Towards a truly progressive tax system

Is the UK’s tax system out of date and no longer fit for purpose?

Many people, including myself, would say it is.

Politicians, though, seem unable or unwilling to address the creaking tax and social security systems.

Here are some, perhaps radical, ideas that could transform the lives of ordinary people. The proposals are unlikely to meet with approval from the very wealthy, from those who receive very high incomes, or from those who otherwise have a stake in the status quo. Nevertheless, here goes:

1. Realised comprehensive income

By adding together an individual’s earned income, their dividend income, their savings income, their property income, their capital gains, and their receipts from legacies, one arrives at an individual’s realised comprehensive income.

Taxing comprehensive income simplifies the tax system and makes it harder to avoid tax because all types of income would be taxed at the same rate. The current system taxes the individual components of comprehensive income at different rates. The current system hence provides incentives for taxpayers to manipulate their affairs so as to take advantage of differential tax rates. For example, under the current system, it is usually advantageous for an individual to take the benefit of a transaction as a capital gain rather than as income. This is because capital gains are generally taxed at a lower rate for individual tax payers.

2.  Increase annual tax free allowance to £100,000

The first £100,000 worth of comprehensive income received in a year would be tax free. Such a move, were it to be implemented, would take most, perhaps as many as 98% of tax payers, out of income tax altogether. Only those with comprehensive incomes above £100,000 would be liable for income tax. Incomes above £100,000 are more likely to be unearned, they deriving from rent extraction activities, holding gains, and luck.  It is unlikely that extremely high incomes result from a commensurate contribution towards the common good. Genuinely earned income, that is income derived from an individual’s contribution to society, is likely to be lower than £100k per year and should therefore escape income tax altogether.

3.  Simplification of income tax

Every income tax payer would have the same marginal rate of tax. This would ensure the average income tax rate rises with comprehensive income.

A formula can be used to determine an individual’s tax rate taking account of their annual comprehensive income. The formula would only be applied to comprehensive incomes above £100,000 p.a.

An example of such a formula is a follows:

0.9 x (Y –  £100k)

where Y = annual comprehensive income, the £100k shown in brackets is the annual tax free allowance and the 0.9 (90%) is the marginal tax rate and the limiting tax rate (i.e., the tax rate will never exceed 90% however large an individual’s comprehensive income may be)

Here is a graph which plots comprehensive income against the applicable average tax rate using the formula shown in blue.

Top tax rates graph

Comments

The graph shows how an individual’s average tax rate is determined by their comprehensive income.  For example, an individual with an annual comprehensive income of £0.4 m would have an average tax rate of just under 70% of that income, (the exact percentage is 67.5%).

An individual with a comprehensive income of £0.1m or less would not pay tax on their comprehensive income at all.

As an individual’s comprehensive income increases the closer their average tax rate approaches the 90% limit. However, no individual, however high their comprehensive income, will have an average tax rate of 90%; but very high comprehensive incomes will come close to the 90% limit.

Taxing comprehensive income this way is consistent with free market principles. Company directors and others who can, and do, effectively set their own pay will continue to be free to do so. Using the proposed formula to assess tax on comprehensive income supports freedom but also enables society to benefit. A high marginal rate may also discourage “superstar” remuneration, and thus may help to address runaway inequality which is becoming increasingly prevalent.

4.   Universal Basic Income

The introduction of a universal basic income would guarantee every adult citizen of the UK an unconditional basic income. This would guarantee every citizen social security. This would obviously need to be funded and a Land Value Tax may provide such a fund. A quick estimate suggests that £208 bn per year would be need to be raised to pay a basic income of £100 per week to 40m adults. This is clearly a lot of money.

The universal basic income would have many benefits. For example, the minimum wage could be abolished. The bargaining power of workers would be be enhanced in wage negotiations with employers. Self-employment, because of the risk reduction impact of a basic income, should mean more workers eschewing employment in favour of self-employment. This would contribute to economic dynamism and creativity. A basic income may permit younger people to stay on at college to acquire skills from which they, employers and society benefit. The benefits of a universal basic income are manifold and, encouragingly, the concept is increasingly finding support from both the left and right ends of the political spectrum.

5.   Land Value Tax

A tax on the value of land is thought by many to be a rich potential stream of taxation income.  It has been suggested that, very approximately, one-third of the value of a house is due to the value of the land the house sits upon.

A land value tax would be an annual charge on land owners. It would be charged as a percentage of the value of land owned. Whether a Land Value Tax would provide sufficient funds to finance a meaningful Universal Basic Income is at the time of writing unknown to this author.

A powerful argument in favour of a Land Value Tax as a means of funding a Universal Basic Income is that it supports justice in distribution. Land is a God-given resource which should be available to everyone to profit from. But the land is owned by private individuals who capture the benefits of land ownership despite having acquired the land by means of dubious morality in the first instance. So it makes sense that landowners should fund a Universal Basic Income to compensate those who are forcibly displaced from the means of subsisting from the land.

Appendix

Tax rates for comprehensive income of up to £8m p.a.

top tax table

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7 comments

  1. A very interesting post. Obviously it is a fairly extreme version of the high personal allowance/high rate type model. But it is easier to consider extremities as features are more pronounced.

    Assuming this model could be implemented fully, addressing certain practical issues, is there a risk this model could give the wealthiest elements of society disproportionate leverage over the state? This leverage would be available to use intentionally or unintentionally.

