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Re: The Effects of Taxes and Benefits on Household Income, 2011/12

Posted on the 16 July 2013 by Markwadsworth @Mark_Wadsworth
From City AM Forum: NEW figures from the Office for National Statistics (ONS)* have led the Daily Mirror and some political commentators to wax lyrical about our "unfair tax system".  The killer stat, from the ONS's annual The Effects of Taxes and Benefits on Household Income survey, was said to show that the poorest fifth of households paid 36.6 per cent of their income in tax, while the richest paid 35.5 per cent – an apparent slam dunk to the progressives who argue our tax system is not redistributive enough.  One commentator went as far as saying that Britain was "heading towards the flat tax nirvana so beloved of the right"... The key point is that the progressivity of a tax system cannot be considered in isolation from benefits, because benefits are essentially like a negative tax. Thought of in this way, we can calculate effective tax rates, which measure the net contribution for the average household in each group as a proportion of their earned or original income.  Doing this we see that the poorest fifth of households on average actually face an effective tax rate of -49.9 per cent, while the richest fifth face an average tax rate of 33.5 per cent. This shows that, for every £1 earned in income, the average household in the poorest quintile is transferred another 50p in cash benefits, while the average household in the top decile pays 34p in tax. In other words, the tax and cash benefits system is very progressive.  Yes of course, a good point well made.  Tax = negative welfare payments. Welfare payments = negative tax. Pretending that tax and welfare payments are something different is like pretending that your restaurant bill has nothing to do with the food you just ate.  But he overlooks two things: 1. There is a difference between overall average rates (which are of course negative for households on welfare) and marginal rates on earned income (or savings).  Because of savage means testing, lower earners face the highest marginal rates of up to 100% on earned income (the so-called poverty trap), middle earners have the lowest marginal rate (about 50%) and higher earners pay a marginal rate of about 65%.  Basic maths tells us that with a flat rate tax combined with flat universal benefits, everybody would have the same marginal rate but the average rate on the bottom quintile would be negative and the average rate on the top quintile would be a couple of per cent shy of the marginal (flat) rate.  Having looked at the figures, it is not difficult to devise such a one-page tax/welfare/pensions system which would leave few people significantly better or worse off than they are now - so this achieves the "right wing nirvana" of a flat tax with the "left-libertarian nirvana" of universal benefits.  2. He blithely leaves the rental value of land out of the equation and assumes that taxing earned income instead of the rental value of land is just normal or sane.  For example, he adds back the value of non-cash benefits (NHS, education) to calculate an overall average tax rate of 27% on the top fifth of households. His welfare figures include the value of social housing (or Housing Benefit) so why not factor in the non-cash value of untaxed rental income which two-thirds of households (i.e. owner-occupiers) consume, net of privately collected tax (mortgage payments), which would reduce that average 27% even further, quite possibly down to zero?  And why not factor in the privately-collected tax (ground rent) which tenants have to pay on top of their publicly collected taxes, which would easily double that 27% rate? * Summary here. As the ONS points out: "On average, households in the top two income quintiles paid more in taxes than they received in benefits, while households in the bottom three quintiles received more in benefits than they paid in taxes."

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