Tax and the Family – farewell
Tax and the Family is having to close as two of its major contributors, Don Draper and Leonard Beighton, are well into their 90s and so far have not found any successors. Anyone interested in pursuing the work, please get in touch.
This farewell piece by Leonard Beighton looks briefly at where the tax/benefit system is today and how the many issues it faces might be tackled.
The issues
The current tax/benefit system is riddled with disincentives and unfairness. To give a few examples:
The combined impact of the withdrawal of universal credit and income tax and national insurance contributions leads to a marginal deduction rate of 72% or more, If you are repaying student debt, there will be a further 9%. If you have several children and live in a high rental area such as parts of London and Edinburgh, you may well be entitled to universal credit at an income of £60,000 or more when you will be liable to the High Income Child Benefit Charge so that your marginal deduction rate could be a further 20% or so. Is it any wonder that for some people the question is ‘why work?’ especially if they may face additional costs such as more formal clothes and travelling to work as well as a loss of freedom of time to do whatever they like? This may well have contributed to the significant reduction in labour market participation since the pandemic.
Above the figure of £100,000 the income tax personal allowance is withdrawn at the rate of £1 for every £2 of additional income. This means that the marginal rate is in effect 60% up to £125,000 when it drops to the additional rate of 45%, plus 2% NIC throughout. As a consequence, if you are earning £99,500 today, you may be better off not seeking to increase your income by, for example, seeking promotion unless you can increase it to at least £125,000 or, as there is also a cut-off of free childcare at £100,000, may be £135,000. It creates a disincentive for some of the most productive taxpayers in the economy to increase the hours they work or the intensity of their effort to work hard; it impedes increased productivity and growth.
For many pensioners the issue is that of fairness. If your income is up to £227 a week if you are single or £346 if you are a couple you will be entitled to pension credit: this can be up to £85 a week depending on your circumstances. In addition you are entitled to a free TV licence, otherwise costing you £174, and free NHS services such as for dentistry. But if your income is £1 over the limit you will not be entitled to pension credit and none of this will be due: as a result you will be quite a lot worse off. When Ministers first introduced restrictions on the winter fuel allowance worth up to £300 a year it would have been given only to those on pension credit and again someone with an income of £1 over the limit would not have qualified. Were Ministers and officials aware that they were adding to the unfairness and thought that it did not matter, or were they not aware of it?
Child poverty
Inequality has been growing since at least the turn of the century. The centre of current debate is child poverty. And so it should be. There are currently 4.5 million children living in poverty (as usually defined which is living in families whose income is less than 60% of the median). Poverty harms children’s health, education, and social and emotional well-being: it affects not only their childhood but also their life when they have grown up.
Very soon after it came to power in July last year, the Government set up a child poverty review. Earlier this year the review made a number of useful, but relatively minor, recommendations such as widening the scope of free school meals. The report is due to be released in full either immediately before or with the Budget on 26 November. The major issue is the two child limit on income related benefits. The cost of removing the cap altogether in the flight of the very considerable political pressure is that there may be some partial easements rather than abolition. Other changes such as increasing the child element in universal credit are also possible.
Although we do not know for certain, there has been no indication that the review has considered the impact of income tax in the equation. Don Draper has produced tables which show how income tax and benefits interact in considering a family’s income. The combination of having a large family and living in a high rental area can lead to children being in poverty in families with a high gross income and therefore paying a large amount of income tax. While removing the two child limit in full, or even in part, would reduce child poverty considerably, the impact that it would have would be moderated in these cases where a high income tax liability remained.
A way ahead
We need a strategy to tackle these issues of disincentives, unfairness and inequality. First, and most important, the impact of tax and of benefits must be looked at together and not, as generally hitherto, in silos. The Treasury has a key role to play in looking at such issues in the round, not least at the impact on labour market incentives and on growth and productivity. It is responsible for strategic tax policy, and for approving changes to the level and design of benefits that affect public spending.
Second all benefits, including benefits in kind, should be taxable. There should be one tax charge applying to all income with no exceptions, reliefs, cut-offs or additional charges. Above the income tax personal allowance there should be a charge starting at a low rate and increasing progressively, may be by steps of 5% at a time or even less. What the personal allowance should be and where the steps in the charge should come, determining how steep it is at any level, cannot be determined now, but the intention would be that it should be revenue neutral and, if possible, the top rate should not be above around 45% because that is where experience suggests that disincentives begin to emerge so that increases in tax rates do not produce much additional revenue. Most difficult perhaps would be the treatment of National Insurance Contributions of both employees and the self-employed which would need to be built into the system, raising issues which have hitherto defied reformers.
Third, the combined income/benefits scheme would be based on the household as are benefits today. There would be separate rate schedules for single people, one earner couples and two earner couples, the difference between the schedules being determined by equivalisation factors which take account of the different costs of the different family circumstances.. The present benefits for children would be combined into child tax allowances: child care allowances could be retained but would be taxable. Likewise pension credit, disability allowances and so on would all be taxable. The use of equivalisation factors to determine the difference between the rate schedules would mean that there would be neither fiscal advantage nor disadvantage for couples to live together in marriage, cohabitation or apart. There would be no need for intrusive questioning on the issue.
Such a major recasting of the tax/benefit system with all its disincentives, injustices and complexities would require a very great deal of consultation, redesign of computer systems, legislation and administrative change over a number of years, although hopefully AI could help considerably. It would create large numbers of winners and losers, with the latter, especially those with special benefits today, shouting the loudest. The transition, which might well require additional funding, would require a Government with a large majority and nerves of steel, but the rewards would be great indeed.
In the meantime the present system is grossly unfair and acts as a significant economic disincentive to increasing productivity and GDP. These faults in the system have become more embedded with decisions taken by successive Governments which may make sense on their own terms but not when seen against the wider economy as a whole. We need to make sure that future decisions do not make the problem even worse and that there are significant improvements to the system as and when the economic situation allows.
Leonard Beighton was a Deputy Chairman of the Board of Inland Revenue; he is an Honorary Fellow of the Chartered Institution of Taxation, and was one of the first members of the Low Incomes Tax Reform Group.