My tax system07 February 2011
Around the time of the 2010 emergency budget I wrote a bit about what changes I would have made. However since I could not find where I put it, I decided to redo the exercise and below is the result. While I am sympathetic to the arguments of the UK being a high-tax country, the debt legacy the country has precludes any real tax cuts. Hence it is the structure of the UK tax system I will discuss here, with administration costs being the motivator.
Pure flat decentralised income taxA major problem with income tax is the centralisation required to make sure the correct deductions are made. If a pure flat income tax is levied, then the costs of centralisation can be avoided as the deductions by one payer (e.g. employer) are independent of others such taxation on savings interest deducted by banks. It also makes fraud based around having multiple employers an impossibility, as there is no allowance to claim multiple times. For similar reasons, it also avoids charades of spouses and children nominally working for a family company in order for it to be taxed at a lower rate.
One commonly cited problem with scrapping personal limits is that it hits those on breadline salaries hard, and this is difficult to avoid without either sacrificing centralisation or adding a loophole for fraud. However one should consider that the tax saving (i.e. 20%) on the £6,475 personal allowance is approximately the amount a household has to fork out in Council Tax, and in my opinion the costs (let alone the security implications) of PAYE administration far outstrip problems caused by benefits targeted at sub-£20,000 households.
Abolish NI contributionsThese days national insurance is just another income tax, and one that is somewhat opaque in the rate applied (my favourite being the necessity to distinguish between 4-weekly and monthly payments). HMRC have also done some major-league screw-ups in applying contributions to accounts, so using it to qualify for state pension is dubious as well as outdated. Call a spade a spade, and make things clearer by just having a single income tax deduction. IR35 also becomes a moot point.
Merge Employer NI into corporation taxEmployer NI is basically a tertiary income tax that is partly veiled by the employer having to pay it in addition to gross salary rather than being paid by the employee. Main problem with Employer NI is that it is a per-employee cost, which is a disincentive to recruit and retain. Employer NI also only applies to income below a threshold,so is not particularly progressive either. One problem is that having a low marginal employee taxation also means difficulties of linking company taxation to company size, and this could easily translate into a significant nett loss for companies that have a small number of high output workers.
Scrap National InsurancePretty obvious follow-on from having both income components of NI scrapped. Together these eliminate a lot of PAYE administration, which due to various combinations of employer-employee conditions, has 21 different classifications. Being able to much reduce administration was part motivation for seeing whether both components could be moved elsewhere.
Minor changes to VATVAT is the gorilla of indirect taxes, so it tends to be a lightening rod for criticisms of indirect taxation in general. The main one is that since poorer people tend to spend a higher proportion of income on consumables, vat affects them more than the better off. However this is somewhat blunted by core essentials (especially unprocessed food) being zero rated, although the current 20% rate does apply to some things it ought not to. Clothing is the major one. I am not sure why there is a lower 5% rate, but considering the goods that come under it, I would abolish the band and zero rate everything that falls under it. I would also extend the children's clothes exemption to all clothing. I would also zero-rate all fuels, as they are typically have specific duty levied on them already.
Being a tax on consumption VAT tends to drop much more sharply than direct taxes during recessions, but I fundamentally agree with taxes that reward frugality. I also think there would be difficulties in abolishing VAT, even though it is a costly tax to administer.
Minor changes to Council Tax exemptionCouncil tax is a monumentally unfair tax, particularly as it comes out of nett income, but I do not see how the fundamental structure can be changed. Poll tax did not last, and there are major problems with adding a local income tax. The main one is that I do not believe councils should be trusted with personal financial data, and that is even before the minefield of multiple addresses (common as house sales have basically stopped at a time people are having to take jobs far from home) and dependants. One big change I would make is having unemployment being an unconditional reason to get council tax exemption, although I am not exactly sure how this would be implemented. Having the council as a notional employer (i.e. they hold your P45) is a possibility.