Tax is an important determinant of inequality, for two reasons; first, it is a major factor in the distribution of income and wealth in the country,, and is directly responsible for poverty in some instances. Second, any proposal to reduce poverty and inequality by improving benefits must answer the question – can more money be raised by taxation without being too unpopular, causing widespread evasion, and damaging the economy. it would be rash to assume that money can be made available from elsewhere in the government budget while there are so many areas of public expenditure in need of funds. Tax levels influence health in a number of ways additional to their redistributive effect, most obviously through the level of public services that can be supported. Here, however, we are discussing only the impact of tax on the distribution of personal financial resources.
Tax reform is a complex area. Understanding the real effects of the present system, let alone accurately predicting the impact of changes, is a major task. This section outlines some of the issues that arise in creating a more redistributive tax s stem, in particular when taxing income and health. We have excluded the topical controversy, over local taxes as it is well covered elsewhere.
Tax Changes since 1979
The Conservative government talks a lot about the need to reduce the level of taxation. In fact, they have slightly increased the proportion of national income taken by taxation. The illusion of lower taxes is largely the result of a shift in patterns of taxation from income tax to less visible taxes such as VAT. The ill-fated poll tax was an instance of a wider trend.
A series of Conservative budgets have reduced the tax paid by the rich. The 1988 Budget was a watershed in redistributing from the poor to the rich, abolishing all but one of the higher tax rates, leaving 95% of taxpayers on the basic rate, and giving other generous tax cuts to the better-off. Although the total effect of Conservative budgets has been to cut direct taxes, in the words of one commentator: “Remarkably, what has happened has been a virtual zero net cost reform the cuts in direct taxes have been entirely paid for by cuts in the generosity of benefits…. There has, however, been a major redistribution from those on low incomes to the better off… The losses [resulting from changes since 1979] for the bottom fifty percent average out at nearly £8.50 per family, while the top ten percent have gained nearly £40 per family.
Reforming income tax
There are two basic ways of making income tax more progressive without reducing revenue – increasing personal allowances or introducing graduated levels of income tax. Larger allowances paid for by raising the basic tax rate bring slightly greater benefits to the poorest taxpayers but leave large numbers on middle incomes worse off and raise marginal tax rates. Most taxpayers would still pay a flat rate. A graduated system has the advantage that the tax reductions for those on low incomes are paid for by the better off rather than those on average incomes. This is preferable from a health point of view and is politically more acceptable, in that fewer people are worse off. The UK is unusual in not having a graduated structure. Of the 19 OECD countries in 1988 the UK was unique in having as few as two tax bands; Belgium had thirteen, France and Japan twelve, and West Germany a graduated curve. The UK also has lower marginal tax rates on top incomes than any country except Switzerland.
It is tempting to hope that gaining access to very high incomes could raise substantial revenue without the need for large tax increases for those on above average earnings, including the articulate and politically powerful people on professional and middle managerial incomes. However, this is unfortunately wishful thinking, for two reasons. First, the very rich are likely, to be able to arrange their finances to make them less liable to tax if marginal tax rates get very high. It has proved remarkably, hard to extract high tax rates from those who can afford good accountants. Second, people on professional incomes are comparatively richer than they recognise. As Hills puts it: “Someone earning 1.5 times average earnings does not sound very rich, but they are within The top 10% of the earnings distribution. Someone on “twice average earnings” (Just over £25,000 in 1988-9) is within the top 3% of the Such people do not think- of themselves as amongst the very rich.”
Raising tax rates for those with significantly but not massively above average incomes is a nettle that has to be grasped; graduated tax bands are the obvious way to do it. In theory, income tax allowances should prevent the lower paid from paving tax on the income they need to avoid poverty. In fact, allowances are of more value to the better off for two reasons.
First, they are worth more to high-rate taxpayers; because they reduce the amount of taxable income, less will be taxed at the higher rate. An additional allowance of £1 is worth £25 to a basic rate taxpayer, £40 to someone paving at 40%. This would become an increasing problem if graduated tax bands were introduced. Restricting personal allowances to the basic rate, through a tax credit or zero-rate system, as has now been done for mortgages, overcomes this problem. In either case revenue would increase as higher rate taxpayers would pay, more and some taxpayers would be pushed into a higher rate.
