Time to scrap the lower marginal rate?

Michael Taft has a blog post promoting a proposal from Social Justice Ireland for refundable tax credits. The idea being that if your tax bill was lower than your personal credit allowance you would recieve a cheque for the difference. While this proposal comes from a left-wing source, it is similar to an idea for a Negative Income Tax proposed by Milton Friedman.

Which got me thinking. Given that, at least in the USA, wage increases increasingly go to the already well-paid (in particular senior managers) – (see relatively small gains in median household income in the USA in recent decades or Yves Smith’s analyses of a proposal to make service sector jobs better here). Should we scrap the lower marginal rate of tax? We could increase tax credits in combination with the tax credit refund proposal. As a result all tax reliefs would be available to workers at the same rate. This would mean, in the future, if we found that productivity gains were resulting only in higher wages for upper management those gains could be democratised by increasing the flat tax rate and tax credits simultaneously. In the case where real median wages were rising, and there was scope for tax cuts, the inverse would hold and the tax rate could be lowered.

Update: Example

Employee on €20,000.

Currently: (No pension contributions)

Net Salary : €18,724.16
Tax Paid : €1,275.84
They can contribute up to 20% of salary to a pension but may find it expensive to do so.

Currently: (Pension contributions)
Net Salary : €16,000
Tax Paid : €0
Pension: €4,000

New System: €18,000 tax credit
Net Salary : €7520 + €15,000 = €25,524
Tax paid: €0
Pension : €4,000

(53% tax on €16k + tax credit.)

Assuming tax rate of 53%, and 20% pension contribution. A worker on €50k would go from €23,324.16 to €36,800 with a 18k tax credit. A worker on €100k would go from €60,389.20 to €55,600. An executive on €500k would go from €260,233.67 net, to €206,000.

Update 2:

I forgot to include 20% pension contributions for the current net salaries of executives and workers on €100k.

The figures change to –

€100k : €50,017.84 (current), €55,600 (new)
€500k : €206,619.68 (current), €206,000 (new)

At those levels (€18k tax credit, 53% flat tax) , increased net salaries for lower-paid workers, would have to be funded from other forms of taxation (e.g. a Land tax) or a cap on tax reliefs on pensions. Alternatively a higher tax rate could be used. A 62% tax rate would reduce the executives net salary to €164,515.24.

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  • Anon

    No flat tax is a bad idea and has always been a bad idea.
    You either reproduce a progressive taxation system via a series of tax rebates that for the life of me that I can’t see is more simple to operate, or you wind up massively increasing rates on people whose next marginal dollar is much more valuable to them than a millionaire.

    Second, taking people out of tax altogether is a negative thing. You create a constituency of people who have incentive to raise taxes on everyone else,a nd promote class warfare. The original conception of the welfare state was one where everyone paid, and everyone received. It is a social contract, and it has value beyond pure econmic efficency,

    Not a fan of the lib dems push towards removing the poor from tax for that reason, but I suppose they pay NI and VAT.

  • Mack

    The system described above is progressive. The tax credits & negative income tax benefit the lower paid the most, then the middle classes, and hit upper middle class / executives rather more hard than most other systems.

    It has the advantage of giving everyone access to the same tax reliefs -at the applicable rate.

    If you look at the example a worker on €20k, could see their net salary increase to €25,524 (from €18,724.16) while making €4k worth of pension payments).

    You have a point about moving people out of the tax net, but one the advantages of the flat rate system is that if you raise the rate it rises for everyone. What should happen more often is that if we can afford it, and wages are rising faster at the top than the bottom, you raise the tax credits.

    UPDATE The worker on €20k is in the tax net. If the tax rate rises he’ll feel it with a lower income. The tax credit is bit like the government increasing your hourly wage.

    Otherwise how do you account for runaway executive compensation? A third marginal rate is rather blunt – and will either be set at too low a threshold or too low a rate.