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November 12, 2004

A Modest Proposal: Abolish the Income Tax

Posted by William D. Rubinstein

Professor William D. Rubinstein has recently argued that the BBC in its present form should be abolished. Here he makes the case for abolishing another institution: the income tax.

The first response which any reader is likely to have to the title of this piece - it goes without saying - is that I must be joking: self-evidently, this must be an attempt at comedy, or some kind of reductio ad absurdum parody of free market economics. So let me assure readers that I am not joking and that this is not a parody: my proposal is a serious one and I mean what I say. The second response all readers will have is that my proposal is self-evidently impossible: no one has ever proposed abolishing the income tax, even the most advanced advocate of monetarism, which is a good reason for supposing that no one in the mainstream regards it as realistic or achievable. (Actually, this is not true: there is a small but apparently growing movement in the United States, which has received virtually no publicity here, which aims to abolish the income tax.)

But why is abolishing the income tax impossible? The answer is seemingly self-evident: the government relies on the income tax to pay its bills. It uses the revenue from the tax to pay for the military, for the NHS, for pensions, for the police, for road building, for the schools, and for the salaries of university apparachniki like myself. Abolish or even drastically scale down the income tax and - among many other things - I could well kiss my own salary goodbye, to say nothing of the pay of every nurse, teacher, policemen, soldier, fireman, and M.P. in the country, which would simply vanish. Ah! - and here we come to the crux of the matter - you see: this isn't true. Perhaps the best way to appreciate why this isn't true is to answer the following question: what percentage of British government revenue do you think is raised by the income tax? My guess is that not one person in a hundred, even among those who regard themselves as well-informed about public affairs, would be able to answer this question with even approximate accuracy. Moreover, I would be willing to wager a considerable amount of money that if most people were to try and guess the answer, they would be dead wrong. Almost certainly, most people would probably guess that something like 70, 75, or 80 per cent of British government revenue is derived from the income tax, with only a small portion coming from other taxes like VAT, the tax on petrol, death duties, and so on.

The actual answer is quite different: in 2004-5, the government expects to derive 28.1 per cent of its total revenues from the income tax, or 128 billion. According to H.M. Treasury's official publication Budget 2004: Prudence for a Purpose (p. 14), in 2004-5 the government expects to spend a total of 488 billion and received 455 billion in revenues (in other words, it expects to run a deficit of 33 billion). It expects to derive the 455 billion from the following sources: income tax, 128 billion (28 per cent); National Insurance, 78 billion (17 per cent); VAT, 73 billion (16 per cent); Excise Duty, 40 billion; Corporation Tax, 35 billion; Council Tax, 20 billion; Business Rates, 20 billion; and "other sources" - Stamp Duties, Vehicle Excise Tax, Death Duties, and so on - 62 billion.

Probably many readers of this list will have the same response as I did when I first saw it: while the 128 billion raised by the income tax is obviously a great deal of money, it is also - to wax paradoxical - not a great deal of money. The cost of building the Channel Tunnel starting from scratch today (as opposed to twenty years ago) would probably be around 20-25 billion; the cost to Britain of the Iraq War has been something like 30 billion for Britain's supporting cast (to the Americans) participation in a conflict which is hardly World War Two. (Fighting World War Two over again would probably cost at least a hundred times as much, maybe five hundred times as much.) Moreover, the planned total of government expenditure for this year stands at the end of more than seven years of Gordon Brown's porcine policies of government largesse and gladhandedness: any truly prudent Chancellor could probably trim at least 20 billion, maybe far more, from this sum on a Sunday afternoon, using a pocket calculator and the back of old envelopes.

My proposal is therefore simple: eliminate all of the 128 billion raised by the income tax and find this revenue - or a lesser amount, after prudent cuts - by increasing other taxes. The aim of ending the income tax is, of course, to increase the disposable income of most people, especially the hard working, and to let them spend their own money as they see fit. It must be said with complete frankness that - obviously and unquestionably - the sales price of almost all goods and services would immediately rise. If, say, VAT were doubled across the board, the price of all goods and services subject to VAT would rise by about 17-20 per cent, although many competitive manufacturers and retailers would certainly try to limit the increase. The cost of petrol would rise, as would the price of alcohol, of tobacco, hotel and restaurant bills, air fares, the sales price of automobiles, death duties, and so on, in order to find the 128 billion (or whatever fraction of this remains after budget-cutting). This must be made crystal-clear, in an unambiguous way.

