Wednesday, 13 January 2010

Taxation

Labour's approach to taxation stinks.

Taxation generally has 3 purposes:

  • Revenue - to raise money to fund public services;
  • Repricing - to discourage or limit use of goods or services, e.g. tobacco;
  • Redistribution - to redistribute wealth from the rich to the poor.

There is no doubt that Labour have succeeded in accomplishing the first of these aims. They do spend money on public services. Like it's going out of fashion, in fact. Whether such expenditure is efficient or necessary is another matter.

They certainly go for that second aim. Duties on tobacco, alcohol and fuel are very high. Higher, I suspect, than they've ever been. Although, has it actually resulted in less consumption? Perhaps not.

My beef is with Aim No. 3 - redistribution, which to me epitomises the entire point of taxation. To limit the effect of the rich getting richer and the poor getting poorer. The whole principle of taxation is that it is based on ability to pay. Those who can afford to pay more, do so, because they will miss the money less than others.

Therefore, it is reasonable to say that the fairest method of taxation is direct taxation, like Income Tax and National Insurance, which, to use a ghastly phrase, are means-tested. Forms of indirect taxation, such as VAT, Council Tax and Road Tax, are not based on your ability to pay, and as such, are inherently unfair.

People on lower incomes pay less Income Tax & National Insurance. But do they pay less in indirect taxation?

The short answer is no.

So we have a ridiculous and contemptible situation where the poorest in society actually pay a higher proportion of their income in tax than the richest.

Labour have actually done something about this, probably out of desperation rather than any sense of social responsibility, by adding a super tax band of 50% to Income Tax. However, this doesn't really address the fact that poor people are paying too much, it just makes the rich pay more.

The most intelligent policy thus far has come from the Lib Dems - who suggest raising the Income Tax personal allowance to £10,000, lifting the lowest earners out of the tax system altogether. This would be funded by an increase in the rate of Capital Gains Tax from 18% to 20%, and a reduction in the Capital Gains Tax personal allowance from £10,200 to £2,000.

This is the best plan so far, unmatched by either Labour or the Conservatives.

Labour's plan to address this problem is Gordo's great invention, the tax credits system, where people on low incomes have that income supplemented by benefits payments. Personally, I question the logic of this system: if someone's income is so low that it needs to be subsidised by State benefits, why tax them in the first place?!

The tax credits system is complicated, expensive, and an administrative nightmare.

The Conservatives? They plan to cut tax credits to those being paid over £50,000, abolish Child Trust Funds, and freeze Council Tax. They also plan to raise the Inheritance Tax threshold, bring back the married couple's allowance for Income Tax, abolish Stamp Duty for first time buyers, and cut Corporation Tax.

Now, I am all for cutting tax. For any reason, and wherever possible. However, the Conservative plans strike me as muddled and confused. Raising the Inheritance Tax threshold, whilst admirable in principle, will only benefit people with estates worth between £325,000 and £1m. Not exactly addressing the redistribution problem, is it?

Bringing back the married couples allowance, to honour marriage in the tax system, is also an admirable goal. Until you look at who it would affect. Married people tend to earn more. Not exactly addressing the redistribution problem, is it?

It astonishes me that it hasn't occurred to any of the mainstream political parties to adopt a more radical approach, like:
  1. Merging Income Tax and National Insurance. They're both levied on the same people, so the collection of both might as well be streamlined. A large proportion of the National Insurance Contributions Office at HMRC could be closed, making significant administrative savings;
  2. Adopting the Lib Dem policy. Cutting Income Tax for the lowest paid by increasing Capital Gains Tax strikes me as inherently fair - low earners don't tend to use their Capital Gains Tax allowance. They could even adjust the higher rate Income Tax threshold to ensure that the cut doesn't benefit higher rate taxpayers;
  3. Consolidate all taxes on purchases into VAT, e.g. duties on fuel, tobacco and alcohol. Again, this would simplify the administration and collection of these taxes - we already administer different rates of VAT. This would lead to further administrative savings at HMRC;
  4. Abolish Road Tax and increase VAT on fuel. Road Tax is unfair - someone who has low mileage has to pay a comparable amount towards road maintenance and environmental protection as someone with high mileage. Having it all on fuel means that people who use the roads, pay for them;
  5. Abolish Council Tax and increase Income Tax. Council Tax is unfair - the size of someone's house doesn't necessarily have anything to do with their ability to pay. In addition, most of local government funding still comes from Whitehall anyway, so what's the point in it?
Under my suggestions, people who earn more would pay more, which is fairer. However, the caveat to this is - when taxes are cut, the highest taxes should be cut first. If you're going to expect the rich to pay more, they should be the first to benefit when taxes are cut.

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