Tax and Fiscal Policy

Politicians need to wake up to the flaws in our tax system


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Without drastic reform of the UK tax code, the future is bleak for taxpayers Problem_web.pdf
The future for British taxpayers is bleak unless politicians agree to drastically reform the UK’s tax code. Policymakers have continued to sidestep the fact that we have been let down by a chaotic and inefficient tax system. It is unacceptable to persist with a system that drags millions into paying a higher rate of income tax and erodes the aspirations of those on low pay to progress up the pay ladder.

Taxing Problem: The UK’s incoherent tax system, by Ryan Bourne looks at how the UK’s tax system is no longer fit for purpose. The government should have the long-term objective of creating a simpler, more coherent tax system – enabling people to keep more of their hard earned money.

A failure to adjust tax thresholds has resulted in close to 3 million more taxpayers being dragged into paying the higher rate of income tax between 1990 and 2013/14. Despite the Conservative’s pledge to raise the threshold to £50,000, over 5 million taxpayers will pay the higher rate of income tax by the end of the next parliament. Indeed, it is likely that the number of higher rate taxpayers will continue to increase even if the threshold is raised.

Problems with the current system:

  • Fiscal drag – Government complacency has resulted in millions being pulled into the higher rate of income tax. Since 1979, the threshold has fallen by 10% in real terms and 43% relative to wages. Recent proposals will do little to prevent middle income earners from paying the 40p rate.

  • Discourages aspiration – High marginal tax rates have meant that individuals on low incomes are finding themselves with little incentive to progress into higher paying jobs. Even with the implementation of Universal Credit, which will eliminate the most severe cases, family households on low-middle incomes could still encounter marginal tax rates as high as 76%.

  • Incoherent and over complicated – The UK suffers from a bizarre structure of marginal tax rates. Measures such as the additional rate of income tax, the withdrawal of the personal allowance for higher earners and  increases to the personal allowance without increasing national insurance thresholds have succeeded in making this problem worse. Proposals by the Labour Party to reinstate the 50p tax rate and introduce a 10p tax band above the personal allowance will succeed in further convoluting the system.

Key recommendations:

  • Simplifying the current system – Abolishing the savings income allowance and withdrawal of the personal allowance for those earning £100,000 a year would simplify the system at relatively little cost.

  • Equalise income tax and national insurance thresholds – A substantial gap exists between the level of income at which an individual starts to pay income tax and national insurance. Increasing the threshold at which national insurance contributions become payable to the level of the personal allowance, would be a first step towards merging them into a single tax on the income of labour.

  • Reform the tax thresholds – Statutory indexation to wages would protect taxpayers from moving into higher tax bands through fiscal drag.

  • Welfare reform –Introducing a negative income tax would prevent millions from paying income tax whilst simultaneously receiving income transfers. If implemented with family-based tax allowances, such a policy would also end discrimination against family formation.

  • Reduce government spending – Significant cuts to public spending are needed to facilitate tax reform. Reducing government spending to between 30 – 33% of GDP would facilitate lower marginal tax rates across all income levels.

Commenting on the research, Professor Philip Booth, Editorial and Programme Director at the Institute of Economic Affairs, said:

“The UK’s tax system is not fit for purpose. It is complex and huge numbers of people – at all income levels – face very high marginal tax rates. The situation has worsened under this government. In the next parliament, we need urgent reform to create simpler and flatter taxes.”

Notes to Editors:

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Taxing Problem:  The UK’s incoherent tax system, by Ryan Bourne can be downloaded here.

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