Poor tax design creates inefficiency and unfairness but it is possible to correct the flawsby Helen Miller / April 9, 2019 / Leave a comment
We spend much more time talking about the specific ways in which the government spends money than about how revenues are raised in the first place. This is somewhat surprising given that annual tax revenues are around £740bn—that’s 35 per cent of national income.
As pressures continue to grow on public services, including as a result of an ageing population that demands more and more expensive health and social care, we may see more discussion about the size of the state. But how we raise tax can be just an important as how much we raise. Governments use the structure of taxes to redistribute incomes and to manipulate behaviours, thereby shaping the kind of economy and society we have.
The majority of tax revenue (63 per cent) comes from just three taxes: income tax, National Insurance Contributions and VAT. This has been true for decades, is true across most developed economies and will likely remain true in future. But even considering the source of revenue can mask many important choices about which people and activities are actually being taxed. For example, while income tax provides the same share of revenues today as in 1990, the share paid by the top 1 per cent of income taxpayers has almost doubled (from 15 per cent to 28 per cent). This resulted largely from growing inequality (which changes the tax base), and is despite cuts in the top rate of income tax.
Considering the details of tax design is necessary for evaluating whether various political goals are being achieved. It also reveals that our tax system distorts choices by much more than is necessary to achieve political objectives. Poor tax design is a problem for efficiency—the costs imposed by taxes are significantly higher than they need to be—and equity.
For example, a job generating £40,000 of income will attract over £3,500 less in tax each year if the job is done by a self-employed person rather than an employee; taxes are even lower if the person operates through their own company. More broadly, people working for their own business get large tax breaks relative to employees that are based purely on the legal form in which work is undertaken—they do not reflect differences in access to government benefits. It is hard to argue this is fair. Lower taxes are…