“Work doesn’t pay” is the oft cited justification for Universal Credit (UC). It’s not clear that rolling up six separate benefits into one single payment will address this problem, aka the unemployment trap. Wages in the UK are at best static and may have been falling in real terms over the last decade. Coupled with declining real wages has been the almost complete elimination of affordable council housing. Wages nowadays are insufficient to meet private housing rental costs which have soared due to shortages. So yes, it may pay claimants to remain on benefits, particularly Housing Benefit.
An alternative to UC is to integrate the tax system with benefits. Low earners, instead of paying income tax, would instead receive a generous negative tax payment. The incomes of low earners would be enhanced to the extent that they would no longer need benefits just to survive; in short, integrating tax and benefits could give low earners independence. But how can this be achieved? One framework to achieve this is a system of cumulative hourly averaging combined with comprehensive realised income (CRI) subject to a single rate of tax
Cumulative Hourly Averaging – the advantages
It rewards work – those who work will pay less tax on their comprehensive realised incomes
It can integrate benefits with tax – a generous negative income tax is facilitated
It supports flexible labour markets – the incomes of zero hours contract workers will be enhanced and less variable. There should be no need of a minimum wage.
It restores or strengthens the contributory principle.
Comprehensive Realised Income – the advantages
It addresses inequalities in wealth distribution – wealth transfers and other windfall gains are taxed at the same rate as earned income
It overcomes equitable objections to Inheritance Tax – legacies would be taxed according to the recipient’s circumstances and at the same rate as earned income
It reduces incentives to avoid tax – a single rate of tax can be applied to all sources of income
Cumulative Hourly Averaging – the Generalised Model
The tax charge in period n would be calculated with the following formula:
T(n) = m∑Y(n) – c∑H(n) – ∑T(n-1)
T(n) = tax charge in period n
∑Y(n) = Cumulative comprehensive realised income received by the end of period n
∑H(n) =Cumulative hours worked by the end of period n
∑T(n-1) = Cumulative tax paid at the start of period n, and so ∑T(n) = T(n) + ∑T(n-1)
m = the marginal tax rate. I have used a single marginal rate of 50% applied to all components of CRI without preference
c = the value of an hour of work. I have set this to £20 so as to produce a generous negative tax component which encourages work
Before illustrating how the tax calculation works, I have set out some parameters which I have used in the examples below. These are:
The standard working week has been set to 40 hours per week
The standard wage rate (or the value of an hour of work) is £20. Note this is an administrative value and has nothing to do with a minimum wage.
There is no minimum wage
A flat rate income tax of 50% applies to all components of comprehensive realised income without preferment. This is a limiting rate, meaning no one in work will pay tax at this rate however high their income.
Tax free personal allowances depend on cumulative hours worked and are valued at £20 per hour worked.
Tax free personal allowances are carried over to succeeding years, unlike the current “use or lose” system
No individual’s personal allowance can exceed 48 hours in a week
HMRC operates RTI (Real Time Information) so that incomes and changes in circumstances are reported as and when they occur.
Freda starts work for 30 hours per week at £7 per hour (£210 per week). She has no other sources of income.
T(1) = = 0.5 x £210 – £20 x 30 = – £495
Freda will pay no income tax and instead will receive £495 under the negative tax mechanism. Her disposable income will thus be £210 + £495 = £705. Not bad for a week’s work !
In the second week, Freda’s tax calculation is as follows:
T(2) = 0.5 x £420 – £20 x 60 – (-£495) = -£495
So again, Freda’s disposable income (take home pay) will be £210 +£495 = £705. Enjoy yourself, Freda. you deserve it! And so it will continue until Freda’s circumstances change.
George starts work as a director of a large company. His monthly remuneration package comes to £60,000. His monthly hours of work are restricted to 208. He has no other sources of income
T(1) = 0.5 x £60,000 – £20 x 208 = £25,840
So George’s disposable income will be £60,000 – £25,840 = £34,160.
T(2) = 0.5 x £120,000 – £20 x 416 – £25,840 = £25,840
So long as George’s circumstances don’t change his monthly disposable income will remain at £34,160.
Mark Anthony is a notorious playboy who has never done a day’s work in his life. His very rich father bequeaths Mark Anthony £500,000 in his will. Mark’s tax liability will be:
T(1) = 0.5 x £500,000 – £20 x 0 = £250,000
In the second period, Mark Anthony decides to do some voluntary work. He registers 30 hours with HMRC.
