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April 10, 2005

Flat Tax and Miscalculations.

Roger Bootle looks at the Flat Tax proposal from the Adam Smith Insitute. He rightly starts to add in the National Insurance part of the taxation system but then commits something of a howler.

Now the bulk of the population faces a similar marginal tax rate. True, the basic rate is 22 per cent, compared with a top rate of 40 per cent but on top of the basic rate there is NI at 11 per cent and 1 per cent for higher earners, making the overall rates 33 per cent, and 41 per cent.
The first is equalising tax rates for basic and top earners. This would have to be combined with a rationalisation of NI. If you abolished the ceiling on employee NI contributions and did away with the top rate of tax, that would give a combined income tax and NI rate of 33 per cent.

When you add the NI and income tax systems together the UK already has something pretty close to a flat tax system (horribly riddled with examptions etc but...). For there is not one NI tax, but two, so called Employer’s and Employee’s. Together these amount to some 22% of wages from anything just over spit to just below the 40% income tax band. Add the 22% income tax that applies to most of that income (personal allowances for income tax are very low in the UK and the 10% income tax band is very thin) and you have for anyone earning the minimum wage full time a marginal tax rate of 44%. It drops in that small band between the NI earnings limit and the higher income tax rate to 22% and then rises again to 41% with the higher income tax rate. Now you could say that this means the UK has a regressive taxation system and given that higher income earners are more likely to be able to take advantage of various exemptions etc you may well be right. Add in taxation of capital gains etc you would certainly be right. The higher your income and the higher the proportion of it that comes from investment income, the lower your marginal tax rate.

So something really does have to be done about this absurd system. We might also ignore the minor details of rates, 44% to 41% and so on, and simply say that we already have a flat tax system, although it doesn’t look that way as we have it divided up and part of it hidden from us in the Employer’s NI.

Now, there will be those who look at the above and cry "But that can’t be right ! Employers pay that NI charge." Really? where do you think it comes from? A company works out what it is willing to pay to get a job done. It includes all of the costs, the desk, computer, car allowance, maternity pay, taxes and the rest, deducts all of the costs that are not in the pay cheque and then goes out to see if someone is willing to do the job for that portion that is left over. Just because the 12% or so of Employer’s NI is called that, it doesn’t mean that the employer is somehow paying it out of profit. They’re treating it just like all of the other costs associated with employing someone. In a competetive market for labour (assuming we have one, of course, and the UK probably does) if that tax did not exist then take home pay would rise by that 12%.

So to my mind Bootle has made something of an error. When you add the NI to the income tax system you have to conclude that we already have something close to a flat tax system. The next question is whether we want one at such a high rate, one with so many exemptions and allowances, or would we prefer to have a lower one with fewer? I’d prefer the latter, as it is marginal rates that influence behaviour.

April 10, 2005 in Economics | Permalink


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» Telegraph on ASI's flat tax from Adam Smith Institute Blog
The UK Sunday Telegraph's regular economic commentator, Roger Bootle, has a full-page article reviewing our recent survey of the remorseless... [Read More]

Tracked on Apr 10, 2005 11:36:06 AM

» Flat tax in the UK, part 3 from New Economist
I did not think I'd be writing about this issue so soon after my last post, but Roger Bootle's piece on flat taxes in today's Sunday Telegraph, Is a flat tax a fairer way to raise revenue? (registration may be required) has re-opened the debate. He nai... [Read More]

Tracked on Apr 10, 2005 6:43:22 PM


Interesting analysis, though employers' NI doesn't apply to the self-employed and/or freelancers and/or piece-rate contractors, who make up a significant and growing part of the economy. Hence the reason companies are so keen to hire workers without contracts.

Posted by: Jarndyce | Apr 10, 2005 3:47:44 PM


In answer to your question, and quoting from the online UN manual on the system of national accounts (SNA):

6.222: Gross value added is defined as the value of output less the value of intermediate consumption.

6.147: Intermediate consumption consists of the value of the goods and services consumed as inputs by a process of production, excluding fixed assets whose consumption is recorded as consumption of fixed captital.

In other words, value added includes not only profits but compensation of employees, as they are not intermediate consumption.

See: http://unstats.un.org/unsd/sna1993/toclev8.asp?L1=6&L2=12 and related pages

Your point about employer NI is only true to some extent. Ultimately of course the public pays for all taxes one way or another, but simply adding income tax, employee NI and employer NI together is simplistic. Employer NI matters principally because of the tax wedge it creates, which raises the cost of hiring workers.

I discussed the flat tax idea a week on my blog (my weblink takes you there). I accept the point that the current UK income tax system is not very progressive, while the VAT and other direct taxes tend to be regressive. That suggests fewer tax exemptions and loopholes, and less middle class welfare, not a less progressive (i.e. flat) income tax system.

It's an interesting debate, and I'll write more on this anon.


Posted by: New Economist | Apr 10, 2005 5:47:17 PM