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Would you Adam and Eve it?

Proposals for the introduction of a flat tax in the UK have had a mixed reception

Last week I looked at the subject of flat tax and the proposals for its introduc- tion made by the Adam Smith Institute. I closed with a statement that the current Government appears to be distinctly unenthusiastic to seriously consider introducing a flat tax in the UK.

The Adam Smith Institute believes that the initial shortfall in revenues would be made up by increased tax from greater economic activity and growth within three years. And that’s the bet – that flat tax would more than make up for lower nominal tax by increased overall tax yield driven by greater business activity.

As a result of the more economically conducive environment that flat tax could bring about, in the view of the Adam Smith Institute:

“The country would also benefit by attracting more wealthy foreigners, both as private individuals and (more important) as company executives. These, by moving their spending and business to the UK, would create wealth and jobs (and pay taxes) that would otherwise not have come here.

“Part of the flat tax proposal should be the abolition of various existing tax allowances, both to recoup some of the revenue loss and (most important) to reduce complexities and eliminate distortions.

“The main (non-business) allowances, and the amount by which they reduce the tax take, are given below. These do not include the tax reliefs given to charities (roughly 1bn), personal pensions (roughly 13bn, reform of which would need to be discussed in the wider context of pension reform) and owner-occupied housing (12bn and politically difficult to change).

“With the personal allowance raised to 12,000, all these reliefs could be abolished and still leave everyone paying less (or at least no more) tax.

“A flat rate tax of 22 per cent, with a tax-free personal allowance of 12,000, is possible. The initial loss of Government revenue would be roughly 50bn per year, under 5 per cent of GDP. When you take into account the potential 12bn of savings from abolishing minor tax reliefs, this comes to roughly the 35bn of administrative waste identified by the James review. Even the 20,000 personal allowance is affordable if the 81bn of savings identified by the Taxpayers’ Alliance could be realised.”

So, having considered what the Adam Smith Institute has to say, what is the likelihood of a flat tax being introduced in the UK?

Well, despite apparent lack of Government enthusiasm for a flat tax (all Governments have traditionally used various tax reliefs and tax breaks to influence behaviour), the increasing adoption of flat tax cannot be ignored. Perhaps one of the strongest influencing factors will be if the UK notices demonstrable loss of revenue/ fiscal competitiveness when compared with other jurisdictions which are adopting a flat tax basis. With increased globalisation, the comparative ease with which businesses can relocate to low tax/tax-attractive locations cannot be underestimated.

To make the numbers work initially, though, reduced tax revenues must be compensated by administrative savings and, over time, by increased business activity, otherwise spending plans will have to be cut. Recent scepticism regarding the speed with which this compensation can be secured has been strongly expressed. As with all projections, a careful analysis of the respective assumptions is necessary in order to det- ermine who has the more tenable point of view.

Recently, the right wing think-tank, the Centre for Policy Studies, has stated that, in its view, the introduction of a flat tax:

l Could cause immediate and potentially huge shortfalls that could destroy confidence in the economy.

l Would not of itself solve the problem of complexity andl Should not take place. Instead, we should look to the introduction of two rates for individuals – 20 and 40 per cent, and a single 20 per cent rate for companies.

Flat tax clearly has the capacity to strongly polarise views, as the extracts from the Adam Smith Institute document have proved. Especially given the recently stated New Labour ambitions for reform and change in many key areas, including health and education, it may well be that the introduction of a flat tax in the UK is unlikely to be on the immediate agenda of the Government.

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