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How to provide the safety net

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Political parties differ over the level of the safety net, the extent to which it should double as an egalitarian ladder, and the levels of the tax. But on two more basic propositions they are agreed:

  1. There should be a safety net, and
  2. Low earners should pay little if any tax.

Unfortunately, they confuse headline rates of tax with effective rates of tax. As a consequence, all parties support at least (a) a personal tax allowance on the lowest portion of earnings, where no tax is paid, (b) a lower, basic rate of tax for the next portion of earnings above the allowance amount, and (c) a higher rate of tax for earnings above a certain threshold. Some parties promote more bands, and they differ on the levels of taxes and thresholds, but they agree on the principle of, in effect, at least three different rates of tax for three different portions of people's earnings. This produces a profile for pre- versus post-tax earnings (before taking account of benefits) like the following:

Graphs of pre- vs post-tax income under current system

So far, so good. But as this stands, if you earn nothing, you have nothing to live on. There is no safety-net. So politicians supplement this with welfare payments. And not just a single payment to all, but a myriad of mechanisms targeted at those most needy or deserving (in their eyes), and withdrawn as people earn more, save more or for other reasons. Each instance of withdrawal is like a tax, because, as your earnings go up, your disposable income goes up less as some of the benefits are withdrawn.

Catch-22: High marginal tax-rates or high numbers on benefits

This may seem fair, but there is a fundamental dilemma to this approach:

  1. Either you withdraw benefits gradually as earnings increase, in which case large numbers of people are drawn into the bureaucracy of means-tested benefits, or
  2. You withdraw benefits sharply as earnings increase, limiting the number of people covered by benefits, but creating a very high level of marginal effective tax (and therefore disincentive to work) for those whose earnings are within the band where benefits are being withdrawn.

Of course, politicians being politicians, faced with an unpalatable but unavoidable dilemma, create a mish-mash of mechanisms. They try but fail to avoid being caught on this hook by micro-managing tax- and welfare-levels and beneficiaries, favouring those whose votes they hope to attract and punishing their opponents' voters. The net effect varies significantly from one domestic circumstance to another (e.g. how many adults and children there are, and of what age), but the following is an example of the effect of our current taxes on employment (income tax and National Insurance employees' contribution) and some major benefits (e.g. Tax Credits, Child Benefit, Job Seekers Allowance, basic State Pension, Pension Credit, and Winter Fuel Payment) on a lone-parent household with a single child:

Graphs of earned vs disposable income and effective tax rates

This is a particularly egregious example, but almost all types of household experience some irrational and disincentivising volatiliy in the rates of effective tax at different levels of earnings. It does not include all types of benefit-payments that might be relevant, nor every condition that may be considered by the benefits included, because the system is so complex that it is practically impossible to model thoroughly. The effect of some of the missing benefits may be to smooth some of this out somewhat, but the effect of most (e.g. disability and housing benefits) will be to further complicate and increase the volatility.

The key point is not the extremes of variation, but that marginal effective rates of tax are 70% or more for most of those earning under £27,000 p.a. This is largely due to the withdrawal of benefits, in combination with the modest rates of tax that apply to people with earnings in this range. Those progressive rates of nominal taxation, so attractive to politicians more interested in the headline than the reality, are significantly responsible for the need and opportunity for complex means-tested benefits whose withdrawal results in the highly regressive rates of effective taxation that we see here. Additional unintended consequences include the amount of bureaucracy required to try to micro-manage people's income and entitlements in this way, and the demeaning effect on those who are subject to this state-intrusion and micro-management.

Basic Income plus Flat Tax (BI+FT) - the only solution to the dilemma

If you want to provide a decent safety-net for those at the bottom, and want to reduce the impact on marginal tax-rates of withdrawal of the safety-net, you have to reduce the rate of withdrawal, which draws even more people into the means-tested system. There is only one solution that can avoid the disincentivizing, bureaucratic, demeaning effect of means-tested benefits: a flat entitlement for everyone, regardless of income. Such a universal entitlement has been given many names: Basic Income, Universal Benefit, Citizen's Income, etc. We refer to it as a Basic Income (BI), and to the combination with a Flat Tax (FT) as a Basic Income plus Flat Tax (BI+FT) system. This is the system that this programme advocates in order radically to overhaul our tax and welfare system.

Common objections to Basic Income

We will consider the various objections to a Basic Income on separate pages. For now, we will briefly mention the two most common objections: (a) that it provides government-funded support to those who do not need it, and (b) that people may be inclined not to work if they receive automatic support from the state. Both these objections forget that it is effective rates of tax and support that matter, not nominal rates.

(a) The effective support from a BI+FT system is every bit as "progressive" as the current system. The variation according to means is carried out unbureaucratically and impartially through the tax system, not bureaucratically and partially through the benefit system. As you earn more, instead of bureaucrats withdrawing your benefits according to arbitrary and almost incomprehensible rules, you simply pay more tax in proportion to your earnings, to set against your Basic Income. Whether high earners are better or worse off has nothing to do with the BI+FT system per se, and everything to do with the levels of the Basic Income and Flat Tax, relative to the current system. If the levels were set at (say) £9,000 Basic Income per person, and a Flat Tax rate of 60%, high earners would be making a higher net contribution to the costs of government than under the current system.

(b) People's incentive to work depends on the marginal effective rate of tax that they pay on any earnings above what they currently earn. Because the BI+FT system avoids the means-tested withdrawal of benefits, it offers a lower marginal effective rate of tax than the current system, for most people earning below the average wage. It may seem counter-intuitive that a system of universal entitlement to money from the state will increase people's incentives to work, but it is nevertheless the case. Of course, it is important that the Basic Income not be set so high that a large number of people would be perfectly satisfied with that level of income, but given the level of tax that is required to provide even modest welfare cover (whether under the current system or under a BI+FT system), it is impossible, even if one wanted, for a government to provide such generous provision. However it is provided, welfare can never be more than a low proportion of the average income, because the economy cannot stand to carry any more than that.

BI+FT applicable to range of political philosophies

This programme supports setting the levels of Basic Income and Flat Tax as low as is consistent with (a) a minimum dignified quality of life for the least fortunate in society, and (b) balancing the Government's books. But that ambition is not inherent in the BI+FT system. It would make equal sense for someone who believes in big government and generous provision, because it is principally a way of reducing bureaucracy and barriers to prosperity. This programme's preference for low levels of BI and FT is derived from its preference for small government and self-sufficiency, not from any inherent characteristic of the BI+FT system.



Dr. Radut Consulting