David Cameron has been praising the Latvian tax system, calling it ‘attractive-sounding’ during a speech at the Northern Future Forum Conference in Riga. But one study by the IFS, looking at four plausible and revenue neutral flat tax scenarios, found two main reasons why flat taxes might not be as attractive as they sound.
Spencer Thompson is an economic analyst at the IPPR
According to a story in yesterday’s Telegraph, David Cameron has been praising the Latvian tax system, calling it ‘attractive-sounding’ during a speech at the Northern Future Forum Conference in Riga.
In particular, he singled out the Latvian 24% flat rate of tax as a potential alternative to the UK’s progressive-style income tax.
Is he planning something similar? Who would gain or lose from a flat rate of tax in the UK?
Well, it depends a lot on how the tax is designed, as well as the way it interacts with other aspects of the tax and benefit system, including VAT and tax credits.
But one study by the IFS, looking at four plausible and revenue neutral flat tax scenarios, found two main reasons why flat taxes might not be as attractive as they sound:
1) Flat taxes are regressive: In order to pay to lower tax rates for higher earners you have to increase the tax rate on lower income individuals. Therefore, compared to a progressive system of taxation, flat taxes are more regressive, hitting the poorer hardest as a proportion of their income.
2) Flat taxes weaken the work incentives of lower-income individuals: By increasing the tax rate for those at lower incomes, a revenue neutral flat tax would decrease the benefit to the poorest of moving into work or increasing their hours, hard to square with the Coalition’s welfare to work agenda.
In all likelihood, any government introducing such a tax in the UK would at the same time increase the level of benefits paid through tax credits to lower-income households, meaning their losses would be contained while the gain to those on higher-incomes would be preserved.
This makes the change more expensive, however, or requires a higher flat tax rate, limiting the effects of the reform.
But proponents of flat taxes often argue that they increase tax revenue, by improving the work incentives for higher earners. As their tax rate would be lower under such a system, the argument goes, they would be encouraged to work more and increase their incomes, paying more tax but at a lower rate.
One country often used as an example in this regard is Russia, where the introduction of a flat tax in 2001 was followed by an increase of 26 per cent in the revenue from personal income tax.
The ever-reliable IFS have crunched the numbers, however, and they found that very little of the revenue rise was attributable to the reform, with the majority of extra revenue caused by better performance of the economy as a whole, and more interestingly by those households and families little affected by the change.
While Cameron’s comments can hardly be construed as a firm policy commitment, it may indicate that the Conservatives are trying to sketch out a future position on personal tax reform.
With Labour adopting the largely symbolic 10p tax, and the Lib Dems committed to the worthy but extremely expensive goal of increasing the personal allowance ever higher, perhaps the flat tax will be the Conservatives own distinctive, if flawed, big tax idea.
18 Responses to “Cameron praises flat taxes – but are they fair?”
Newsbot9
Yes, of course you want your “lifestyle” respected. Your leeching off unearned income and corporate welfare. Socialism for your rich, and meanwhile corporatism for the poor – if they can’t find jobs in an environment where there are none, you want to kill them off.
Keep on arguing strongly for raising the benefit bill, as you are, in this case. So you can then throw them out of any accommodation. And keep thinking that “simply” starving tens of millions, while having to RAISE tax to pay for that, is a sensible approach.
Newsbot9
Still using those incorrect figures for tax? This isn’t the 1980’s!
And yes, that is indeed your argument here, that the poor pay far too little for tax, or the services to directly replace services paid for via tax. Raising a threshold which most of the poor are already under…and thus raising the poverty premium to pay for this, socialising your costs…
Ash
Actually, I’d be delighted to see the net income tax burden on minimum wage earners reduced to zero. That would be simple enough to achieve – you’d just return £500 or so to each of them in the form of tax credits. Then you could taper that for higher earners, so that the effective marginal income tax rate rose from 0% at minimum wage level to 20% at, say, £20,000. That’s a far more progressive option than raising the personal allowance to £12,000 for everyone. And far cheaper too; in fact you’d have bags of money left over to reduce the net tax burden from VAT, NI etc. on people whose income was below the income tax threshold – pensioners and part-time workers, for instance – via more generous benefits and tax credits.
At a guess, though, you’d dogmatically and vehemently oppose all such moves to reduce the net tax burden on low earners on the basis that they involve lots of wasteful spending. Also at a guess, and by pure coincidence of course, the sort of tax-cutting measures you *would* endorse (such as raising the personal allowance) would involve bigger cuts going to higher income households.
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A flat tax rate has been a UKIP policy for years he is clearly out of ideas
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Mark Moore
So is a situation only ‘fair’ if it results in the less well off getting more money, or the better well off less money, in the immediate future? If that’s what ‘fair’ is then reductio ad absurdum is so simple it’s not even worth covering it.
With regards the Russia situation, is the IFS saying that the better performance of the economy as a whole was in no way linked to the introduction of a flat tax? One of the key arguments for flat taxes is that simpler taxes remove lots of the perverse incentives present in more complicated tax systems, thus leading to more money to be spent productively (e.g. because you are not encouraged by an artificial ceiling to limit what you put in to your best performing investments).
What we need to be looking at is whether our current progressive tax system is leading to malinvestment that causes our economy to grow slower. I don’t want to go into the idea of ‘self-financing’ tax changes, but if simpler taxes lead to an increase in productive, sustainable investment then that is good for everyone, rich and poor.