As Tories bicker over a flat tax, here’s why it doesn’t work…

Tory policy chief Oliver Letwin is calling for a ‘flat tax’ rate, according to a Mirror exclusive yesterday.

He was talking in private to a laissez faire think tank, Politeia, and although instantly rebutted by Conservative Party HQ, it has sparked debate about Tory plans to cut tax for the rich, with Ed Balls today arguing the party is ‘champing at the bit’ to slash the top rate to 40%.

But that itself marks a step towards a flat tax, a policy both George Osborne and David Cameron have praised in the past. Left Foot Forward covered the topic last year amid a renewal of right-wing interest in the policy. What is it though?

The policy entails everyone paying the same basic rate – usually touted as around 20 or 30%. But it has two major possible implications.

If it was set at a low rate, it would require enormous further cuts to public services to compensate for tax income plummeting overnight. But if it was set at a high rate, it would require enormous tax rises among the poor to fund an effective tax cut for the rich, i.e. from the 45% top rate down to the 31% that the Institute for Fiscal Studies says would be necessary to maintain current Treasury tax receipts.

So we have two options with the flat tax – Cameron’s ‘permanent austerity’ hailed by neoliberals (an outcome which would hit the poorest hardest), or significant tax rises for low earners, which would also hit the poorest hardest. The flat tax is therefore, as is commonly understood, deeply regressive. Doesn’t take a genius to work it out.

But it’s also verified by several studies. Here’s an analysis of US flat tax plans by income bracket:

Flat tax

Citizens for Tax Justice, based in the US where calls for a flat tax rate are frequent, have therefore determined that the shift would result in ‘enormous tax cuts for the richest five percent of taxpayers’ alongside ‘tax hikes for all other income groups’, while leaving the investment income of the wealthy essentially untaxed.

Moreover, there’s little evidence to suggest it would ‘work’ in the way right-wing advocates say it would. It has only been introduced in some Baltic states and Russia. In the latter, it was hailed as dramatically boosting actual payment of tax, where previously it had been avoided. But according to a London School of Economics report, this coincided with a dramatic boost in tax collecting powers, and sweeping changes to other forms of taxation, a finding confirmed by another 2007 study.

Meanwhile, another key argument for the Flat Tax, ‘simplicity’, has been fundamentally rebutted by a University of Chicago study, which showed that in any complex economy there is no such thing as a ‘simple’ tax system, particularly when companies and individuals can avoid tax at whatever level it is set. The implementation costs for shifting to such a system were also significant.

Even a study by the free market IMF stressed ‘empirical evidence on [flat taxes’] effects is very limited’ although they did find that ‘there is no sign of Laffer [curve]-type behavioural responses generating revenue increases from the tax cut’ – in non-academic terms, cutting tax didn’t stop avoidance or boost productivity and government income.

So with the evidence unclear, or if anything pointing against a flat tax rate, the Tories have a choice to make. They could adopt a policy so right-wing even UKIP have abandoned it, in what would entrench their perception as the party of the rich forever…or they could ‘do the right thing’ for ‘hardworking people’ and drop the ludicrous plans.

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