Second, those with higher incomes make more use of many allowances, such as mortgage relief and pension concessions. This is becoming increasingly important. The cost of mortgage interest tax relief grew at a staggering-nine hundred percent between 1960 and 1985. The Business Expansion Scheme, Personal Equity Plans, Enterprise Zones and concessions for share options have been-introduced recently and benefit mainly the rich. Because of the scale of allowances, they have a major impact on tax levels. They are officially estimated to reduce the income tax base (the proportion of income on which tax is paid) by over fifty percent leading to much higher tax rates. Allowances could be limited by a minimum tax, as exists in the USA, or by a maximum allowance (which if it were not raised with inflation would gradually widen the tax base.)
A number of countries give ‘single-earner’ tax relief to support families while one parent is looking after children. But it is a clumsy and inefficient tool for achieving an aim which would be much better met by focusing directly on the costs of children (for example by child benefit) or of lost job opportunities.
Taxation of married women has long been a muddle. Until recently working married women were penalised. The government’s new system, allowing independent taxation but still retaining a tax benefit for being married, reverses this and favours married couples over unmarried ones. Without this aim, there is no justification for retaining additional tax relief for being married. On the principle that the state should not subsidise one pattern of family relationships rather than another, the fairest arrangement would seem to be completely independent taxation, with no married man’s allowance but compensated by an increase in Child Benefit. This is even-handed between married and unmarried couples, heterosexual or homosexual, men and women.
In conclusion, making income tax significantly more progressive is relatively straightforward, though phasing in would be necessary in a number of areas. Converting the personal allowance to a zero rate band, given to everyone irrespective of marital status, and introducing a graduated rate structure with a lower starting-point and higher top rate than at present, should provide the main framework. Increasing the tax base by reducing tax concessions is discussed below.
National Insurance Contributions
National Insurance Contributions are even less progressive than income tax. The effect of going above the lower earnings limit for insurance contributions is that earners suddenly pay contributions on all their income, not just on the amount above the limit, which could be avoided by a zero-rate band. The maximum contribution means that those with higher incomes pay a smaller proportion of their income in contributions, which is clearly regressive. There is currently an incentive for employers to keep earnings down below the threshold. Replacing employers contributions by a payroll tax would avoid this. A number of people have proposed combining income tax and national insurance contributions into one system. There are many ways in which this is logical. However, it should be considered as part of a wider discussion about the future of social insurance.
In the meantime, a zero-rate band with a flat or graduated percentage above this, abolishing the upper earnings limit, would provide a more progressive basis for employees contributions, and a payroll tax for employers would have a beneficial effect on employment practice.
Company taxes
It is difficult to know who ends up bearing the costs of company taxes, and thus to estimate the effect. If it is the shareholders, such taxes would be progressive; if the consumers they would operate like other indirect taxes and tend to be regressive. The latter becomes more likely as investment is increasingly international, so a lower rate of return results in less willingness to invest. But it may be difficult to pass on costs to consumers if imported goods do not carry these costs. It would be hard for one country to raise its rates above those of its rivals. But rates of company tax in the UK are lower than almost all other developed countries, at 35% in 1988 compared with rates over 50% in West Germany, Sweden, Japan and Denmark.21 It is however somewhat misleading to compare rates without also comparing the tax base. In this situation, company taxes could be an easy way for the government to raise revenue – precisely because it is not clear who pays them, they cause little protest. It is interesting to note that Japan, with the most egalitarian income distribution in the developed world, has low rates of personal taxation compensated for by high company taxes.
Indirect taxes
The UK raises a higher proportion of tax revenue from indirect taxes than any other OECD country. Indirect taxes tend to be regressive, as better-off people save more, but in Britain this is not true of VAT because of the zero-rating of a number of ‘essentials’ and the exemption of housing. VAT in fact takes a slightly smaller proportion of the disposable income of poorer households than of the richest. There is a move within the EC to ‘harmonise’ VAT rates (largely to avoid cross border shopping) which would involve charging VAT on most zero-rated goods. This would be markedly regressive and would have a significant impact on the poorest families. This requires vigorous opposition. If VAT rates are to be harmonised, it should be by extending the benefit of zero-rating essentials to other countries.
Two other indirect taxes, on alcohol and tobacco, have obvious direct health implications, as consumption of both is highly price sensitive. Alcohol tax takes least from the poorest twenty percent of households and around the same proportion from the rest. Harmonisation within the EC would involve a very substantial reduction in tax on wine and beer (estimated to result in increasing consumption by around a third) and a smaller reduction in tobacco tax.
Tobacco tax is highly regressive. This poses an obvious dilemma. Major expenditure is involved. The poorest fifth as a whole spend 4.3% of their disposable income on tobacco tax, but as less than half of such households have a smoker in them, in those that do expenditure averages a staggering 9%! If there were effective ways of discouraging smoking other than by price, there would be a strong case for adopting them in preference.
