What do I mean by “improve”?
I consider a change to be an improvement if it makes the taxation of income fairer and also if it makes it simpler in a way consistent with fairness. Fairness is also different in the eyes of different observers so let me say that I consider that a basic requirement for fairness is that there should be some connection between levels of taxation and an ability to pay and, further, that the proportion of a person’s income that it is reasonable to expect them to contribute to society’s needs in tax increases as their income increases. At the most basic level, this is because those with low incomes need all they have to meet their basic needs whereas, for those with the highest incomes an increasing proportion of their income will be available to meet other needs and desires.
A principle
Where a service is paid for wholly or partly out of taxation paid by individuals then such tax can only reasonably be based on the amount of a person’s income or wealth. This article does not address the taxation of wealth except incidentally. Tax on income should not be used to incentivise any behaviour that is not available to all taxpayers as this inevitably leads to distortion and unfairness.
Existing taxes on income in the United Kingdom.
I take these to be National Insurance, Income Tax, Capital Gains Tax and, perhaps controversially, withdrawal of benefits as income increases. Examples of other personal taxes are Council Tax (essentially a tax on the occupation of or ownership of empty residential land and property) , Inheritance Tax and Stamp and Excise duties (both taxes on transfer of assets).
Income tax
I am going to concentrate initially on income tax as this is the most obvious example and will illustrate the main points. I will consider address National Insurance and Capital Gains Tax and withdrawal of benefits later.
Current position on Income tax
Currently there is initially a zero rate or allowance for some income, a personal allowance available to everybody, a dividend allowance on the first element of dividend income, a savings allowance which exempts the first part of interest income but which reduces as a person’s marginal rate increase and a few special cases which I will ignore for now. The main personal allowance is progressively withdrawn as a person’s income increase from £100,000 pa. with the perverse result that the marginal tax rate goes down as a person’s income goes above £120,000. This is complex enough in itself and does not cover the effect of the gradual withdrawal through tax of child benefit payments or the effects of National Insurance on overall taxation.
In order to tax income at all the income has to be linked to a taxable ‘source’ and different types of income may be taxable at various rates. Notably, dividends are taxed at a lower rate than other income.
A starting point proposal
There should only be one personal allowance (or zero rate tax band) applicable to everybody and to all types of income. All income, including dividends, should be taxable at the same rates. The amount of the personal allowance could possibly be higher than at present as a result of abolition of all special allowances, although this saving to the Exchequer may be swept up by abolishing the current clawback of the personal allowance which is a farness essential even though it only affects those with relatively high incomes.
The rate of income tax charged should be progressive, that is the marginal rate for anybody with a higher income than another person in similar circumstances, should never be lower, but may be higher, than the marginal rate charged to the person with the lower income. This should be irrespective of personal circumstances other than income. This is a basic requirement of fair taxation of income.
With these simplifications one may introduce an extra tax band to allow for a steadier increase of marginal tax rate with income, for example, 0%, 15%, 30%, 45% rates (allowance taxed at 0%, starter, main and higher rates). The actual rates would need to be set each year as at present but should be constrained to rise in similar steps. In times of particular economic difficulty affecting the poorest most, as is always the case, an emergency additional higher rate could be added temporarily.
Any sums received (less allowable expenses) by any taxpayer should be taxable as income with no regard for its source unless the payment is exempt or is a capital receipt. This includes gambling wins and any sums which the taxpayer is unable or unwilling to explain and for which HMRC cannot identify a source. There should be no requirement for HMRC to identify a source for the income. This is abolishing the schedular system which is said to have been done already but which has not in reality. This is a major simplification in principle of the income tax rules although in practice rules would continue to be needed for the calculation of various different types of income (with a simple no deductions rule for income with no identified source).
Where Parliament decides that particular support should be given to certain groups of people, such as those with children or those with disabilities, then such payments should be made in recognition of the circumstances being the same for all irrespective of income BUT all such payments should be taxable in exactly the same way as other income. They should never be made in the form of tax allowances as these give higher payments to those with the highest income.
If benefits have to be be income related benefits, and so withdrawn as income rises, they should be ideally withdrawn at a rate not higher than the lowest rate of tax (15% in the putative example above) and the personal allowances should be sufficient so that such benefits will not normally generate income above the personal allowance.
