More Hall-Rabuschka commonsense

1. From page 182 of their Flat tax - Q&A (the figures are historic but the principles are unchanged):

Q: You keep talking about broadening the tax base. What’s so important about this?

A: Tax rates are high today because the tax base is so narrow. Personal income in the United States is about $5 trillion. A raft of exclusions reduces this number to about $3.6 trillion in adjusted gross income and $2.4 trillion in taxable income. A lower rate on all or most personal income would collect the same amount of money as a much higher rate on taxable income.

The same situation applies to business income. Much of this income escapes taxation because it does not fall into the net of taxable income. Altogether, less than half the national income is subject to income taxation, which means that relatively high rates of tax are required to collect enough money to run the government. The only way to enjoy the economic benefits of low tax rates and achieve real simplification is to broaden the tax base to all national income.

2. The main tax break they rail against in the USA is the tax deduction for mortgage interest, they explain on page 164 that removing the tax break is not a big deal, firstly interest rates would come down and secondly, people would be paying a lower rate of tax on a larger amount of income. The point of all this is not just making tax returns simpler, it is reducing the marginal rate - because it is the marginal rate on earned income which does most of the economic damage, and not the total tax burden (yes, there are good kinds and bad kinds of government spending, where the least bad is universal benefits).

3. Conversely, this is why campaigning for tax simplification is doomed to failure - politicians love buying people off with tax breaks, and voters imagine that this is a costless exercise. Far from it, one man's tax break is another man's tax burden, and by and large they all cancel out. So people complain about the large amounts of tax paid on some of their income, but are glad that the rest of their income is exempt (or worse, refuse to accept that their tax-exempt income is income in the first place); they fail to realise that the reason the they have to pay so much tax on some of their income is because the rest of their income is exempt.

The other insurmountable problems include things like people believing these fairy tales that the basic rate of tax is 20%, that there is a National Insurance fund which 'goes towards my pension' and/or that VAT (also 20%) is a tax on 'consumption'. Not true, they are all taxes on income (your spending is somebody else's income) which average out at a rate of 50%.

4. The main explicit tax breaks in the UK are for pensions savings (tax relief for mortgage interest was phased out a decade ago). There is also the tax-free personal allowance/lower earnings threshold is another kind of tax break. HM Revenue & Customs treat these as tax reducers or tax expenditures, and publish figures for how much higher revenues would be if these tax breaks were scrapped and the now-taxable income taxed at the same rates as everything else (approx. £45 billion and £90 billion respectively)

5. There is an implicit tax break for owner-occupation because non-cash rental income was exempted from tax under Schedule A nearly fifty years ago. HMRC still publish a figure for what they think they could collect in Capital Gains Tax if main residences were not exempt (£13 billion), which is strange, because main residences were never liable to CGT, but of course they no longer publish a figure for the value of the exemption of non-cash rental income. So let's estimate non-cash rental income at £220 billion (total value of owner-occupied housing £4,400 x 5%).

6. The list goes on, and then we have the Welfare State, which counts as proper cash expenditure; pensions £122 billion and working age welfare £110 billion in 2011 (from the excellent ukpublicspending.co.uk website).

But is the Welfare State really any different from all the other tax breaks? It's all just redistribution, some downwards (the Welfare State), some fairly downwards but not quite to the bottom (the tax-free personal allowance), some sideways and some upwards (tax breaks for pensions, tax exemption of non-cash rental income etc), which surely all cancel each other out?

7. To summarise the impact of all this in very round figures, total forecast tax revenues for 2012-13 (excluding duties) are pencilled in at about £500 billion and the average marginal tax rate (taking income tax, NIC, VAT, corporation tax and Tax Credits withdrawal into account) is about 50%, so therefore the total tax base must be about £1,000 billion.

We can then broaden the tax base as follows:
- Tax breaks for pensions (contributions, ongoing income and the lower rate for pensions in payment) £100 billion
- The tax free personal allowance £210 billion (30 million taxpayers @ £7,000 each)
- Non-cash rental income from owner-occupied housing £220 billion
Giving us a enlarged tax base of £1,530.

If we wanted to raise £500 billion from a much broader tax base of £1,530, we could replace the entire tax system (including all the odds and sods like Council Tax, Stamp Duty etc) with a flat rate on incomes/corporate profits of 33%, which looks a lot better than the 50% imposed at present. But a lot worse than the fairy tale income tax rate of 20% which most people think they are paying. The only wiggle room I can see here is that people don't realise that Employer's National Insurance Contributions are largely borne by employees. Er's NIC averages out at 8% of wages paid out, so we could shift to flat Er's NIC of 8% and a flat tax on employment income of 25%, people might go for that, I suppose.

8. Working age welfare costing £110 could be made less downwardly redistributive as well, by taking that £110 billion and dishing it out equally between 40 million working age adults and giving each of them £50 in cash every week (or knocking it off their income tax bill).