Wealth
Wealth is a source of income, both in cash (for example from investments) and kind (such as the value of living in a house). The possibility of spending the capital opens up a range of alternatives in times of crisis and when making major life decisions. Equally important, the knowledge that such capital is there to be drawn on if necessary can make a substantial difference to the quality of life (and so to health), freeing people from constant fears about the lack of options they would face in an emergency. The increase in choice and in ability to plan for the future and deal with the unexpected, are benefits of wealth that are underestimated in comparison with its ability to generate higher consumption levels.
Wealth is even more unequally distributed than income. The richest five percent of the population own forty percent of the wealth.”‘ The richest ten percent and twenty five percent increased their proportion of total wealth between 1976 and 1988, whether the value of dwellings is included or excluded.
Since 1979 the Conservatives have reduced taxes on wealth. Investment income surcharge has been abolished, and capital gains have had their tax liability reduced in a number of significant ways, although at least those on higher tax rates now pay capital gains at the higher rate. Inheritance tax liability is reduced; the threshold has increased much faster than inflation and tax is now a flat rate (40%) rather than a graduated one which benefits the largest fortunes.
Taxing wealth is an obvious approach to redistributing resources within society. There are two aspects to taxing wealth – taxing the income generated by ownership of wealth, and taxing wealth directly.
Taxing unearned income
Most of the benefits of wealth ownership come in forms which are not taxed. One might expect wealth to give a nominal ‘rate of return (ie ignoring inflation) of around ten percent. In fact, the total amount of declared ‘investment income’ and capital gains assessed for tax suggests an absurdly low rate of return of only one percent. Attention needs to focus not only on the rate of taxation of such taxable returns, but on increasing the proportion of the benefits of wealth ownership that are taxed, ie the tax base.
The current system is a mass of contradictions; the return on different forms of investment is taxed in very different ways. At one extreme, someone owning a house with a mortgage receives tax relief on their mortgage repayments, the ‘income in kind’ of living in the house rent-free is not taxed, nor is the increase in the value of their house over time (the capital gain). Share option schemes, Business Expansion Schemes, older life insurance contracts and pension contributions are also dealt with by the tax system in a way which makes them better than tax-free. Those who can afford a good accountant can, by careful management making the best of such schemes and taking advantage of capital gains allowances on shares and other concessions, pay little or no tax while reaping a considerable income. On the other hand, the investments most likely to be held by those with small savings – building society and bank deposits and gilts, pay a rate of tax that (unlike capital gains on shares) makes no allowance for inflation and is paid even by non-tax-payers. Thus the richest are likely to be paying tax on capital at the lowest rate, and small savers at the highest.
In addition, investment income is generally treated more favourably than earned income. Earned income pays the marginal income tax rate and the National Insurance Contribution. The only investments at a higher rate of tax will be those – such as building society accounts – where no allowance is made for inflation, in times when inflation is high. An investment income surcharge equivalent to the employees national insurance contribution is often advocated to eliminate this anomaly and raise revenue (cushioning the effect on pensions).
Debate about reforming this untidy and inequitable system has generally been dominated by two models:
- Comprehensive income tax, in which all sources of income, whether earned, fringe benefits, dividends and interest, or the value of goods owned (such as the value to owner-occupiers of living in their own house) are taxed at the same rate. (This may of course have a progressive rate schedule depending on total income).
- Expenditure tax, in which the tax base would be income minus savings and plus expenditure from savings, ie the total amount spent in a year. This is similar to the way in which pensions contributions are tax deductible and pensions are taxable.
Neither of these schemes is straightforward. Comprehensive Income Tax involves considerable administrative difficulties that are not easily overcome. Expenditure Tax causes concern about the negative effect on the government’s tax flow, lack of progressiveness, the interaction with company tax, and the difficulties that might arise for a country that introduced the scheme when surrounding countries had not. For these reasons the interest now is largely in more piecemeal action, aiming to capture a notion of ‘fairness’ in making the tax treatment of different forms of income more equal. One such programme for short term action is put forward by Hills for the Child Poverty Action Group, and discussed further at the end of this section. It aims to increase the tax revenue from the benefits of wealth ownership by removing particularly advantageous tax arrangements, such as the Business Expansion Scheme, share option schemes, Life Assurance Premium Relief and mortgage relief on higher rates of tax. Capital Gains Tax should be given more bite, for example by removing the £5000 tax free allowance. The tax-free status of pension fund income should be investigated. The tax-free status of pension fund income results in a very substantial loss of tax revenue – over £4 billion in 1987/88. If such tax benefits were reduced or eliminated it would seem that either higher contributions or lower pension payouts would result – but in fact pension funds have such large assets that this is not necessarily the case. It has been suggested that the losers would, in the long run, be the employers who are contributing on their employees’ behalf. This is a technical matter that requires careful management not to disadvantage pension holders, but there seems no good reason why saving money through a pension scheme should have such tax advantages over other forms of saving. Investment income should be surcharged to bring it into line with tax on earnings (pensioners who had opted for savings giving interest rather than pensions could be safeguarded).