Where possible and practicable so-called tax breaks, such as ISA’s should be abolished or restricted to the lowest tax rates so they cannot be of greater benefit to better off taxpayers. In particular, deductions allowed for building a pension fund should be restricted to the lowest actual rate of tax. It needs to be remembered that any allowance that gives a greater tax benefit to wealthy taxpayers than others is effectively paid for by all taxpayers representing a relative subsidy from the poor to the rich.
A possible consequence for tax on companies.
A reason sometimes given for taxing dividends at a lower rate is that the income has already been taxed to some extent in the hands of the companies paying the dividends. If that is a concern, then the rate of corporation tax could be reduced to recognise the increase in dividend taxation. However, as companies are legal persons in their own right and enjoy many privileges of incorporation I would argue that there should be no connection between the taxation of companies and that of the income that shareholders receive from those companies. Removing this connection could also enable the abolition of the nonsense of non-payable tax credits on dividends. (A few tax treaties may need some renegotiation as a result).
Going further – a more radical version involving National Insurance (NI)
NI is more difficult in principle, since although obviously a tax on income, it is directly related to the right to receive certain benefits, specifically the state pension. For employed people, it is also currently charged by reference to pay period and not annually as for income tax and entitlement to benefits related to the periods for which it is paid rather than the specific amount paid. There is no reason in principle why it should not be collected on an annual basis as for income tax. It is charged at a flat percentage rate (above an allowance) but is then cut off at a ceiling with a 2% charge only on higher amounts of income and is therefore regressive. This ceiling is justified the suggestion that those with incomes above it have paid enough to contribute in full for the relevant benefits .. but this makes no sense at all as people with incomes below the ceiling are required to contribute in proportion to their income thus subsidising the lower paid. The ceiling for National Insurance means that tax rates on income are, in fact, less progressive even than they appear to be.
National Insurance is a tax on income pretending not to be a tax. It should not be exempt from a basic principle of fair taxation that people should contribute according to their means.
It has been suggested before that NI should be actually or at least practically merged with income tax, and the ceiling be abolished, but this has come up against the challenge of the way it is charged and the desire of policymakers to retain the so called ‘contributory principle’.
Whilst the principle that people should contribute to maintain rights to unemployment benefit and to a pension seems to make sense, it is possible to maintain that in other ways, effectively with enrolment in the income tax system and engagement with it (including where no tax is paid by reason of insufficient income) being the marker of a contributing citizen. In principle this would extend the payment of NI to retired people but this could be partly compensated for by a higher state pension (fully for lower income pensioners) and there is a good argument that wealthier retired people should continue to pay substantial sums into the system in line with younger people. Spreading the tax load in this way would also enable the tax rates across the board to be reduced to some extent.
Of course, the real difficulty for politicians in combining NI with income tax is that it would immediately add to all those headline rates of income tax whilst not, in principle, actually increasing the overall tax load at all. This looks like a difficult ‘sell’ for a politician! Having said that only a dishonest reporter would suggest this represent an actual increase in taxation so we can no doubt rely upon the honesty of the press to report such a change correctly?
At this point I will suggest that it is, in fact, a politician’s job to explain the true effects of proposed changes and, yes, it is also the press task to be honest and not represent something as a tax rise or tax giveaway when it isn’t. This is not a counsel of perfection, merely a plea for basic standards (deliberate dishonesty by press or politicians is below even a basic standard) in public life.
So can we have politicians brave enough to merge NI with income tax please. The administrative saving will be significant as should be obvious!
There is of course also the question of employer’s NI to consider. I do not attempt to tackle this her and assume it would continue at approximately current rates but it is also deserving of careful consideration. In reality it too could be considered as a (slightly hidden) tax on the income of the employed individuals rather than a tax on employers (many ways of viewing this), but trying to consider too much at once is maybe not a good idea so I will leave this alone for now.
In summary
This note is a plea for the principle that tax on income should be progressive and that politicians should resist the temptation to tamper with it in any way that endangers or damages that principle. Put simply .. if I have a higher income than you then I should pay more tax than you, and my marginal rate should never be less than yours.