    We already have a situation where we are very reliant on income tax from the top earners in the UK. That means that tax policy already needs to consider these individuals’ responses to shifts in tax burdens carefully. But by increasing the proportion of tax raised by these individuals further, aren’t we starting to risk distorting democracy? If significant members of this group decided that a particular policy was undesireable, the threat of leaving the UK or suppressing income gives a simple means of leverage.

    Even if the intentional effect weren’t to arise, won’t the substitution effect need to be considered? The rate of tax maxes out at 90%, so there is no complete disincentive to apply effort. However, income tax in the UK currently tends towards around 50% at most, I’m sure this would have a fairly significant effect on behaviour in some way.

    I’m not presuming that the effect would be positive or negative but it would be magnified significantly at that level.

    Do you think that the risks become too significant at the proposed levels? And are there any safeguards?

    • Interesting points and thank you for your kind comments.

      With the model, someone with a comprehensive income of £200 k would pay income tax at 45%, the same rate as is currently extant for incomes derived from employment/self-employment. Only when mega incomes are received would a “punitive” rate of tax kick in.

      Simon Wren Lewis has observed that the pre-tax incomes of top earners have soared since top-rate tax cuts started in the 1980s. Furthermore, top incomes have grown at a much faster rate than GDP growth, suggesting that rent extraction is responsible for the growth in top income. This suggests that top-income growth has arisen because a larger share of national income has been appropriated by the top percentiles, and not because they have contributed to superior economic growth. In short, lower marginal rates at the top end have simply incentivised the top percentiles to grab a larger share of national income. It’s a variant of the “something for nothing” culture that we are currently exhorted to deplore by our opinion-formers. Given this, it seems eminently fair and just to penalise those who award themselves superstar remuneration without superstar performance.

      With regard to behavioural effects, I would expect the model to cause top income growth to moderate. This is because post-tax income gains would be much lower for a given increase in pre-tax income. Hence the incentive for “superstars” to capture a disproportionate share of national income would be diminished. If behaviour did not moderate then society should be indifferent because of the hefty contribution to the common good arising from increased tax receipts.

      Some “superstars” may relocate to lower tax regimes in response to high marginal tax rates. Given they are taking more out of society than they are contributing I don’t see this as something over which to lose sleep. With English now as the “Lingua Franca” and a highly mobile pool of international talent, the current crop of extremely high paid “superstars” is replaceable, most probably at a much lower cost. People choose to live in the UK for a wide range of reasons, not just for the prospect of a superstar income.

      The parameters I used in the model reflect my (political) preferences. The tax-free allowance and limiting tax rate parameters should, naturally, be set via a democratic legislature in the light of the risks you correctly allude to. But I do believe the current top rate of 50% is too low and that clearly excessively high incomes should be penalised.

  2. An interesting thought experiment, but not really keeping with the complexity of how human beings actually behave. Reality is going to be messier than that.

    The resentment in Benefit Street is real and exists, and it is not because they are getting something you are not. It is because they are perceived as not contributing to society and thereby earning their keep.

    Human society is based upon quid pro quo, and that means that not only do you need an income, you need to be doing something that others consider worthy of that income. If you don’t then the income will be removed by political means. That’s why unemployment benefit has been run down. That’s why the pension age is going up when the level of unemployment suggests it should be coming down. That’s why child benefit has been removed for ‘high earners’.

    Basic income cannot and will not work, not only because of theoretical production issues, but because of basic human psychology. People need to be seen to be doing something worthwhile, and the vast majority of people don’t want the responsibility of working out what that is and desire to be told to do something. There is a reason the armed forces are never short of recruits.

    The best we can hope for is a Job Alternative Guarantee, an offer by the state of a job at the living wage working for the public good. The state needs to find more than just money to solve the poverty and demand problems.

    Additionally any Guarantee scheme is funded by the real production of the country. Whether that requires taxation or not is a consequence of how much financial saving the non-government sector is making – *not* how much is spent. You have to be careful to make sure that the automatic stabiliser systems continue to vary sufficiently to smooth out boom and bust. That means taxation of countercyclical variable nature, or government payments of a countercyclical variable nature.

    And don’t forget corporations. They’re taxed separately at the moment.

    • @Neil Wilson

      Thanks for your comments.

      A job guarantee and an unconditional basic income are not mutually exclusive, we can have both! Individuals can be in receipt of UBI and be a voluntary beneficiaries of a Job Guarantee if such schemes existed..

      Yes, corporations are taxed separately. Corporation tax is a relatively minor contributor to the Exchequer. There is not much than can be changed with corporation tax other than varying its rate or abolishing it.

  3. Why not just go for flat rate taxes?

    For example, if we moved to a system under which the only major taxes(sin taxes and resources taxes kept) where a flat 20% Income and Corp Tax, with a 3% property tax(LVT), we get the following results.

    75% of households would have no LVT liabilities, once CI has been netted off.

    The average UK household would be £10,000 per year better off. NET.

    Housing affordability increases four fold for the average household.

    Any household who’s gross income is 10% or more of their home’s selling selling price would be better off.

    Reduction of deadweight costs >20% GDP.

    Here’s where you can find the costings

    http://kaalvtn.blogspot.co.uk/p/the-transition.html

  4. Pingback: Inflation, corporate welfare and another UKIP SOH failure | alittleecon


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