These suggestions are all comparatively straightforward and could be introduced quite quickly. In the longer term, moving towards taxing unearned income more heavily than earnings seems equitable, though small savers and high earners may point to the need for exceptions.
An important and controversial issue is that of home ownership. Owner-occupation is undoubtedly very much higher than it would be without the support it has received from the tax system. The cost of mortgage interest tax relief in 1986/7 was around £4.5 billion, about the same as the cost of housing benefit, even before the value of imputed rents is considered. If the aim of providing financial help for housing costs is to support those in need, this is clearly inefficient and it would be equitable to give help irrespective of whether a property is rented or owner occupied. But mortgage relief was designed to encourage increased owner-occupation, not relieve poverty.
Clearly, financial support for housing costs needs to be positioned within a wider housing policy. Housing is an important aspect of inequality in our society and housing policy needs to address this directly, as well as using the tax and benefits system to ensure that people are not subjected to hardship through inability to meet their housing costs. The division between the majority of the population who live in their own homes and have a substantial inheritance to leave behind them, and the minority who, through necessity rather than choice in most cases, rent their homes, would not disappear by improving the quality or quantity of neglected public housing, vital though this is. Should socialists regard owner-occupation as an important way of giving people control over their own lives that should be made widely available to poorer households? Or should they retain their traditional preference for public housing, albeit with a less bureaucratic and more democratic form of management, regarding home ownership as inherently divisive and individualising? If so, what policy should be adopted towards the two-thirds of households that own their own homes now?
An obvious approach to the immediate problems is to phase out mortgage relief and perhaps to tax the value of living in a house. If relief on mortgages were abolished, house prices would go down, (the capitalisation effect) so it is not necessarily the case that less people would be able to afford to buy in the long run, although there would be considerable hardship if this was introduced overnight. The value of living in a house (the ‘imputed rent’) was subject to income tax until 1963 and is a major benefit of house ownership.
Direct taxation of wealth
Taxing wealth directly provides a complementary approach to that of taxing income from wealth. It is essential for the creation of a more egalitarian society that concentrated wealth should be dispersed and the benefits of security and choice that accrue from even quite small amounts of capital should be more widely distributed. It is tempting to think that substantial revenue could be raised, and redistributed to the poorest, by taxing the wealth of the rich. Unfortunately, this is no simple matter.
The two basic approaches are to tax ownership of wealth directly, usually on an annual basis, and to tax wealth as it is transferred between people through death or gifts. A number of countries, including Austria, Denmark, France, Ireland, the Netherlands, Norway Spain, Sweden, and West Germany have a wealth tax. Their experience has, on the whole, not been encouraging. A major problem is the cost of administration in relation to yield – and it is worth the rich investing heavily in tax avoidance techniques. Tax on capital transfers seems more attractive – as Hills notes: “if wealth changes hands every generation – say, every 25 years – a tax at 25% on transfer would raise as much as a 1% annual wealth tax. Not only would one only have to cope with 4% of the number of cases each year, but they would also be easier,. those receiving transfers have an interest in establishing legal ownership, making the wealth easier to identify.”
Taxes on transferring capital have traditionally been a much more important source of revenue than they are today. Eighty years ago, estate duty raised twenty percent of tax revenue (excluding customs duties); the figure today is under one percent. The Thatcher government’s introduction of a flat rate Inheritance Tax and a number of concessions benefit those inheriting large fortunes most, and mean that “the prospects of living on inherited wealth are now brighter than they have been for many years “.
