Wednesday, 20 February 2013

Taxing question

The Tories have been focusing their efforts for the low paid on increasing the tax free allowance - increasing the amount of money we all earn before income tax starts being deducted.  As well as these changes Osborne has introduced literally hundreds of other tax changes which drive up complexity and accidentally  drive down the tax take.  Labour's Ed Miliband is proposing to reduce the initial rate of income tax for earnings below £10,000 to 10%.  This lower tax rate was scrapped by Gordon Brown (Ed's Mentor) only a few years ago.  It feels to me as if we are spinning in ever decreasing circles!

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
under 15,000           15,000 0.00% 0.00%                    -   0.00%
           25,000           13,500 30.00% 0.00%             3,450 13.80%
           35,000           12,000 30.00% 0.00%             6,900 19.71%
           45,000           10,500 30.00% 0.00%           10,350 23.00%
           55,000             9,000 30.00% 0.00%           13,800 25.09%
           65,000             7,500 30.00% 0.00%           17,250 26.54%
           75,000             6,000 30.00% 0.00%           20,700 27.60%
           85,000             4,500 30.00% 0.00%           24,150 28.41%
           95,000             3,000 30.00% 0.00%           27,600 29.05%
         105,000             1,500 30.00% 0.00%           31,050 29.57%
         115,000                    -   30.00% 0.00%           34,500 30.00%
         125,000                      30.00% 20.00%           39,500 31.60%
         135,000                    -   30.00% 20.00%           44,500 32.96%
         145,000                    -   30.00% 20.00%           49,500 34.14%
         155,000                    -   30.00% 20.00%           54,500 35.16%

This has the benefit of making the calculation simple and removing the marginal tax rate issues also mentioned in Mr Kay excellent article.

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