Tax bands should be abolished and income tax and employee National Insurance contributions (NICs) combined into a single tax ‘schedule’, with all sources of income taxed at the same rate, and on the same basis in order to create a more efficient and progressive tax system, according to the rightwing thinktank, the Institute for Public Policy Research (IPPR)
The think-tank says its approach, which would replace the existing system of marginal tax bands with by a ‘formula-based’ system such that every taxpayer’s marginal rate would depend on their own precise level of income, would raise revenues in a way that is fairer and more politically acceptable.
This approach effectively abolishes tax bands for everyone except those on the highest incomes. Everyone earning above a new tax-free allowance and below £100,000 would have their own personal marginal tax rate, which would rise gradually the higher their income, up to a top rate of 50%. As a result, everyone earning less than £44,400 could see their average tax rate fall.
The IPPR said that the system would enable policymakers to raise much more revenue to fund public services, raising between £6bn and £16bn more a year, while still increasing post-tax incomes for at least 75% of individual taxpayers.
Few countries have adopted flat rate income tax. In Europe, Estonia, Latvia and Lithuania have flat tax rates, but even in Estonia the rate is still 21%, higher than the UK base tax rate. Russia has a flat rate15% personal income tax.
The thinktank argues that as things stand, the variable treatment of different sources of income reduces the current system’s progressivity, creates perverse economic incentives and helps to create political opposition to tax rises.
For example, the effective rate of tax on annual earnings from employment above the tax-free allowance is 32%, compared to 7.5% for income paid in dividends from company profits. The marginal rate of income tax also jumps from 40% to 60% and back to 40% as the personal allowance is withdrawn for incomes over £100,000.
For income tax payers on the lowest earnings, effective marginal tax rates can be as high as 75% as means tested benefits are withdrawn as a result of higher pay. The institute says this variable treatment of different sources of incomes, combined with sharp ‘cliffs’ in the marginal rate between tax bands, creates perverse economic incentives, makes tax avoidance more likely and is far from transparent.
Alfie Stirling, IPPR senior economic analyst and author of its report, said: ‘The UK’s system of taxing incomes is not progressive enough, too inefficient and poorly equipped to raise the revenue that almost certainly will be needed to meet the public spending challenges of the 21st century.’
Tapering Over the Tax Reforming taxation of income in the UK is here.
Report by Pat Sweet, additional reporting by Sara White