Currently Inheritance Tax is paid at a flat rate on the total estate. This could be made more progressive by returning to a graduated system so that larger estates paid a higher rate of tax. An alternative approach is to tax the receipt of wealth, graduated according to the amount received. One variant is a Lifetime Accessions Tax, where tax is paid according to the accumulated amount of gifts and bequests received over a lifetime – perhaps allowing a certain amount tax free, and graduated tax rates thereafter. Another variant is to count gifts and bequests as income, on which income tax is paid. In both cases, someone with wealth to leave will have an incentive to spread it amongst a number of people rather than leaving it to one person. Although this would tend to reduce revenue, it also helps to encourage the spread of wealth to a wider group, albeit largely the already better off. This is usually regarded as socially beneficial, though there are those who argue that giving more of the population middle-class interests leaves those who do not share in this process increasingly marginalised and can work against reducing inequality. An alternative, less explored, avenue to redistributing wealth is to give wealth to the poor. This option, usually ignored by both left and right, has recently been explored by the advocates of ‘market socialism around the Fabian Society. They have suggested using the receipts of wealth taxes to provide a lump sum to every one on reaching adulthood.
The basic disadvantage of taxing wealth on inheritance is that redistribution is so slow. It takes a generation until all wealth has been taxed even once. But without major political changes that could make the current distribution of wealth seem totally unacceptable and overthrow existing patterns of ownership in a radical way, it may in practice prove the most effective way available.
Conclusion
There is general agreement over a number of short-term reforms that could make the existing tax system considerably more progressive and raise additional revenue for increased benefits. However, the regressive redistribution of a decade of Conservative governments is so great that discussion of short-term measures is usually couched in terms of getting back to a situation which is overall no worse than that in 1979! Sometimes even this is considered too ambitious. The proposal by Breadline Britain 1990s for a 5p increase in income tax, which is assumed to be about the maximum that is politically acceptable, is designed to reduce poverty only to the 1983 level. The Labour Party policy documents suggests a fairly standard package of measures, but without details of tax rates and bands it is not possible to work out the redistributive impact. However, the stress on the need to move gradually so as not to disrupt family budgets, combined with a tendency to hope that economic growth will be sufficient to ensure that real losses can be avoided for all except the very rich, suggests that even returning to 1979 levels of inequality might be no speedy task.
Hills” offers a package that has been widely influential. He sets out a modestly progressive strategy for tax reform which is designed to be comparatively easy to introduce both administratively and politically. Most people gain and it can be seen to accord with acceptable notions of ‘fairness’. He points out the conflict between redistribution on the one hand, and ensuring that as many people as possible gain to secure widespread political support on the other. His specific aim is the modest one of reversing the distributive effects of the changes to the direct tax and benefit systems that have taken place since 1979, at the same time eliminating anomalies and creating a fairer foundation to build on in the future and at a cost comparable to the government’s proposals.
Suggested tax reforms include:
- a graduated income tax structure rising to 50%;
- the conversion of Income Tax Allowances into a Zero Rate Band;
- fully independent taxation with no special allowance for married men offset by doubling Child Allowance and an increase in the married pension.
- re-introduction of an investment income surcharge;
- restriction or removal of various unprogressive concessions and allowances, with the reduction or phasing out of mortgage relief and relief on private pensions;
- progressive structures for employee National Insurance Contributions, with abolition of the upper limit and converting the lower limit into an allowance.
Although income tax rate increases for the better-off would be moderate, increased National Insurance Contributions, investment income surcharge and a substantial widening of the tax base would increase substantially the amount of tax they paid. Clearly the effect of such a package depends on the levels at which taxes and benefits are set. Hills suggests levels that will benefit 73% of families, with only 23%, almost all those on the highest incomes, losing. At these levels the scheme costs about the same as current government proposals. Although average marginal tax rates are slightly increased for men (though reduced for women) the number on marginal rates over 70% (ie low earners) is substantially reduced. This is achieved within a tax structure which incorporates a top marginal tax rate on earnings of 61.5% and of 65% on investment income – well within the mainstream of other European countries.
Greater redistribution through these parts of the tax system would involve accepting higher tax rates, more losers or both, but would not put Britain outside the European range. Even without this, there is scope for further redistribution by a progressive method of local taxation, greater taxation of wealth and inheritance, and reformed taxation of savings, as well as ensuring that indirect taxation does not hit the poorest, which involves at least safeguarding zero-rated VAT.
Such a scheme shows that it is possible to achieve four important objectives simultaneously by reform of the existing personal tax system. One could fund substantial increases in benefits, make the tax system itself more progressive and more logical in structure, ensure that a large majority of the population would gain, and financially be roughly equivalent to the present arrangements, not relying on funding benefits out of cuts in government expenditure elsewhere. After a decade in which many have almost given up hope of seeing significant improvements in health, it is elating to realise that a future Chancellor has it within his or her power to make substantial improvements even in a single widely acceptable budget.