The UK has a labyrinthine tax system. Much of the responsibility for this lies with the last Labour government. In 13 years, Labour burdened British citizens and British businesses with more than 5,000 pages of new tax rules and regulations. The result: our tax code has more than doubled in size since 1997, recently surpassing India’s to become the largest in the world.
An entire industry has been created to deal with discovering loopholes in this country’s complicated network of taxation. The TUC claims that tax avoidance costs the Treasury £13 billion per year in lost tax from individuals, and £12 billion per year in unpaid tax from businesses. This dwarfs the estimated £1 billion a year lost as a result of benefit fraud.
With the Coalition Government being forced to make tough choices about public spending in order to reduce the deficit, considerable attention has been paid to how the government spends taxpayers’ money. However, we also need radical reform and simplification of the ways in which the government raises taxes in the first place.
Flat Tax: The Ultimate Simplification
If we really want to achieve simplicity in taxation, we should implement a flat rate of taxation for both personal and corporate income, while concurrently eliminating the complicated system of loopholes, deductions, and exemptions.
This flat tax system would:
• Reduce the level of tax avoidance and evasion;
• Eliminate disincentives for entrepreneurs and small businesses;
• Encourage multinational businesses to locate in Britain; and
• Significantly trim administration costs
This is how it would work. A flat rate taxation policy involves setting a single rate of income and corporation tax, which is usually lower than most existing income tax rates. Logically this should reduce the government’s tax take, but in practice it increases it. This is because the flat tax would lead to a substantial reduction in tax avoidance. Tax exemptions, deductions and allowances would be abolished, and with the lower rates businesses and high net worth individuals would find it was cheaper to pay the tax than their financial advisers. This means that more money becomes taxable income.
Furthermore, a low rate flat tax system would stimulate growth and productivity. Since businesses would no longer find themselves paying higher tax rates simply for becoming more profitable, there would be a real incentive for businesses to expand. This would generate more wealth, create extra jobs, and boost economic growth. Already overburdened with excessive employment regulation and red tape, the complexity of our tax system acts as a further discouragement to small businesses and potential entrepreneurs who can find it intimidating, expensive and oppressive to manage.
Critics of the flat tax rate say it is unfair to ask the lowest paid in society to pay the same tax rate as the wealthiest. When Gordon Brown, the man responsible for saddling Britain with the world’s longest tax code, was asked about the flat tax he dismissed it out of hand for exactly this reason. But, as with so many fiscal issues, Brown had completely missed the point. A new flat tax system would include an exemption (similar to the personal allowance that exists now) which would ensure that those on low incomes paid either very little tax or none at all.
Lastly, a flat tax would save money because it would be cheaper to administer. With exemptions, deductions, and allowances abolished, a flat tax system would require fewer state officials to implement and enforce it than our current tax regime. The authorities would no longer need extensive and detailed financial information about individuals and businesses to calculate their tax liabilities – just their annual income. This would end the requirement for lengthy and complex tax returns. Back in 2008 the House of Commons Public Accounts Committee estimated that every year HMRC spends £55 million answering more than 12 million enquires from taxpayers dumbfounded by their tax forms. This needs to be addressed through tax reform.
Critics say the benefits of a flat tax system are more theoretical than real, but The Economist claimed in 2005 that the flat tax “seems to be working as well in practice as it does on the blackboard”.
Nine countries in eastern Europe have introduced flat rates of personal income tax alongside similar rates of corporate tax. Slovakia is one of these countries. The simplicity of Slovakia’s tax system has, The Economist says, “helped to spur foreign investment and economic growth, actually leading to a slight increase in tax revenues.”
But the flat tax is not just for small, emerging markets. The hyper-capitalist state of Hong Kong has employed the flat tax for decades. There are growing calls for a flat tax system in the US too. Although the USA’s Federal income tax is currently a ‘progressive’ one, seven states, ranging from traditionally Democratic Massachusetts to staunchly Republican Utah, have adopted a flat state income tax.
Russia, the biggest country on the face of the planet, adopted the flat tax in 2001. The effect was instant and remarkable. Russian income tax revenues rose by a quarter in the first year after the flat tax rate was introduced, and by another quarter in the second year. Economic experts attributed this surge in revenues to the flat tax, which made it easier for the Russian government to administer tax, eliminated loopholes, and made it easier for citizens to comply with their tax obligations.
