A new way to do income tax

The system of income tax is in need of an overhaul. The current setup remains unconsciously wedded to 19th century thinking and technology.

I’m suggesting an end to the assumption that, for a given salary, there is a single rate of tax. It’s the equivalent of industry shifting away from straightforward mass production techniques towards an era of mass personalisation.

Before I get on to that though, what’s wrong with the current system? Off the top of my head I’d say:

1. Not enough people are paying it. The book Freakonomics mentions a 20% evasion rate in the USA and this figure is doubtless much higher in some other countries. The reasons…

2. Virtually all connection between the money you pay in tax and what it’s spent on has been lost. You pays your money into a huge dark pit – called the Treasury – a bunch of which comes out the other side to be spent on things you don’t agree with (the Iraq war say) or wasted in a giant cesspool of mismanagement and bureaucracy. When you walk into a shop, you know exactly what your money is buying. Governments seem to think this isn’t necessary: that the mere concept of “government spending” is enough to satisfy us. It isn’t. There urgently needs to be a tighter connection established between our hard-earned money and how it’s spent.

3. This cuts both ways - those drawing benefits also feel no particular sense of loyalty to the donor. The money isn’t from people it’s from a faceless state machine. The system lures recipients into the assumption that the money is always a right and not a privilege. The facelessness also encourages fraud.

4. The tax system is a very blunt tool. In a world where individualism is so highly prized (arguably too highly prized) the UK income tax system puts us into one of three buckets: no tax, standard rate and higher rate.

I propose using technology to break this old tax paradigm that assumes just a single variable: how much money you earn. Other than that, the tax system is largely a one-size-fits-all affair. Governments are missing a trick here.

Citizens should each have access to their very own online ‘account’ with the government. When you pay tax your account gains credits and, conversely, as you draw benefits/services you lose credits.

As such, Mr and Ms. Average would be expected to contribute exactly the same amount as their draw out of the government over the course of their lifetimes. Their account would stand at zero when they die as they put in to the system the same amount as they drew out.

But of course there are those with more money who pay more tax into the system than they will ever receive out of it. These net contributors will see what they’ve paid in over the average odds.

Similarly those in debit will see by how much. This is private data and the purpose is not to stigmatise those who are poor or pensioners or otherwise ‘in the red’ but to state honestly what the financial situation is.

This is the clever bit: a single rate of tax per income rate band would be replaced by two rates. As such, the standard rate income tax might be set at, say, 20/25%, while higher rate is set at, say, 40/50%. Different people start paying different rates of tax. Let me explain…

Those in net credit at any time would pay the lower rate in each pair, while those in net debit would pay a higher rate. What good does this do? It ends the notion that benefit received from the government is ‘free’ money. It injects the notion that government services come with strings attached. It re-introduces a sense of personal responsibility.

The upshot is that someone who had been unemployed and clocked up £10,000 in benefits before finding a job would pay the higher figure in each band until she/he made up the £10,000. So the the money is clawed back by the state through the individual paying 25% rather than 20% standard rate tax (or 50% instead of 40% if they’re lucky enough to get into that bracket).

Example 1: someone with £20,000 of earnings liable to standard rate tax would take a decade paying off their ‘debit’ (5% of £20,000 each year) before returning to the lower standard rate of 20%.

Example 2: someone on a higher income, with (let’s imagine) a full £30,000 earnings liable to standard rate tax and a further £35,000 at higher rate, would ‘pay off’ their £10,000 benefit in two years. At that point their rates go down from 50%/25% to 40%/20%.

The good thing about the system is that it wouldn't squeeze money unduly out of people who can’t pay it. If you’re not earning any money your government debits would mount up in theory, but you would never reasonably be expected get back into credit.

This way, all government service suddenly relate much more closely to the individual. In some cases they could be viewed vaguely like a soft loan (from a caring aunt who would never dream of getting the money back until you were willing and able to pay it). Detractors would say that this is all akin to extending the much-hated mechanism of student loans. I disagree.

Nor is this proposal incompatible with the principle of redistributing wealth from rich to poor. There is nothing proposed here to suggest that this needs to stop or be curtailed (and for what it’s worth I believe that it should continue). Indeed, these tax reforms should help any redistribution become more equitable.

Ascribing government costs to an individual is quite straightforward in some cases: a hip-replacement operation costs £x while any unemployment benefits received can be logged to the nearest pence. It gets more difficult when it comes to something like defence spending. Here one could argue that the rich receive a disproportionate benefit from not being overrun by foreign hordes (as they have more to lose). As such, I would propose that defence spending is not apportioned equally among all citizens but correlated with income.

Such teething issues aside, I see no reason why each citizen should not get to see an online profile of government services apportioned to themselves…and whether they are covering these costs or not. And those that aren’t should expect to make up for it in future if they can. What’s so unreasonable about that?


Coming soon... Tax hypothecation: sexy or what?