27 January 2011

Lunch and flat tax

Lunch today with top Lib Dem blogger and Baltophile - Cicero.

As usual he was very keen to impress on me the positives of all things Estonian - including their system of 30% flat tax.

I've never been convinced by the proponents of flat tax - usually because they are a bunch of right wing nut jobs or US tea party loons. But Cicero made the case that it actually can be progressive (in the true use of the word) and is fearsomely efficient - the 'fiscal drag' (the amount of money lost through collecting tax) is miniscule as a result of its simplicity.

The key is to have a sufficiently high tax rate and a sufficiently large tax free allowance. For example if the UK introduced a 40% flat tax on all earnings over £20,000 (earnings up to this level - approx 80% of average earnings - would be tax free) the marginal rates of tax effective overall tax rate would be as follows:

£15,000 = 0
£25,000 = 8%
£40,000 = 20%
£100,000 = 36%

And it would be much much simpler to collect. The complexity of the current tax regime is reflected by the fact the Revenue and Customs currently employs nearly 75,000 people (not all obviously involved in tax collection) and spends £39 billion each year. (Source HMRC accounts)

Given it can be progressive, is clearly far more efficient to collect and results in government getting more revenue bang for its buck - it's time the Lib Dems and the coalition look seriously at a flat tax for the UK.

We also talked about Estonia's land tax, but that's another story...

10 comments:

  1. Just a small point, but the "marginal" tax rate is the tax you would pay on earning one more pound (so it's 0% and then 40%, 40% and 40%).

    What you mean is the effective overall tax rate
    :-)

    Aside from that, good piece & worth thinking about

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  2. Thanks MD - have corrected piece accordingly.

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  3. If the lib dems want to become the UK's answer to the tea party then this sure is the way to go. Unless you're a total loony and fully signed up to Ronnie Regan's voodoo economics then you surely acknowledge a flat tax would have to result in a massive increase in income inequality and massive reductions in public spending?

    Also, while I recognise this is only a quick blog post but your figure of the HMRCs budget is highly misleading - £21bn of the £39bn is tax credits.

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  4. Anonymous- what do you think the collection/distribution cost of tax credits is? The fiscal drag of the current system is incredibly high- our tax system costs three times more to run than the US as a percentage of GDP- roughly 1.4% of GDP. The whack jobs are those who think we should make only cosmetic changes to a system that is falling to bits.
    The point about a tax being progressive is that it *REDUCES* inequality- and structured this way that is precisely what a flat tax can deliver- bearing in mind that our current system despite being nominally progressive at the marginal rate is actually regressive, since the total burden falls more on the poorer and middle income groups and less on the rich.
    The world is filled with conventional wisdom that was considered radical lunacy- fiscal reform, including flat or at least simpler, could well be one of those ideas.
    Good to see you too Dan, look forward to catching up again soon.

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  5. "what do you think the collection/distribution cost of tax credits is?"

    £500m / chicken feed in government accounts.

    "The fiscal drag of the current system is incredibly high- our tax system costs three times more to run than the US as a percentage of GDP- roughly 1.4% of GDP."

    Is that the federal tax code and states or just federal? What is the source of these numbers? The US tax system is highly complex and requires individuals to file their own tax returns telling there employers what taxes they should be withholding for them.

    "The whack jobs are those who think we should make only cosmetic changes to a system that is falling to bits."

    It needs substantial reform to eliminate loop holes and crack down on tax evasion.

    "The point about a tax being progressive is that it *REDUCES* inequality- and structured this way that is precisely what a flat tax can deliver- bearing in mind that our current system despite being nominally progressive at the marginal rate is actually regressive, since the total burden falls more on the poorer and middle income groups and less on the rich."

    A flat tax will not reduce income inequality, it will massively increase it and wipe out government tax receipts.

    "The world is filled with conventional wisdom that was considered radical lunacy- fiscal reform, including flat or at least simpler, could well be one of those ideas."

    The world is also filled with radical lunatic ideas that are just plain lunacy. If the libdems want to come out as proud Thatcherite backwoodsmen then a flat tax is the way to go, the IEA will love you for it.

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  6. Anonymous - I wouldn't normally debate with someone who hides behind a cloak of anonymity, but you seem keen to engage.

    I have some sympathy for your view and would certainly not support a flat tax if it had the effects you fear. But your argument seems to be basicaly that because some right wing whack jobs have proposed it it must be wrong and anyone even considering it must be an evil Thatcherite.

    I'm keen to hear the evidence (on both sides of the debate) - so instead of bald statements such as 'A flat tax will not reduce income inequality, it will massively increase it and wipe out government tax receipts' it would be good if you could provide some facts (as Cicero has done).

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  7. The people advocating flat tax are the same people that were allowed to run the banking system and look where that ended up. Casino banks run by capitalist cowboys who flushed the real economy down the drain and asked the tax payer to bail them out.

    If we let those free market fundamentalists run taxation policy their 'flat tax' will be introduced and the threshold and over all rarte will both fall until we have Russian levels of inequality (which is their plan). And the still won't pay tax themselves anyway as they will continue to dodge taxes as education & welfare budgets are cut.

    The Lib Dems are fast becoming the UK's version of the US tea party, which isn't so bad as the Lib Dems are rapidly being consigned to the political dustbin. Good riddance to by rubbish I say. Scotland showed the rest of the country the way...

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  8. It needs substantial reform to eliminate loop holes and crack down on tax evasion.

    - HELL YEAH. I'll vote for that.



    A flat tax will not reduce income inequality, it will massively increase it and wipe out
    government tax receipts.

    - Yep. If they ever get one they'll start arguing that the over all rate needs to be lower so the greedy pigs aren't forced to use elaborate avoidance schemes, when it's pointed out that that won't leave enough revenue they'll say just reduce the threshold then, and they will continue to avoid their social responsibilities and dodge taxes anyway.

    I've an idea. No tax on 60% of median earnings, 30% tax on 60% to 100% median earnings. 40% on 1 - 2 times median earnings and 60% on anything above twice median earnings.

    What wrong with a structure like that? Then we seek international agreements to stamp on tax dodging world wide.

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  9. Thanks for the recent comments. I think the point about flat tax is that it is only progressive if the threshold is set sufficiently high and the rate is sufficiently large. But it is super efficient to collect, which is the disadvantage of the current system - and that proposed by the final anon.

    I remain to be convinced by flat tax, but I certainly don't reject it because some mad people are proposing it as David suggests. He also seems to think that those regulating the banks were some sort of right wing tea party clique. New Labour weren't exactly my cup of tea - but I wouldn't go quite so far as to describe them like that!

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  10. To be honest Dan, I don't think it's the different tax bands that make tax difficult to collect.

    Your system has a calculation on £50k as follows:
    0% on £15k + 30% on £35k = £10.5k

    Compared to the current system:
    (Using this years allowances and rates)
    0% on £7.5k + 20% on £35k + 40% on £7.5k = £10k


    Not really a huge increase in complexity, especially when it's all being done through a computer system. A spreadsheet that dealt with variable rates would take an whole extra 5 mins to design! :p

    When people talk about complexity in the system, I think they're more talking about the thousands of tax breaks, exceptions, special rules etc.



    As anonymous said, a 30% flat rate would amount to a HUGE tax break on high earners and an extremely significant loss on government income. The cuts that this would require would be VERY painful. All in all, I think the flat rate remains an argument for those who want to cut taxes for the super-rich.

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