UKIP's Flat Tax policy

We never got round to updating our original flat tax policy of 2006, so here is my personal summary of what it looks like and why:

1. The first step is to work out the tax-free personal allowance.

a) The simple approach is to work out how much somebody can earn working full time on the National Minimum Wage of £5.93 per hour from October 2010. 52 weeks x 37.5 hours x £5.93 = £11,563.50 (assuming holiday days are paid, as is currently the law).

b) Another approach is to assume that everybody who qualifies has a straight choice between i) claiming the personal allowance and ii) claiming the non-taxable, non means tested 'Basic Cash Benefit' but foregoing the personal allowance. UKIP would set the BCB at the same rate as Income Support/Jobseeker's Allowance etc, which is currently £64.30 per week. So the personal allowance would have to be such so that the value of the personal allowance is the same or slightly higher than the value of the BCB. £10,785.81 x 31% divided by 52 = £64.30, so the personal allowance can't be lower than this.

c) A higher personal allowance allows us to scrap Working Tax Credits (which merely give back some of the tax and/or compensate people for having their out-of-work benefits withdrawn). Benefit withdrawal would be dealt with via the normal PAYE system (see b) ii) above). There is a cut off point at about £10,000 a year, at which stage a single person pays £20 a week in PAYE and can claim £20 a week in Working Tax Credits which seems like madness to me.

So £11,500 looks like a good place to start
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2. Next, we need the rate.

a) Let's ignore taxes that are legally borne by the employer (Employer's NIC - which UKIP would phase out and VAT) and just look at income tax, Working Tax Credits withdrawal, Employer's NIC and Class 4 NIC for the self-employed, as well as more specialised bits like the extra 9% for student loan repayments or the 30% band for pensioners who are losing the age-related personal allowance. This gives us a whole range of tax rates between 20% (for bank interest) and 70% (for people claiming Working Tax Credits).

b) The rate paid by most people on most of their income - i.e. basic rate employees - is 31%, i.e. 20% basic rate income tax plus 11% Employee's NIC, which is just heavily disguised income tax. It is yet more madness to have 'contributory benefits' (under which people who earn more pay extra tax but get extra benefits if they lose their job) and 'means-testing' at the same time (under which people who have more savings or some earnings get less benefits than those who don't ). The two more or less cancel out, so let's be honest and just have a flat rate of income tax and flat rate benefits.

31% looks like a good place to start (and there are even worse taxes than income tax, like VAT or Employer's National Insurance, so I'd phase those out next before I go back to looking at income tax).

c) NB Obviously, old age pensions would continue to be taxed at 20% as at present, but as a quid pro quo, they would also have to pay 40% higher rate tax, which would no longer apply to current income.

d) There are some sources of income currently taxed at less than 31%, such as self-employment income (30% income tax plus Class 4), and bank interest or rental income (20%). The self-employed would win more with the higher personal allowance than they lose on the extra 1% tax of course and people who happen to only have rental income or bank interest income up to just below the current higher rate threshold may end up a few £100 worse off, but such is life. The main determinant of interest income is the gross amount of interest, not the tax rate, i.e. you'd rather have 69% of 5% interest than 80% or 100% of 2% interest.
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3. What will the impact on tax revenues be?

a) The Laffer Curve says that if you cut the tax rate on a particular source of income from 70% to 31%, the tax take would not go down by 39/70, it would go down by maybe a quarter or a fifth or it might even be fiscally neutral or revenue positive - for example, for millions of people working just over the 16 or 30 hours a week to qualify for Working Tax Credits have no incentive to work longer hours - most of them are on £10 an hour or less, so they only keep a £2 or £3 net for every extra hour worked. Under UKIP's system, they'd keep between £4 and £7, so they'd work more, they'd be better off and they'd pay more tax.

b) Conversely, the Laffer Curve says that if you increase the tax rate on a source of income that is taxed at a rate well below the revenue maximising rate, it is always revenue positive, so increasing the rate on interest or rental income from 20% to 31% would increase revenues by nearly half.

