Thought of the Day

People's incentives are determined by the combined effects of tax and benefits, not one or the other in isolation. The current combination is highly toxic to incentives to work at either end of the earnings scale. We aim to minimise disincentives to work for any given level of income tax and social safety net. They may both sound draconian in isolation, but the combination of Basic Income and Flat Tax produces a simpler, less perverse and less punitive system than any alternative. One (Basic Income) is netted off against the other (Flat Tax), so:

• almost no one pays an effective rate of 43% (you'd have to earn more than a million a year),
• anyone earning under £13,000 a year pays no tax (effectively a Negative Income Tax, as recommended by Milton Friedman, for those earning below this level),
• most people don't receive £5,500 (because it is netted off against their flat tax obligation), and
• everyone keeps more than half of each additional pound that they earn (the marginal effective rate of tax), as opposed to the current system where the government takes well over half of any extra money people earn at significant points in the earnings scale, thanks to means-tested withdrawal of benefits, deterring people from trying to improve their lot through work.

I had a letter published in this week's Maidenhead Advertiser that tries to explain the rationale, which I have posted as a news entry (this is probably the best place to go for a simple explanation and illustration). Or you can find some pages that try to walk through the logic in our policy section. Or why not try comparing it against the current system for your own circumstances and other hypothetical households if you like, using the Calculator we provide to work out how they compare (roughly, given the extraordinary complexity of the current system). Put a few basic details into the form in the left column on the home page or on the right on the Calculator page, and then click Calculate and have a look at how the two systems compare for disposable income, and how they would compare as your earnings varied between £0 and £100,000.

If you are of a mathematical bent, it may help to view this as that simplest of algebraic forms we learnt at school: the straight-line graph, represented by the formula:

y = ax + b, where

y is disposable income after accounting for tax and benefits,
x is earned income before tax and benefits
a is the rate of tax (or strictly the inverse of the rate of tax, i.e. 57% for our proposed rate of 43%), and
b is the social safety net - the level of income that the state would guarantee regardless of circumstance, in order to prevent serious hardship.

A system based on this formula means that we keep more and contribute more as we earn more (the Flat Tax, or a), and there is a minimum level of income that we will guarantee as we are not prepared to watch someone starve or sleep in the streets (the Basic Income, or b). It is the result that the current system and the mainstream parties' proposals aim roughly to achieve, with some tweaks to offer benefits to certain income brackets whose votes they want to buy. But their targeted, micro-managed solutions (which nevertheless hope to achieve this outcome through their micro-management) require extraordinary levels of bureaucracy and waste in their failed attempts to deliver this effect, which can be delivered more simply and cheaply by the basic mechanism we have proposed.

43% is just a starter for ten. We have committed to be honest with people. All the mainstream parties' economic proposals are full of unfunded promises and claims that they will pay for the hand-outs for their supporters by "slashing waste". We determined not to go for these soft options, which inevitably disappoint on non-delivery. We have not counted any assumptions of efficiencies in that 43%. In practice, we would look for those efficiencies like anyone else would, and to the extent that we could find them, we would bring down the rate of tax.

The same goes for any "Laffer Curve" benefits (i.e. where tax cuts do not reduce revenues pro rata, because economic growth and greater willingness to pay make up for the cuts in the headline rates). The mainstream parties like to count these benefits as though they know they are guaranteed and how much they will be. They almost always over-estimate them, because it is such a convenient way of magic'ing money out of thin air in their models. This was the approach that George W Bush and his "supply-siders" took, and ended up with big-government conservatism, with a more-bloated public-sector, rampant pork-barrel politics, not enough tax to pay for it, and a deficit-funded boom and bust.

We believe that there will be significant "Laffer" benefits to the economy and therefore to tax revenues from reducing the high marginal effective rates of taxation in the current system, which inhibit people from trying to earn more money, particularly if they are low or high earners. But we have not counted any gains from this effect in our calculations. The right way to treat them is to bank them when you've got them and know how much they are, not build them into your calculations in advance, other than very conservatively. They then become part of a virtuous circle, enabling further tax cuts, that produce further "Laffer" effects, and so on.

There is another virtue to 43%. There is deep and somewhat justified hostility to the fat cats in both public and private sectors. If we had aimed for a much lower rate, like UKIP's proposed 31%, not only would people have been able to accuse us of inventing numbers we couldn't deliver (like UKIP), but they could also have attacked us for favouring high earners, when it is the low-to-medium earners who are struggling most.

At 43% (and £5,600 Basic Income), high earners are better off than under the latest arrangements for income tax (including the 50% rate), national insurance (we are subsuming employees' contributions within our Flat Tax), and changes to the rules on personal allowances and pensions contributions. But they are not so much better off than the rules before the recent changes.

It is low earners who are particularly encouraged by these changes. In terms of political acceptability, and of getting the economy going, that is an important balance to strike. As we start to see the economic benefits, we can share the gains with everyone by reducing the flat-tax rate. That is likely to be more acceptable when people are feeling like they are winning too, than if high earners got a big boost now, when people are struggling and resentful of the harm that has been done by some of our well-paid but inept leaders (in parliament, finance, energy, etc.).

Hope that helps. It really just comes down to simple maths, and using it to scrap the ineffective, bureaucratic, expensive complexity of the current system.