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TAX NEWS: Low income families 'most to gain from flat taxes'. By Dan Martin

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14th Aug 2006
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People on low incomes have the most to gain from a "flattening" of income tax rates, new research claims.

While critics of flat tax systems argue they are a means of reducing the tax burden on people with higher incomes paying the top-rate tax, the social policy research charity the Joseph Rowntree Foundation (JSF) said most severe losses to the taxman from additional earnings are encountered by families on lower incomes.

It claimed three million people in low income families lose over 50% of any additions to their earnings, when the loss of tax credits is taken into account.

To combat this, JSF proposed a flat tax system under which a single rate of tax is imposed on individuals for all income above a tax-free allowance similar to the current level and tax credits are paid to families based on their composition and working hours and not withdrawn according to income.

Under the proposed system, the basic rate of income tax would have to increase from 22% to 37%, largely in order to recoup the money paid out in tax credits, the report said.

If the cap on National Insurance contributions were lifted to create a flat-rate NI system, higher earners would pay more, the report added, so a slightly lower tax rate of 35% would be needed.

Donald Hirsch, JSF special adviser, said: "This paper is not advocating a flat tax, but pointing out that a true flattening of effective tax rates may not have the results that some advocates envisage.

"It draws attention to the fact that while the tax credit system makes a positive contribution to relieving poverty, it can trap families on just-adequate incomes, making it very hard for them to raise their living standards.

"An alternative system, which stopped means-testing tax credits but instead had a higher general tax rate, has some attractions. One is that it would enable the government to give support to low income families and to combat child poverty, while avoiding the complexities and administrative nightmares of the present system."

JSF's full report can be viewed here.

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Richard Murphy
By Richard Murphy
20th Aug 2006 20:15

Disappointing stuff
It's disappointing to see Joseph Rowntree lending their name to flat taxes - because whilst their intentions are sound the result is that those who promote flat taxes will argue that they support the cause - and it's not clear they do.

They shouldn't.

Whilst they're entirely right - marginal taxes are highest on the poorest 10% in the UK - flat taxes will always benefit the top 10% much more than by any benefit the poor get. I have shown this in my study of lfat taxes for the ACCA.

So, this report ignored one objective necessity. By all means suggest a 37% tax above a high starting threshold if you wish - but then increase the rate even further for the top 10% or so to make sure they do not win hands down, as they would otherwise do. That way the tax system can be sustained and the benefits in which Joseph Rowntree undoubtedly believes can still be afforded.

There is no substitute for progressive taxationnin the cause of social justice.

Richard Murphy
http://www.taxresearch.org.uk/blog/.

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