Flatter taxes could help people on low incomes.
‘Flat taxes’ have often been seen as a means of reducing the tax burden on people with higher incomes who pay top-rate tax. However, in Britain, the most severe losses to the taxman from additional earnings are encountered by families on lower incomes: these stand to gain the most from a ‘flattening’ of income tax rates. This is explained in a paper by the Joseph Rowntree Foundation’s special adviser, Donald Hirsch, based on calculations by researchers from the Institute for Fiscal Studies of what a flat tax system might involve.
By historic standards, the main income tax and National Insurance (NI) rates are already quite ‘flat’. Most people on basic rate tax pay a total 33% in the pound in tax plus NI, while those on the higher rate pay 41%. But the paper points out that over 3 million people in families on low incomes lose over 50% of any additions to their earnings, when the loss of tax credits is taken into account.
The paper imagines a flat tax system, under which:
- a single rate of tax is imposed on individuals for all income above a tax-free allowance similar to today’s; and
- tax credits are paid to families based on their composition and working hours and not withdrawn according to income.
Under such a system, the basic rate of tax would have to rise from 22% to 37%, largely in order to recoup the money paid out in tax credits. If the cap on National Insurance contributions were lifted to create a flat-rate NI system, higher earners would pay more, so a slightly lower tax rate of 35% would be needed.
Many people on modest incomes (a bit below average) would end up better off, in particular those with children. This would build on the strategy of reducing child poverty, supported by JRF, by making it easier for such families to achieve reasonable living standards. The biggest losers would be higher earners without children, with the highest-paid tenth losing 6-8% of income.
Donald Hirsch commented:
“This paper is not advocating a flat tax, but pointing out that a true flattening of effective tax rates may not have the results that some advocates envisage. It draws attention to the fact that while the tax credit system makes a positive contribution to relieving poverty, it can trap families on just-adequate incomes, making it very hard for them to raise their living standards.
“An alternative system, which stopped means-testing tax credits but instead had a higher general tax rate, has some attractions. One is that it would enable the government to give support to low income families and to combat child poverty, while avoiding the complexities and administrative nightmares of the present system.”
