Basic Income + Flat Tax - the principles

Most people agree with two basic propositions:

  1. We have a responsibility to help the least fortunate.
  2. The better-off should pay more towards the costs of government.


It does not necessarily follow from (1) that the state should take responsibility. Family, friends, community and charity all have a role to play, and probably a bigger role than at present.

But this programme accepts that the state also has a role to play. Not everyone is lucky enough to have family, friends and an understanding community to fall back on. One cannot depend on charities, whose donations may dry up in exactly the economic conditions that yield the greatest demands for help. The fear of destitution in countries (such as Japan and China) where there is a very limited state-funded social safety-net is an inhibitor to the risk-taking that is vital to innovation and economic progress, and encourages state-intervention to preserve failed businesses for the sake of the jobs they provide. Creative destruction is a vital part of economic progress, but it can be politically unacceptable if the consequence is serious hardship for the people whose jobs are destroyed.

State-funded welfare, then, provides a valuable economic service. But its purpose is purely as a safety net for those fallen on hard times, not as a ladder to greater prosperity and equality. The latter should be achieved through people's own efforts. To dilute personal responsibility for improving one's condition is to reduce the incentive to work, without which our economy goes backwards and we are all impoverished, including those that the ladder was intended to help.

Progressive taxation

It does not necessarily follow from (2) that rates of taxation on income should increase at higher levels of earnings. Taxation applied as a percentage is inherently progressive - if you earn more, you pay more.

High levels of tax at high levels of earnings are a disincentive to the effort and innovation that bring generous rewards to the individual and to society. Persistent, excessive rewards are a sign of an uncompetitive market, where competition has failed to drive down margins, and should be tackled by identifying and correcting the barriers to competition, not by penalizing high earners regardless of whether they achieved their wealth through desirable means (hard work and innovation) or undesirable means (exploiting market power).

Headline, effective and marginal rates of taxation

In any case, headline levels of tax are not the relevant figures in people's experience. If we have low nominal levels of taxation on low earners, but withdraw their benefits so aggressively, as they earn more, that their disposable income barely increases (as is the case with the current system), that is not progressive, it is regressive. What matters is how much of a household's gross earnings remain to it as disposable income after the combined effect of taxation and welfare. We call this combined effect of taxation and welfare the effective rate of tax. The effective rate of tax determines how well-off a household feels relative to their earnings. The amount that a household's disposable income would increase if its earnings increased is called the marginal effective rate of tax, and determines people's incentive to work.

Most systems that combine welfare payments with taxation of earnings, whether or not the headline rate of tax is progressive or not, will result in a progressive effective rate of tax. At low earnings, the welfare payments will outweigh the tax paid and result in a negative effective rate of tax (negative because the government gives more than it takes). As earnings increase and welfare payments are increasingly outweighed by the amount of tax paid, the effective rate of tax increases. It does not need "progressive" increases in the headline rates of tax to achieve progressive effective rates of tax. "Progressive" taxation complicates, distorts and disincentivises - unnecessarily, to little benefit and material disadvantage. A system with a state-funded social safety-net and a flat tax (as a proportion of earnings) will be just as progressive, more efficient, fairer, less bureaucratic, easier to understand, and better for the economy and our prosperity. It is the system that this programme supports.