T(2) = 0.5 x £500,000 – £20 x 30 – £250,000 = – £600
Mark Anthony is rewarded for his voluntary work to the tune of £600 via the negative income tax mechanism. Work pays! Even unpaid work.
Lois has a severe disability that limits the amount of work she can do in a week to 10 hours. She is paid £3 per hour (there is no minimum wage). HMRC credits Lois with 30 additional hours per week to compensate her for the hours she is unable to work through no fault of her own. She has no other sources of income. In week 1 her tax will be calculated thus:
T(1) = 0.5 x £30 – £20 x 40 = – 785
So Lois’s disposable income in week 1 will be £30 + £785 = £815. This is an example of how institutions can be used to compensate disadvantage.
In week 2, Lois receives a pay rise of £2 per hour to £5 per hour. Her tax calculation in week 2 will be
T(2) = 0.5 x £80 – £20 x 80 – (-785) = -£775
Lois’s disposable income in week 2 has risen to £50 + £775 = £825. A pay rise of £20 per week has resulted in Lois’s disposable income increasing by £10 and the state subsidy falling by an equivalent amount.
Tony is a homeless alcoholic, without work or income. He is offered 40 hourly work credits per week which will trigger weekly payments of £800 via the negative income tax mechanism provided he undergoes treatment for his alcoholism at a residential clinic. In Tony’s case, the weekly payments are paid directly to the clinic instead of to Tony, Tony will need to price himself into employment when his treatment is completed, a task made easier absent a minimum wage.
HMRC will need to keep an up-to-date record of every taxpayer/claimant and changes in their circumstances. This is not as onerous or as intrusive as might at first appear; RTI, which requires employers to submit details of employee hours and pay in “real time”, has already been introduced. The road has already been dug.
Here is a logical record of the information and processing that HMRC would need to collect and process for an employee. The particular employee shown in the record has had a particularly turbulent time, starting as a highly paid director, becoming unemployed, suffering disability, inheriting a sizeable estate, etc, all in six weeks!. The record is not intended to be of a typical employee but is illustrative of how income tax would work under cumulative hourly averaging with CRI .
One thing writing this post has taught me is how difficult it is to design a safety net which both protects and incentivises. A safety net which is too generous removes incentives to return to, or to get into, work. A safety net built around stick and no carrot is cruel and damaging to individuals. I fear that Universal Credit, with its vicious sanctions regime and its heartless treatment of the sick and disabled, falls into this latter category. I venture to suggest that the negative income system outlined above, albeit with its fault lines, would be more effective than the proposed UC project should the latter ever go live. The system outlined above is certainly kinder than UC. Having said this, it may be that the proponents of Unconditional Basic Income win the day – UBI sidesteps the tension between incentive and protection. Perhaps this is the way to go.
It would be remiss of me not to acknowledge the brilliant work of Douglas Bamford in the field of taxation and philosophy. Douglas very kindly gave me sight of his then forthcoming book in advance of its publication. His ideas on cumulative hourly averaging have very obviously informed this piece, as has his idea of using comprehensive income as a tax base. His book is entitled Rethinking Taxation – An Introduction to Hourly Averaging. ISBN 9781907720918.
Any errors or sub-standard work contained in this piece are mine, and mine alone.
Addendum 2 September 2014
1. Quite rightly, it has been pointed out to me that the negative tax proposal outlined above does not say much about unemployment support. To answer this, I suggest work placements should be available for all jobless people, which they can choose to take up. There should be no compulsion as to participation or as to the type of placement. If a jobless person can arrange a placement of their choice, say in a museum, then so be it. The only requirement would be the readiness and agreement for the placement provider to submit the hours worked to the HMRC as registered hours. The registration of hours worked each week under RTI reporting would then trigger a payment via the negative income tax mechanism to the worker in the same way as for other employees.
2. People who have caring responsibilities, either for children or for aged parents, should receive hourly credits equal to the standard working week (40 hours according to the parameters used in my examples).
3. Profits on the sale of houses, even if a house in question is a Principal Private Residence (PPR), should be brought into the Taxable Comprehensive Realised Income calculation. Currently, the gain on sale of a PPR is exempt from taxation.