Less means more
Robin Harris argues that flat tax — one rate for everyone, no allowances and nothing to pay on savings — would make us richer and happier
Although taxes, like death, may be inevitable, a complicated tax system is not. So why is Britain content to tolerate one? Fiscal complication arises for different reasons in different countries. But the driving force everywhere is government's desire to raise as much revenue as possible with the least possible resistance. In Britain, the present government has managed to create a jungle of taxes at different rates, levied at differing thresholds, amid an impenetrable thicket of allowances and credits. Meanwhile, the shadow Chancellor Oliver Letwin's own proposals for simplification are even more modest than his plans for reducing public expenditure. Mr Letwin has, for example, dismissed the project of a flat tax as 'nirvana'. This is a mistake.
A flat tax aims at simplicity, transparency and equity. Within limits, it is possible to pick and mix features according to political necessity. But there are three essential aspects of flat tax: a single rate is levied on all individual and business incomes; tax allowances and exemptions are removed; and unfair multiple taxation of savings is ended.
The idea of a flat-rate tax was born in America, But it never grew to maturity there. The most powerful advocate of the project today is Art Laffer, of `Laffer Curve' fame. Mr Laffer is now pressing the new California governor, Arnold Schwarzenegger, to introduce a flat tax as a way of overcoming his state's financial crisis. But although flat taxes have been applied successfully in several US states, they will probably never be so by the federal government. This is because Congress cannot resist tacking on to tax-reform measures a host of provisions to buy off special interests. The Land of the Free is also the land of the pork barrel.
The lands of the newly free are, by contrast, keen to give full expression to the flattax philosophy. In all the ex-communist countries, getting people to pay their taxes is an enormous problem. The populations of these states developed the techniques of evasion to a fine art — none more so than the Russians. Accordingly, President Putin in 2001 introduced a flat tax on personal income of 13 per cent, in place of a previous three-bracket system with a top rate of 30 per cent. It worked. In the first year alone, revenue increased by 28 per cent after adjustment for inflation. The Russian economy has also enjoyed a surge of growth.
Russia was not, though, the first to implement such reform. Flat taxes had already been introduced in Estonia and in Latvia. These and other EU candidate countries saw the simplification and reduction of income and business taxes as crucial to their exploitation of the European market. Indeed, of the ten EU candidates, five now have flat-tax systems and the other five are moving in the same direction. The most recent convert is Slovakia, which last year implemented a flat tax of 19 per cent. Significantly, Samsung, the semi-conductor giant, has since announced that it will make Slovakia the centre of its operations and has cut 800 jobs in Britain and Spain as a result.
By contrast, Western Europe remains wedded to high and complex taxes. Recent French and German tax cuts are extremely modest, but at least testify to a dawning realisation of the dangers. Yet Britain, which continues to live off the legacy of the economic reforms of the 1980s, remains deeply complacent about its marginal tax rates. It has no reason to be. The country's unreformed tax system — featuring rising taxes, with 37 per cent more people paying top-rate income tax since 1997— is at least partly at the root of its poor productivity performance.
When tax rates rise they affect the behaviour, not just the pockets, of taxpayers. That is particularly so when a prospective taxpayer moves into a higher incometax bracket. He may respond in different ways, but all of them adverse. He may choose to work less; or he may prefer to work less productively; or he may move
abroad where taxes are lower; or he may just fiddle. Clearly, any of these decisions at a certain point will reduce the revenue of the government — hence the Laffer Curve. Still more important, they will reduce the prosperity of the country. And indeed recent research studies show both that as tax rates rise the black economy grows too, and that it is countries with low tax rates (or which sharply cut tax rates) that grow fastest.
Equally damaging is that other feature of Britain's tax system, the multiple taxation of savings. This leaves potentially profitable businesses undercapitalised and it encourages people to spend rather than save for retirement, It is therefore a factor in both low productivity and the pensions crisis. It is also grossly unfair. Taxes on dividends from shares and on interest from bank accounts represent a double taxation of money which has already been taxed once in the form of income. At the last election, the Conservative party pledged to end this abuse — though, somewhat illogically, only for basicand lower-rate tax payers.
The attraction of the flat tax is that it not only provides a remedy for these ills but does so in a manner that is philosophically coherent. A flat-rate tax proclaims that fairness is not to be measured in equal outcomes but rather in equal opportunities. But the rich would not in the long run keep a higher share of their income, as experience shows. Thus the result of the Reagan-era tax reductions and reforms was that the share of the total tax take paid by the wealthiest groups increased sharply. On the other hand, probably the greatest benefits were those received by people further down the economic chain, who found jobs or increased incomes because of the extra economic activity that was generated.
This reminds us of the important truth that those who actually bear the brunt of a tax are not those who initially pay it. That is why using the tax system in order to redistribute income is demonstrably futile. Welfare benefits are a more honest, more effective and less damaging short-term means of helping the poor.
The case for a flat tax is, indeed, so strong that one must look to politics rather than economics for the reason not to propound it. Perhaps the idea of fundamental tax reform just has too many echoes of the poll tax to prove acceptable. But even the poll tax could have worked if it had been lower, had reflected ability to pay, and had boosted economic growth — as would the flat tax. Oliver Letwin, whose paternity of the poll tax has never been denied, recently warned that 'the temptation to tear up the tax structure and start again must be resisted'. But this is, in truth, one temptation that should be indulged. He should start tearing.
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