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Level paying field

What are the arguments in favour of a flat rate of income tax and how likely is it to be adopted in the UK?

Given the significant – albeit slowing – growth in property values and the Chancellor’s well-publicised need for funds as a result of lower than predicted economic growth, you could be forgiven for thinking that flat tax was another land or property-based revenue-raising exercise.

With the significant redevelopment of many of this country’s watersides and docklands, the yields to the Government from such a tax might be pretty attractive – although, if liability were based on the properties being occupied by their owners, or, in the case of some of the many developments along the Thames both east and west of London, even occupied, then the tax yield might not be so impressive.

The goods news for the owners of this type of property is that flat tax is something altogether different. Flat tax (a single rate) is now a reality for many Eastern European countries and Ireland is introducing a flat tax for companies.

The Adam Smith Institute recently published a briefing paper on the subject and what follows are what I believe to be the key extracts from the paper. It should be noted that these are extracts from the paper prepared by the Adam Smith Institute and do not necessarily represent the views of Technical Connection or myself. Their publication is, I believe, justified by the fact that there has been a reasonable amount of publicity on the idea of a flat tax and it is the Adam Smith Institute’s document that appears to have been the main catalyst for the latest debate in the UK. So here goes – everything in quotes is from the Adam Smith Institute.

“The flat tax is therefore no longer a theoretical concept or one confined to specific ‘tax havens’. It is on the UK’s doorstep and our competitors are enjoying a more benign tax climate than we are. Concern about tax, particularly among those starting their career, is rising. In a recent survey of 18 to 22-year-olds, the high levels of tax was their biggest worry, cited by 81 per cent (above war, the environment and tuition fees). There is clearly, therefore, a real current concern, both with business and individuals, international and domestic, with the UK’s tax system.

“The concept of a flat tax can be made to cover a wide range of different tax systems but the fundamental principle is that income should be taxed at a single rate of tax for all taxpayers. “In practice, there are additional aspects that are common to most flat-rate tax proposals and flow from this basic principle:

“A low rate of tax. Theoretically, we could calculate an average rate of tax under the current multi-rate system and charge everyone this rate under the flat tax. However, this would result in taxpayers (particularly the lower earners) paying more tax. In practice, therefore, most flat-rate tax systems propose a single rate roughly the same as, or lower than, the existing standard rate. This means that no one will pay more tax on the transition to a flat tax.”Remove most tax allowances and deductions. One of the advantages of the flat rate is its simplicity, in that taxpayers and collectors only have to use one rate of tax in their calculations. This simplicity is commonly extended by removing most of the specific tax deductions within the existing system that try to give allowances for specific circumstances or incentives for particular activities. In part, this removal of allowances is practical because, once a single low flat rate is introduced, they become less important.”Greatly increased personal allowance. The personal allowance is the basic amount that each taxpayer is allowed to earn free of tax. Most flat tax proposals involve a significant increase in this amount, primarily to ensure that all low earners are better off under the flat tax system (in many cases by being taken out of the tax net altogether), even after abolishing many of the specific allowances.

“Obviously, a flat tax will reduce the overall tax take, at least initially, unless it is set at the current average rate (in which case, many taxpayers would pay more under the reforms than they do currently). Certainly, raising the personal allowance significantly will also result in a substantial loss of tax revenue. But how much?

“The cost of abolishing higher-rate tax is also much lower than many would expect. The actual revenue loss would be lower, due to decreased tax avoidance. Also, these revenue reductions should not result in an equal increase in public sector borrowing, as the greater incentives to work should reduce benefit payments.

“In addition, numerous studies show that reducing taxes causes the economy to grow faster than it would otherwise, resulting in increased wealth for the population and (in time) increased tax revenues. As an estimate, this increased economic growth means that tax revenues will recover in just over three years.”

Whether such a recovery would take place and at what speed is one of the great unknowns. The current Government seems unwilling to take the risk of shortfall over an extended period.

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