It’s nonsense to argue our tax and benefits system hits the poorest hardest

 
Ryan Bourne
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NEW figures from the Office for National Statistics (ONS) have led the Daily Mirror and some political commentators to wax lyrical about our “unfair tax system”. The killer stat, from the ONS’s annual The Effects of Taxes and Benefits on Household Income survey, was said to show that the poorest fifth of households paid 36.6 per cent of their income in tax, while the richest paid 35.5 per cent – an apparent slam dunk to the progressives who argue our tax system is not redistributive enough. One commentator went as far as saying that Britain was “heading towards the flat tax nirvana so beloved of the right”.

Yet a few seconds’ thought about how the figures should be interpreted would show that this is nonsense. The figures cited calculate how much direct and indirect tax the average family in each group pays as a proportion of their gross income. Yet gross income includes cash benefits, which are transfers from one group to another. That a household uses money redistributed to it to spend, in turn paying what the ONS describes as indirect taxes (things like VAT, beer duty, tobacco duty, the TV license and fuel duty), can hardly be described as “regressive”. This is akin to taking from Peter to pay Paul and then saying that – because Paul spends a large proportion of this money – the whole tax system is unfair. It’s a doubly bizarre outlook given that those most in favour of redistribution tend to be those who agitate for higher beer, cigarette, and fuel duties, and are most committed to the regressive TV license fee.

The key point is that the progressivity of a tax system cannot be considered in isolation from benefits, because benefits are essentially like a negative tax. Thought of in this way, we can calculate effective tax rates, which measure the net contribution for the average household in each group as a proportion of their earned or original income. Doing this we see that the poorest fifth of households on average actually face an effective tax rate of -49.9 per cent, while the richest fifth face an average tax rate of 33.5 per cent. This shows that, for every £1 earned in income, the average household in the poorest quintile is transferred another 50p in cash benefits, while the average household in the top decile pays 34p in tax. In other words, the tax and cash benefits system is very progressive.

In fact, our welfare state is more redistributive still, because it is set up with the intention of providing many other public services for the poorest in society. Once benefits-in-kind (education, healthcare, and subsidies for housing, rail and buses) are considered, these effective tax rates for the average household in the richest and poorest fifths become -191 per cent and 27 per cent respectively. That’s why the ratio of original income between the richest and poorest households (14 times) falls dramatically (to 4 times) once all taxes and benefits are considered. On average, the richest fifth pay £20,958 more in taxes than they receive in benefits, whereas the lowest quintile household receive £10,387 more in benefits than paid in taxes.

Now, I have not said whether this is necessarily the right or wrong level of redistribution. But the way many have warped the debate by discussing taxes paid on gross income in isolation, ignoring benefits, is misleading.

Ryan Bourne is head of economic research at the Centre for Policy Studies.

Follow on Twitter at: @RyanCPS