But, of course, there would be no income tax. If my plan is to succeed, it is crucially important that the whole of the sum hitherto taken by the income tax from every pay cheque be credited immediately and in full to everyone in the workforce, so that - without any sleight-of-hand or tricks with smoke and mirrors - every wage and salary earner immediately receives a larger net income. What would this mean for the average person, especially those in the middle class? A moderately successful man or woman in the upper middle classes who earns, say, 50,000 a year currently receives a net salary of around (I suppose) 2900 per month. Eliminate the income tax, and his or her net salary would rise forthwith to about 4000 per month (National Insurance would still exist). Obviously, those making less would receive less, but would still be markedly better off in terms of their net incomes. They would - by definition - have to spend more on virtually all goods and services, but most people would probably rearrange their expenditure patterns to come out ahead, which most people would be in a position to do. Pensioners and those on very low incomes would plainly have to be compensated in some way, probably by issuing them a card exempting them from any resulting increase in taxation for the time being (although not from any existing taxes, such as VAT, which they already pay).

In terms of disposable income, most adults would certainly find themselves better off; this is the whole aim of the exercise. While some might use their extra income for gambling holidays to Las Vegas (which they are quite entitled to do), most would certainly use this money responsibly, above all by reigning in the mountain of credit card debt and personal loans which have recently escalated so dramatically, and by paying off their mortgages early, steps which would be good for the British economy and might well lower interest rates. The ancillary effects of abolishing the income tax would also be strongly positive: tax avoidance by the self-employed would greatly diminish, as would the attractiveness of off-shore tax havens among the very rich; Britain would become the investment haven of the whole world, an island Switzerland, seeing unprecedented amounts of inward capital savings; trade union demands for wage increases would probably moderate.

The main objection to my proposal would presumably come from the left, namely that it would have a highly regressive effect on income distribution. While it might, there are several points to be made: with the revocation of Labour's Clause Four in 1996, no mainstream party is now committed to socialism or to forced economic equality for their own sake. More importantly, the income tax assuredly falls most heavily on the salaried middle classes, not on the rich, let alone the super-rich. The Duke of Westminster is supposed to be worth about 5 billion. If this yields income at only a five per cent rate, he earns about 250 million each year; on paper his income tax liability is thus around 100 million. I have absolutely no knowledge of the Duke's private affairs, but I would be rather surprised if he actually pays 100 million in income tax each year - 40 per cent of his income - whereas hundreds of thousands of ordinary salaried men and women have no way of avoiding this level of taxation, and hand it over to the government as money deducted from their pay cheques before they actually see it. Upper middle England, and those aspiring to join it, would benefit most from my scheme, which is no bad thing.

William D. Rubinstein is professor of modern history at the University of Wales - Aberystwyth.

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There's another even better way to do it called a "Consumption Tax" Rather than loading up on VAT(for example) which is all too easy to evade, you use the current income tax system but tax people only on their consumption. That part of their income that they have saved is untaxed Similarly, that part of past savings that is spent in the tax period is taxed, while retained earnnigs from savings are not.
Net good effect for the right is to encourage and reward thrift and investment. For the left, this is a great deal more progressive than income tax at the very high end, as trustafarians get hit with the consumption tax in a way that they don't with income tax.
The Economist was a big supporter of this a couple of decades back.

Posted by: Tim Worstall at November 13, 2004 01:08 PM

Tim's right, although on practicality grounds (less paperwork needed) and on incentive grounds (that it better incentivises risky investment) I'd go for the Hall-Rabushka model.

Whereas the traditional Consumed-Income Tax Tim mentions taxes capital EET (exempt on saving, exempt on earning, taxed on consumption), the Hall-Rabushka model taxes it TEE (taxed on saving, exempt on earning, exempt on consumption). Both have an added element of revenue variability - the CIT will be more short-term variable (people have more control over savings, etc) but the Hall-Rabushka will be long-term variable (i.e., a growth in the capital-dependent population means people who don't pay any taxes).

The paperwork gain comes from the Consumed-Income Tax having to track every saving (all bank deposits, bond and equity purchases) and every liquidation (all bank withdrawals, bond and equity receipts). The Hall-Rabushka (effectively, a Produced-Income Tax) simply has to track all wages, salaries and business profits at the source. You don't need to apply taxes to the financial system at all.

Posted by: Blimpish at November 14, 2004 02:20 PM
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