It's time to reform our tax system

Brexit, a challenging economic climate and growing inequality make now a good time to smash up our tax system and start again. Maybe

Felicity Hannah
Wednesday 25 October 2017 14:12
Parents earning £50,000 are among those paying a higher tax rate than millionaires under the current system
Parents earning £50,000 are among those paying a higher tax rate than millionaires under the current system

There are 775,000 people in the UK who pay more tax per pound than the country’s millionaires. That’s not because of some dubious sweetheart arrangement or a failure to pursue the rich, it’s because the system is so complex that it draws extra people into a far higher rate than is intended.

At least, that’s the finding of mutual insurer Royal London, which is calling for the tax system to be rationalised in the coming November budget.

Under the current system, the amount of tax paid on an extra pound is intended to rise as incomes rise. That means those who earn under £11,500 pay no tax on their income while those earning up to £45,000 pay 20p in the pound. After that, high earners pay 40p for each pound up to £150,000 and anyone earning more than that, such as millionaires, pay 45p in the pound.

Yet Royal London has found that some people can lose as much as 60p to 70p in every pound thanks to a series of complications, meaning that people who are not the super-rich could end up paying more than millionaires.

Who pays more

Parents where one partner earns over £50,000 will lose 1% of their child benefit for each £100 a year they earn above that threshold.

“The extra £1000 costs them £400 in income tax, £179 in child benefit, and £20 in National Insurance or £599 in total; this is a tax rate of 59.9%,” reports the mutual.

Then individuals who earn between £100,000 and £123,000 begin losing their tax-free personal allowance.

“For example, someone earning £101,000 has £1,000 above the threshold so loses £500 in personal allowance; this is an extra £500 which is now taxed at 40%, increasing their tax bill by £200; overall, the extra £1,000 costs them £400 in income tax, £200 in lost personal allowance and £20 in National Insurance or £620 in total; this is a tax rate of 62%.”

Finally, people with total taxable income including employer pension contributions of between £150,000 and £210,000 a year face the equivalent of an almost 70% tax rate as they lose their pension tax relief.

“Above the £150,000 threshold, this ‘annual allowance’ is reduced at a rate of 50p in the pound; many people in this income band will be paying tax at 45%, so a reduction of 50p in the annual allowance will mean an additional 22.5% in tax; including National Insurance Contributions, this means a tax rate of 69.5%,” it stated.

Fair and square

Steve Webb, director of policy at Royal London, said: “Most people would agree that as people earn more they should pay a higher rate of tax. But a series of complex changes which have been bolted on to the tax system over recent years mean this is no longer true.

“This analysis shows that there are hundreds of thousands of people who pay more tax on each extra pound that they earn than a millionaire – in some cases losing 60p or 70p in the pound. It is hard to believe that this is a sensible way to run a tax system.”

Of course, many people will struggle to feel that much sympathy for these high earners who are losing allowances and benefits that they don’t need as much as others.

If Chancellor Philip Hammond were to be planning tax reform for his November Budget speech – and the rumours relate to tinkering rather than major reform – then there are plenty of people with ideas.

Perhaps it’s time to scrap the complex current system in favour of a transformed, simplified and fairer structure.

Fortunately for Mr Hammond, there’s no shortage of people with ideas for how to do that. Unfortunately, they disagree quite a lot about what needs to change.

Here are some of the ideas.

Collect more taxes

A report published earlier this year by the Institute for Public Policy Research (IPPR) asserted that public spending cuts are putting pressure on public services, causing problems for the economy and society more generally.

It’s called for reform to ensure all taxes are collected. The report stated: “Public spending as a percentage of GDP is around 40%, around the developed world average. Yet this exceeds total government receipts at around 37% of GDP, and at around 33% of GDP UK taxation is considerably lower than the average for comparable economies.

“The complicated nature of the British tax system, and the significant ‘tax gap’ between taxes owed and those collected, suggest that this is a field open to reform.”

Integrate income tax and National Insurance contributions

Audit and taxation consultancy RSM called the General Election a ‘lost opportunity’ for tax reform, saying the country has been unable to have a sensible conversation about taxes.

George Bull, senior tax partner at the firm, says that integrating income tax and National Insurance would allow for a “massive simplification” in the country’s tax system.

“If we integrate income tax and National Insurance Contributions, we also have the opportunity to consider how we tax things like self-employed income, employment income, pensions, property income, interest, dividends, short-term capital gains and long-term capital gains,” he argued.

“We have a magnificent opportunity to create a post-Brexit tax system which meets our future needs as a nation, and is much better at meeting those needs than the current system is now.”

Fewer taxes, fewer ‘fiddly’ taxes

The Institute of Economic Affairs (IEA), a right-wing, free-market think tank, argues that taxes should be as transparent as possible, as neutral as possible – meaning the same tax is applied at the same rate to different activities, and that marginal tax rates should be as low as possible.

It has called for transaction taxes such as stamp duty to be abolished entirely, as well as ‘sin’ taxes, wealth taxes, inheritance tax and “various other fiddly, opaque or distortionary taxes” such as air passenger duty and the TV licence.

The paper outlined its preferred system and how such a system might work, assuming a 15% single income tax above a personal allowance of £10,000; a 12.5% VAT, including on both residential rental property and the rental value of owner-occupied property, and a location value tax aimed at capturing 75% of the location value of land.

“The impact on households would be largely progressive due to the substantial cuts in highly regressive sin taxes and the reform of property tax. The biggest winners would be households in the bottom three income deciles, gaining tax cuts worth 26, 19 and 17% of gross household income, continuing to fall to 7% at the fourth richest decile. The richest two deciles would enjoy tax cuts worth 13% of gross income.”

Make corporations pay the same as individuals

There have been plenty of news stories in recent years about vast corporations paying comparatively tiny quantities of tax in the UK, despite large chunks of their business being present here.

Writing for the left-wing think tank Compass Leo Aylen has called for a serious change, particularly given what he sees as the post-Brexit dangers of becoming a tax haven by slashing corporation tax rates.

“Make the multi-nationals and the rich individual tax-avoiders pay the same proportion of their income as the ordinary person does,” he urged.

Tax investment income the same as earned income

Richard Murphy, the author of the Joy of Tax and Professor of Practice in International Political Economy at the University of London, has a number of ideas for tax reform. One is to equalise taxes paid on investments and income.

Writing in his Tax Research UK blog, he suggested that it is an “extraordinary anomaly” in the UK that investment income is taxed at far lower rates than on workers’ earnings, particularly once National Insurance contributions are taken into account as they are not paid on investments.

This means that the wealthy can accumulate more wealth faster than those saving from earned income, enabling inequality, Murphy claims. Secondly, it encourages tax avoidance.

Until the 1980s, the UK had an investment income surcharge, payable on interest, dividends, rents and other unearned income above a set limit.

“Historically this surcharge was set at a rate of 15%. This is still less than the amount of National Insurance due in combination between an employee and employer on most salary payments in the UK.

“We believe that the time has come to reintroduce this investment income surcharge to create social justice between people so that whatever a person’s income they should be charged an equivalent rate of tax.”

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