Morning Line: In support of a 'negative income tax'

It will be a real improvement if the coalition seriously gets to grips with tax simplification.  As a first step Her Majesty’s Revenue & Customs is calling for views on how the Pay As You Earn system of tax collection can be made more efficient for millions of taxpayers.  In particular, HMRC is looking at ‘how more frequent or ‘real-time’ PAYE information could support the tax and welfare system.’

One area that needs urgent attention is Tax Credits.  It has always been a mystery why we need a parallel bureaucracy alongside HMRC to deal with tax credits.   Millions of employees on earnings up to £58,000 a year have been entitled to tax credits which could easily be incorporated in tax codes.  This would eliminate the huge number of clawbacks of tax credit which have occurred in the past because the system is too inflexible to accommodate changes in income. 

The current PAYE system is able to deal with variations in pay and deduct the correct amount of tax.  Why could it not also deal with tax credits which are, after all, just allowances to be set against pay?    HMRC is clearly thinking along these lines saying that reform would ‘allow income related benefits and welfare payments to better reflect the current circumstances of the individual and remove much of the uncertainty that leads to errors in the Tax Credits system.’   

Benefits

And why stop at Tax Credits?  Benefit claimants and consumer groups constantly complain of the indignity of ‘means testing’.  So why not incorporate as many benefits as possible into PAYE – which, after all, is just another form of ‘means testing’ to establish how much tax an individual should pay?

Negative income tax

The Taxpayers Alliance has just published a document on benefit reform which revives the old Conservative idea from the 1970s of ‘negative income tax’ alongside a bonfire of the benefits to simplify and streamline the system.  This would work by calculating take home pay and deducting tax by PAYE – but could also incorporate the payment of benefits when employees were out of work or on low pay. 

TPA proposes a simple negative income tax that would replace most of the benefits that are currently paid to working-age households, shows how it could be administered, and provides a model for policymakers to see the cost of a number of combinations of negative income tax levels and taper rates.

Anyone who has dealings with benefit claimants will tell you that the system is impossible to understand.  Handbooks describing the rules run to several volumes and some benefits are so complicated that they need a handbook of their own.  There are more than 50 different benefits, all with different rules and taper rates and a total of 8,690 pages of guidance for DWP benefits alone.

Administrative chaos

Nobody would deny TPA’s claim that the benefits system is administratively chaotic, with take-up rates for key tax credits and benefits as low as 57% in some instances, with an annual benefit fraud and error bill of £4.5 billion, and over 1 million households affected by tax credit overpayments every year.

Couples are unfairly treated, with an estimated 1.8 million low-earning couples losing an average of £1,336 per year because they live together.   And there is a huge disincentive to work.  Those returning to work face losing Housing Benefit, Council Tax Benefit and tax credits, at the same time as paying income tax and NICs.  This equates to a marginal tax and benefit withdrawal rate of 95.5%.   Over 2.5 million non-disabled working-age households face a marginal tax and benefit withdrawal rate of over 60%.  No wonder we have so many long term unemployed.   Streamlining PAYE to incorporate a reformed benefit system would be an enormous improvement.

Reform overdue

‘If a reformed system was introduced as a single negative income tax, it would greatly increase take-up and reduce the incidence of severe poverty. It would greatly improve work incentives, encouraging the most sustainable route out of poverty – employment. Decades of increasing welfare dependency have not solved the problem of poverty.  Reducing dependency could help to give low-income households a better chance,’ says the TPA report.

Let’s hope that our policymakers listen to the TPA.  Reform of the tax and benefits system is decades overdue and could produce the greatest boost the economy has had in years, creating real incentives to work, while saving billions.  Combining tax collecting with benefit payments would streamline both systems, remove duplication of administration and go a long way to cutting out fraud.  As the TPA acknowledges, it won’t be easy.  But it could prove to be the coalition’s lasting legacy.

Copies of the TPA report Welfare Reform in Tough Fiscal Times can be downloaded from www.taxpayersalliance.com.