The tax and benefit system is highly redistributive: Look at the net effects
Now, I’m all for that. But this claim is highly, highly misleading indeed. Where does it come from? The figures presented by the ONS allow one to calculate the sum of direct taxes and indirect taxes paid (on average) by households in each quintile and divide it by their ‘gross income’. This shows the poorest pay 37.8 per cent of their income in tax, vs. 30.2 per cent for the second quintile, 33.3 per cent for the third, 34.5 per cent for the fourth – and for the very richest 34.8 per cent. This relatively flat distribution looks on the face of it, as Richard Murphy described it, as ‘the flat tax nirvana so beloved of the right’.
Yet a few seconds’ thought about what the figures actually mean shows this claim is tosh. Gross income (the denominator in the calculation) includes cash benefits, which are transfers from one group to another. That a household uses money redistributed to it to spend, in turn paying what the ONS describes as indirect taxes (things like VAT, beer duty, tobacco duty, the TV license and fuel duty), can hardly be described as “regressive”. This is akin to taking from Peter to pay Paul and then saying that – because Paul spends a large proportion of this money – the whole tax system is unfair. It’s a doubly bizarre outlook given that those most in favour of redistribution tend to be those who agitate for higher beer, cigarette, and fuel duties, and are most committed to the regressive TV licence fee.
Put simply, benefits don’t fall like manna from heaven. One person’s taxes are someone else’s benefits. Therefore the tax system cannot be looked at in isolation from benefits. Indeed, public finance theory says that taxes should be raised in the least distortionary way possible (hey – we can dream) and then any redistribution done on the spending. That the tax system is not ultra-progressive then is not what matters – it’s what the overall tax AND benefits system does that counts.
Thought of in this way, we can calculate effective tax rates, which measure the net contribution for the average household in each group as a proportion of their earned or original income. This is key: how much of the income that you earn is being taxed away and given to others – i.e. how progressive is the taxpayer funded welfare state.
Doing this we see that the poorest fifth of households on average actually face an effective tax rate (taxes minus cash benefits, all divided by earned income) of -45.4 per cent, while the richest fifth face an average tax rate of 32.5 per cent. This shows that, for every £1 earned in income, the average household in the poorest quintile is transferred another 45.4p in cash benefits, while the average household in the top decile pays 32.5p in tax. In other words, the tax and cash benefits system is very progressive.
But even this excludes so-called ‘benefits in kind’ which disproportionately benefit the poor. Once benefits-in-kind (education, healthcare, and subsidies for housing, rail and buses) are considered, these effective tax rates for the average household in the richest and poorest fifths become -181 per cent and 26 per cent respectively. That’s why the ratio of original income between the richest and poorest households (15 times) falls dramatically (to 4 times) once all taxes and benefits are considered. On average, the richest fifth pay £20,777 more in taxes than they receive in benefits and benefits in kind, whereas the lowest quintile household receive £9,982 more in benefits than they pay in taxes.
By all means let’s debate (as we do often) whether this is the right level of redistribution. But let’s stop the delusional talk of the poor being burdened most by taxes.
Ryan Bourne is the IEA’s Head of Public Policy.