and locally) are in charge for very personal reasons: they want to be in charge: they want authority (without responsibility) over the rest of us. Your prescription will limit that power (if only by making the tax and spending systems transparent). Worse - much worse - limitation on tax might result in some of the public sector parasites being thrown out of their heavily feathered nests. That's why it won't happen. Mind you, just because something desirable might never happen is no reason for us out here to stop going on about it.

For an illustration of the contempt with which tax-funded bureaucrats view taxpayers (in this case licence payers) I would cite the interview on Today this morning of Caroline Thomson, the BBC's chief operating officer. For once Humphrys was biting (OK - aggressively nibbling) the hand that feeds him.

marksany said...

Nice analysis Mark, I really like this scheme.

Before you and A-C1 introduced me to LVT, this is the kind of tax utopia I wanted to live in, but I never had any numbers for it.

How would the transition to your flat tax work as there would be losers.

Would you still have the current plethora of benefits, or is the Citizen's Income a replacement for all of them? If so £60 is not enough, especially for someone getting housing benefit in private rented.

Would the £60 be per child too?

Mark Wadsworth said...

MA, I'm with the Citizen's Income Trust on this. CI would replace all existing cash benefits (housing, see below).

They envisage CI for adults the same as IS/JSA rates (i.e. current rates = adults 18 to 24 get £48/week; adults 25 to 65 get £61/week); pensioners get same as Pensions Credit rate = £127/week. Child Benefit and Child Tax Credits get rolled into Child Benefit £30/week. Plus top ups for truly disabled.

Housing Benefit is a thorny issue. I'd scrap it completely for private landlords (it's like a negative LVT) and people in council housing would pay 20% of gross income as rent (instead of claiming means tested Housing Benefit).

Mark Wadsworth said...

MA, apart from the three million quangista who get given the boot, the only people who would be worse off are those with a lot of rental and interest income (currently taxed at 20%) who for whatever reason don't spend much on goods and services liable to VAT.

Lola said...

I have done something similar working the other way about and I reckon we could work to get the flat tax down to 20% in double quick time, especially if we stop the state borrowing money, or rather having a structural deficit. The keys are sound money, only borrowing to support a short term shortfall on a month by month basis, or for genuine capital investment (warships, bridges, etc etc) and similar good housekeeping type things. Of course this also implies scrapping every bloddy allowance, quango, special developement area, selective grants etc etc, and tax relief on pension contributions and scrapping, ISA's, EIS's, etc etc

My aim would be to have a 10% flat tax funding everything with a £12,000 p.a. allowance.

I like 'tithes'.

John Pickworth said...

I like it... where do I sign? ;-)

Excellent Mark.

Instictively, if you were to invent a tax/benefit system from scratch, I'm sure you'd create something similar to this... indeed, some countries have if I recall?

Personally speaking, I can't always follow the math but I do understand the insanity of a system that self consumes so much of its own product. Scrap it I say, and start again.

Mark Wadsworth said...

JP, try UKIP. Oh, you did.