What would you do to reform the UK tax system?

27th March 2012

Mindful Money asks – What should really be done to reform the UK tax system?

The Chancellor of the Exchequer announced last Wednesday that as of April 2013 the 50p income tax rate would be reduced to 45p. He risked controversy when he announced that the higher rate for 320,000 people earning over £150,000 a year will be phased out.

Ed Miliband attacked the removal of the higher tax rate. He said in the Daily Telegraph: "What we need today is action to get jobs and growth moving in this country, he said.

"What the Chancellor must do is ensure that every penny he can raise from those at the top is spent on helping millions of ordinary families who are struggling to get by."

However, removing the higher rate was backed by former Chancellor Lord Lawson who said removing it would be good for the economy. He told Radio 4's Today programme: "It will be good for the economy. He [the Chancellor] has already said of course he regards the 50p tax, which the previous Labour government introduced, as temporary. If it really is temporary, now is the time to remove that."

Alternatively, Shaun Richards, Mindful Money's economist blogger, says on his blog that the Chancellor's plan is "flawed" with a "lack of logic".

He says: "My contention is that the highest economic effect in terms of improved efficiency and incentive to work comes from reducing the highest effective tax rates on income and then working ones way down that list.

"Just because we have a tax called income tax it does not mean that this is the only tax on income – we also have what is called National Insurance. This is often ignored in the debate but is a tax on income for both the employed and self-employed and goes into the central government pot. There is a myth that National Insurance pays for the National Health Service and state pensions – but it no more does so than income tax.

In fact, he points out on his blog: "If we do this we see that rather than the 0%, 20%,40%,50%  of popular imagination the situation is quite different. If we now add in national insurance contributions for employees we come to a different conclusion. Taxes on employed income in the UK go 0%, 32%, 42%,62%,42% and 52% which is really quite different."

MickC 2 comments on the post: "The UK tax system is an absolute mess-but none of our rulers dare tackle it because we would then see how much we really pay.

"Obviously NI (as you say, just another tax) should be merged with income tax. In my view no-one should pay tax on income less than £15k. I would then have a flat tax at such rate as is necessary to pay for the services the electorate decided should be provided by the state -hopefully these would be minimal, but that would be the voters choice.

"The accumulation of capital would be encouraged (no IHT) so people could look after themselves as much as possible. Those who could not do so (and I think on £15k many could) would get state assistance. The capital accumulated could be invested in capital projects in the UK to provide a return."

Rods adds: "Although the tax burden is still around the 1950's average of 38%, there is a big difference, where then the biggest budget was defence and now it is the social security budget.

"One of the big problems is that the funding of the social security budget and the scale of benefits means that if you are working with no family (so no benefits) on an average wage of £25k pa, then employer and employee NI, income tax, VAT, fuel tax, council tax and TV tax then around 50% of your economic activity is going in tax. I include employer NI as it is your economic activity that has to pay for it in a private company and a portion of business rates should also be added to this."

On the range of tax measures introduced in the Budget, including raising the personal allowance for average earners, among others, Simon Ward, chief economist at Henderson and Mindful Money blogger, says: "The aim should be to reduce marginal – not average – rates for the maximum possible number of taxpayers to boost incentives to work, save and invest."

He says: "It is possible to lower marginal rates without losing revenue (i.e. without cutting average rates) by reducing reliefs and increasing wealth taxes (not stamp duty, which is a transactions tax).

"The government has made minimal net progress in this area. Raising the personal allowance cuts marginal rates for relatively few but gives away a lot of cash to basic rate taxpayers. It would be better to cut the basic rate IMO. The cut in the top rate similarly affects few. The Budget, meanwhile, lowered the basic rate limit, drawing more taxpayers into the 40% band. Marginal rates, moreover, soar at the points where child benefit and the personal allowance is withdrawn.

"The Budget may actually have raised marginal rates for more taxpayers than enjoyed a reduction – quite an achievement for a Chancellor claiming to be a tax reformer!"

Tony Levene, author of the Which? Guide to Tax adds:

The biggest anomaly is the interplay between income tax and national insurance (NI). This gives an effective 32% tax rate (20% income tax and 12% NI) ) for most basic rate taxpayers rather than the 20% headline rate.

There are many examples of the unfairness of these two taxes, especially to those on average or lower earnings. There is now little that is based on NI contributions. The government announced a consultation last year on merging the two taxes and re-announced it in the budget. But Treasury insiders say little has been achieved and the project may be frozen.  Ministers know that any change will bring winners and losers and they would rather the status quo than scare or anger the electorate.

Older people could be the biggest losers of an amalgamation. Currently, anyone over state pension age pays no NI while there is no NI on investment and savings income. 

Mindful Money would like to hear what you think should be done to reform the UK tax system.


More on Mindful Money

Budget 2012: Winners and Losers

Everything you need to know about the UK Budget

The Budget: The view for investors

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