There has been a long running debate on the how to reduce the tax burden on the poorest in society whist not give too much away to the rich. Both sides of this argument (increase allowances or reduce rates) are unable to resolve the conundrum that the rich benefit more from these changes than the poor.
John Kay in the FT explains the problem of margin tax rates at or around the £10,000 earning mark.
Suppose the starting rate of tax is 20 per cent and is payable on all income over £10,000. Now compare two policies. Either raise the tax threshold to £11,000, or introduce a lower rate of tax of 10 per cent on the first £2,000 of taxable income. Both these changes are worth £200 a year to anyone who earns more than £12,000, and the reduced rate halves the tax bill of those who earn between £10,000 and £12,000.
But the higher threshold eliminates completely the tax liability of everyone earning between £10,000 and £11,000 and reduces the tax liability of everyone between £11,000 and £12,000 by more than half. A higher personal allowance is always a better way of spending money on helping the low paid than a lower initial rate.
What Mr Kay doesn't model is that better off taxpayers receive the £200 benefit of the raised allowance or reduced rates and this is why cutting tax for the very poor is so expensive.
The simple innovation I have in mind is variable allowances. The poorly paid should not pay any tax the better off should have a tax free allowance that reflects there total income. By simplify the tax system to link total earnings to variable allowances and simple flat rates of tax we can raise the tax take and solve the marginal tax rate issue. My model looks like this:
|Taxable income||tax free allowance||flat rate tax %||Top rate on all income over 115 k||total tax paid||actual rate of tax|
This has the benefit of making the calculation simple and removing the marginal tax rate issues also mentioned in Mr Kay excellent article.