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'.