A More Transparent Tax System

A More Transparent Tax System

One of the challenges of the tax system is how complex it is. And that’s not just in terms of the rules and sub-rules, but because it’s hard for people to really visualise what the limits mean. If someone proposes to raise taxes on everyone earning over £100,000 how many people does that affect? What should the threshold be for inheritance tax? And when we add in benefits the complexity compounds even further

A further problem is the way that inflation can erode the value of thresholds – for either tax or benefits. A tax rate that was originally meant to hit 5% of the population could end up hitting 20% after a few years of inflation (for example, the proportion of people paying higher rate tax has doubled in the last 20 years). The trouble with changes of this sort is that they effectively take place by stealth, rather than allowing us to have a genuine public debate about what level of tax we want.

A simple and elegant solution would be to have a single basic tax threshold and then to express everything else as a proportion of this. Conveniently, the tax rates that have been proposed to be in place in 2020 work out particularly nicely:

  • Basic rate tax threshold: £12,500
  • Higher rate tax threshold: £50,000
  • Top rate tax threshold: £150,000
  • Inheritance tax threshold: £500,000 (assuming the person owns a house, which seems a reasonable assumption if they have this level of assets).

So if we call the basic threshold N, we have thresholds of N, 4N, 12N and 40N. The same principle could of course be extended to the benefits cap, to thresholds for tax credits and for National Insurance. It’s immediately much easier to discuss. We have the top rate of tax set at a level that’s ten times the basic threshold. Is that right? Maybe it should be more, maybe less. Either way, the ratios are clear to see.

There are two further changes that would make the change even better. These are:

  1. Express all the thresholds in terms of multiples of the annual minimum wage (for someone working a typical full time week). The minimum wage is a much more meaningful threshold than the basic rate tax threshold as it would allow us not just to compare different taxes, but to relate them to how much someone on minimum wage would earn in a year. The numbers don’t work out quite as neatly (annual minimum wage in 2020 will be about £17,500) but we can see that, for example, the higher rate tax threshold will kick in for someone earning just under three time minimum wage. Is that right? Maybe it should be twice the minimum wage – or five times. But it’s an immediately relatable way. The benefits cap (for a single person outside London) is set at about 80% of minimum wage – right, or not?
  2. Formally link all the measures in legislation, such that when the minimum wage changes, all the others change too. At a stroke this would remove the ability of inflation to erode both taxes and benefits. Of course, Parliament could certainly change taxes – that’s a fundamental prerogative – but to do so it would need to be explicit: ‘we’re going to bring the higher rate threshold down from 2.9 x minimum wage to 2 x minimum wage’; or ‘we’re going to raise the inheritance tax threshold to 40 times the minimum wage’. Popular, or not? That would be for the people to decide.

In conclusion, by explicitly linking major taxes and benefits to multiples of the minimum wage, and enshrining those ratios in legislation, we’d create a simple and relatable system, that would ensure thresholds could only be changed in a deliberate and open way. The system is entirely compatible with either high or low levels of taxation – this isn’t a right/left issue – and would be a great way of creating transparency about what we pay and receive.

10 thoughts on “A More Transparent Tax System

      1. Thanks for that clarification. When I hear “benefits cap”, I generally think of the household/ family level, which is the one that got all the headlines a few years ago, but it’s equally important to think about whether the single person’s allowance is properly set.

        1. Yes, the household one was also in my head, for similar reasons. I’ve amended in the original post – thank you.

  1. Another element of transparency would surely be to combine income tax with both employees and employers National Insurance, so that we could see the actual tax rate with one figure.

  2. But doesn’t this also create a fairly arbitrary rule that if you choose to increase minimum wage then by default you raise all tax bands as well? That’s fine if you assume changes in minimum wage are purely a reflection of a certain quasi-objective point in terms of a ststistical distribution of income but it’s totally counter productive if you e.g. Want to add 50% to minimum wage in the name of greater wage equality and this immediately gives a tax cut for higher earners

    1. True, unless you were to increase the minimum wage by 50%, while also at the same time decreasing the relative tax limits by the same amount. That would also be more translated in the sense that it would clearly show that the minimum wage increase is also corresponding to an relative increase in earnings.

  3. PS more generally I’m conflicted about things that stop stealth/default devaluation of things. It’s more honest but there’s already a massive status quo bias – people are far more defensive of current benefits or exemptions than they are demanding of new ones – and a system whereby a decision made once naturally declines in impact over time unless renewed has some elegance as a solution.

  4. Thanks Iain – you make really interesting points on relating income tax to wage. Though my view is that inheritance should not necessarily be included in being linked to minimum wage income. It isn’t part of the income tax regime at present and has its own separate rules so it may just add more confusion to link them. I would be in favour of a more drastic overhaul of inheritance tax to make it transparent for everyone.

  5. Lots of great discussion!

    Josh, I completely agree on NI. Lafayette, I have some sympathy for your idea that it would be nice for the impact of a decision to naturally decay over time, but inflation here has the opposite effect. More people get dragged into a new tax band and a benefits cap or threshold gets more severe: i.e. the impact gets harsher, rather than less severe.

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