Therefore, the overall fall in income tax revenues would be nowhere near as much as the static calculation suggests (about £35 billion per annum). We can then reduce the fall in revenue by a further £9 billion from 3c) and another £15 billion from 4).

c) There are six million people on the official public sector payroll, paid headline salaries averaging £25,000 (let's say), giving us an annual salary bill of £180 billion. UKIP's flat tax proposals would make most employees between five and ten per cent better off, so another quick win would be to cut public sector salaries by five per cent on Day One, this saves another £9 billion without making any of them worse off (and most would still be a few £100 or £1,000 a year better off).
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4. Politics - isn't this just a 'rich giveaway'?

a) In UKIP's pensions paper we said that tax relief for pension contributions would be restricted to the first £10,000 of contributions per year, which is still at a level which only a small minority can afford. The generosity of tax relief for pension contributions for very high earners has since been restricted by fair means or foul (mainly foul), but until recently it was the case that half the value of all pensions tax breaks went to the top ten per cent of earners. So that gets the cost down by another £10 bilion or so, along with all the other rubbish like film tax breaks, EIS, VCT and so on.

b) It is, to my mind, better for our Exchequer to collect 31% of something than 50% of nothing.

Any realistic calculation of the impact of the 50% super-high income tax rate is at best fiscally neutral - the extra £2 or £3 billion in revenue (yes, that's all we are talking about) is wiped out by people moving abroad, not coming here in the first place or getting involved in ever more convoluted tax planning.

Ergo reducing the 50% rate to the old top rate of 40% doesn't 'cost' much revenue and reducing it further to 31% would mean that even fewer high income people leave; more would come here (31% would be one of the lowest top rates in the world - not forgetting that other countries with superficially low rates have 'National Insurance' or similar on top and have double taxation of dividend income). So for every £1 static loss there's a 50p increase from other factors, so this reduces the overall static cost by another £5 billion a year or something.
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5. Bank bashing

All the other parties are gung-ho in favour of some form of super-tax on banks or bankers bonuses. Before we even think about introducing such a tax, let's get the banks to repay the £300 billion in taxpayer funded loans they have received and which are due for repayment in the next couple of years.
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6. The merits of simplification

I am, if nothing else, a simplification campaigner. Having a flat rate of tax solves a myriad of other problems:

a) No more arguing about who is self-employed and who is an employee, so no need for IR 35 rules.

b) Only the self-employed and people with rental income would have to do income tax returns (not employees).

c) Life would be easier for payroll departments, it's all one flat rate of tax (OK, there'd be a 19% surcharge for people in social housing instead of making them pay rent and Council tax and then claiming Housing Benefit and Council Tax benefit, so they get a K-code and their total tax rate is 50%).

d) There'd be no need to do income splitting to make optimum use of husband's and wives' personal allowances and basic rate bands, and no need for anti-avoidance legislation whereby HMRC unpicks all these arrangements and works out which allocation gives the highest tax bill.

e) Husbands and wives who still have to submit tax returns would be able to go for joint taxation if they wish and pool their personal allowances. If their total income is less than 2 x £11,500, then whoever earns less than £11,500 might prefer to waive the personal allowance and claim the BCB instead, it all comes to much the same thing.

f) Having one flat rate of tax on cash or near-cash income fits in with my other (personal) campaign, which is to roll all property-related taxes (the big ones like Council Tax and Business Rates which raise over £20 billion per year each, as well as the little ones like capital gains tax, stamp duty, stamp duty land tax, inheritance tax, TV licence fee, VAT on domestic fuel, insurance premium tax which raise about £3 billion a year each) into a flat annual tax on land values.

Carrying out the two reforms together would significantly reduce the number of people who think that they have lost out on the property tax side (actually, nobody loses out from the property tax reform, but perceptions are important, however misguided).