Flat Tax: The Figures
If we in Britain implemented a flat tax rate of 22% with a £15,000 allowance, it would result in a one-year reduction of tax revenue of £63 billion. However, the Taxpayers Alliance identified £81 billion in potential savings from closing loopholes and the elimination of deductions and allowances – an estimated £18bn increase in Treasury revenues.
The government’s planned clampdown on tax avoidance hopes to raise £4 billion over the course of four years , while the Treasury estimates the spending cuts as a whole will amass to £6.2 billion. The government is right to tackle tax avoidance, but it is a task that would be made far easier, and bring in more revenue, if Britain had a simpler, less avoidable, and more easily administered flat tax system.
Flat Tax: Fairness
The Institute for Fiscal Studies estimates the average household will lose £750 this year as a result of higher taxes. What is more, our current, so-called “progressive” income-based tax system is actually structurally biased against those on lower incomes, who do not have access, as some wealthy individuals do, to a team of accountants, financial advisers, asset managers and private client lawyers who can instruct them in the complex methods of tax avoidance and offshore tax evasion.
A flat tax would remove the opportunities and need for the wealthy to use complex tax avoidance schemes. Properly implemented, a lower, flat rate of tax would cut the proportion of their income that the wealthiest in society paid in tax, but encourage them to pay tax on more of their income, thereby increasing the total amount of tax the wealthy pay. This is not mere conjecture – it is tried and tested. Almost every time the top rate of income tax has been significantly reduced, the wealthy have increased the proportion of tax revenue they contribute.
For instance, under the Thatcher government, the top rate of income tax was reduced from an outrageously punitive 83% in 1979, to the current level of 40% in 1990. The result; higher rate earners handed over a much lower percentage of their income to the taxman, but paid tax on far more of their income. Consequently, high-earning individuals who had paid 35% share of total tax revenues in 1979, at the end of Callaghan’s premiership, were paying 42% of tax by the time John Major became Prime Minister in 1990.
It is not just in Britain that lower taxes have boosted tax revenues and increased the proportion of the tax bill paid by the wealthy. Similar results are found for three major periods of tax cuts in the United States (1921-26, 1964, and 1981-84). The latter period of tax cuts, during Ronald Reagan’s administration, led to increased tax revenue. A report of the Joint Economic Committee of the United States Congress found that, during Reagan’s two terms, the wealthiest 10% of taxpayers paid a larger share of the Federal government’s tax revenue, while the lowest 50% of earners paid a smaller share of the national tax burden.
So clearly reducing taxation as a whole would shift the tax balance away from low-income earners towards the more well-off.
But if we went further and introduced a flat tax, around 10 million of the lowest paid current taxpayers would see their entire income tax bill disappear. This would help some of the lowest earners in society and provide strong incentives for those on welfare to try and find work. Labour created a flawed welfare system which left thousands of individuals and families with little incentive to get off benefits and go out to work. “The best long-term help and security for the poor,” the Adam Smith Institute suggests, “is for them to get well-paid jobs in a growing economy. Keeping millions on benefits only really helps those politicians who want to keep their voters dependent.”A flat tax system structured so that the lowest earners paid no tax at all would make work pay. That would be a truly progressive tax system.
A country’s tax system has a huge impact on its citizens, businesses and economic prospects. Britain needs an efficient, modern tax system and competitive tax rates that maximise our potential as our economy recovers from the worst recession in 60 years. First, a new tax system should be far tougher to avoid than our current regime. Second, it should be able to be easily and cheaply administered by HMRC. Third, it should be clearly understood by ordinary taxpayers. Fourth, it should not only impose minimal administrative burdens on British businesses, it should both encourage those businesses to expand and multinational companies to locate in Britain.
In our hyper-globalised world, it is only two easy for mega-corporations to up sticks and shift their operations abroad. A flat tax rate, however, would make Britain more internationally competitive, attracting wealthy foreigners, both as private individuals and as company executives. The flat tax is a potential game-changer in the international arena.
The Government is rightly focused on tackling the enormous deficit left to this government by the previous Labour administration. However, in doing so it should not ignore the opportunities presented by reform of the tax system. When addressing Britain’s economic problems, we in the Conservative Party should view tax reform not as a side issue but as part of the solution. The government should urgently consider introducing a flat rate of taxation to stimulate foreign direct investment, increase domestic productivity, raise the Treasury’s tax revenues, and allow businesses to expand, create jobs and provide the economic growth that is central to Britain’s economic recovery.